Will the Yuan Become a Global Reserve Currency?

Why the Yuan will Become a Global Reserve Currency

The Yuan has seen its steady rise in importance in the global economy for the past 20 years.
Currently, the People’s Republic of China (PRC) is the world’s largest trading partner. Therefore, the increasing enthusiasm in making trades directly in Yuan is simply common sense.

The move by the People’s Bank of China (PBOC) to introduce the Digital Yuan is an effort that will be sure to streamline this growing demand for international Renminbi transactions.

In 1944, with the establishment of the IMF and World Bank, the US Dollar was given its dominant position in the Bretton Woods System, which required currencies to be pegged to the USD. This move has established the US Dollar as the primary currency used in global trade long after the system came to an end.

However, now, the USD’s role as an intermediary currency in global transactions comes at too much of a cost to many nations. The role of the US Dollar as the “middle man” in a bulk of global financial transactions, even when the transaction is not directly with an establishment in the United States, can be too high a price to pay.

For developing economies, this can even be considered extortionate. 152 nation states around the world are still listed as Developing Countries: currently consisting more than 80% of the global population.

The Disciplined Evolution of the Renminbi

On the 1st of December 1948, the Renminbi was introduced along with the establishment of the PBOC. Following the victory of the Communist Party of China, in 1949, in an effort to standardize the currency used in China and contain hyperinflation at the time, the Renminbi was assigned as the standard currency used all across the PRC.

In 1978, China moved onto a socialist market economy. Having had a centrally planned economy until then, China opened its doors to foreign investments, and began participating in extensive international trade.

At this time, China’s share of global trade stood at less than 1%. However, this changed in the beginning of the new millennium. On 11th December 2001, China was admitted into the World Trade Organization (WTO). This development also coincided with the emergence of Global Value Chains (GVCs). A GVC is when steps involved in the production of a particular good are carried out in various parts of the world; for example, iPhone chips are produced in Taiwan, while the phones themselves are assembled in Mainland China.

Since 1994, the Chinese Yuan has had a currency peg. This allows goods produced in China to be lower in cost. The Yuan’s currency peg has allowed foreign companies with production facilities in China to bag record profits, by keeping goods produced in China affordable. A few of these companies are namely Microsoft, Motorola, Philips Electronics, Samsung Electronics etc.

In July 2005, the Yuan was moved to a managed float, and was allowed regulated appreciation by 2.1% against the USD. Yuan appreciation was halted in 2008, and as of January 2014, was allowed to appreciate and depreciate within 1% against the USD.

The decision of the Chinese Government to keep check of the Yuan’s appreciation comes as a great decision considering the path taken by the Japanese Yen. The value of the Yen shooting up resulted in the bursting of Japan’s Bubble economy in the late 1980s. The rising Yen slowed down Japan’s extensive export industry to debilitating levels. This led to almost 20 years of stagnation of Japan’s economy alongside continued price deflation. These are the effects of unregulated fluctuation of a currency in an atmosphere with a single global reserve currency. As of 2022, China surpassed the United States as the world’s largest trading partner.

The Renminbi’s Key Role in International Trade and The Belt and Road Initiative (BRI)

At the moment, around 172 countries have signed over 200 agreements with China for cooperation on the BRI. The Belt and Road Initiative is of great importance not only to China, but all countries along the Belt and Road as well as adjoining economies. Enhancing trade among BRI countries will prove to be a momentous decision in moving towards a more multipolar world with more diverse economic players.
Already, trading bilaterally with China is proving to be a sound move for many economies given the large amounts of trade conducted between China and any given country. This will help make international transactions faster, more direct, and at a lower cost.

In 2015, before China overtook the United States as the largest international trading partner, the CNY was the 5th most used currency in international settlements, and the 6th most traded.
Today, international Renminbi settlements are just the rational choice.
The introduction of the Digital Yuan will only lower the cost of cross-border payments.
With hyper-inflation looming around the world in 2022, lowering expenditure on international payments is bound to become a priority for many nations. Turning to direct payments in Yuan en masse is soon to be expected.

The Chinese Yuan’s Inclusion in the IMF SDR Basket

“The SDR was created as a supplementary international reserve asset in the context of the Bretton Woods fixed exchange rate system. The collapse of the Bretton Woods system in 1973 and the shift of major currencies to floating exchange rate regimes lessened the reliance on the SDR as a global reserve asset. Nonetheless, SDR allocations can play a role in providing liquidity and supplementing member countries’ official reserves, as was the case amid the global financial crisis.

The SDR serves as the unit of account of the IMF and other international organizations.

The SDR is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. SDRs can be exchanged for these currencies.” – imf.org

Read More About the SDR Basket in detail here.

The inclusion of the Yuan in the Special Drawing Rights Basket means that all Central Banks around the world are now required to keep reserves of Yuan.

A nation’s currency qualifies to be included in the International Monetary Fund’s SDR basket based on the strength of its economy. This will allow the nation more “quota shares”.
On the 30th of November 2015, the IMF declared that the Renminbi qualified to be included in the SDR basket. As of 01st October 2016, this has been carried out.

The Crisis in Ukraine, and the Acceleration of the Renminbi’s Global Presence

The war in Ukraine has been a warning signal for many economies to protect themselves from “being bullied by the dollar”. With Russia making major moves to increase their bilateral trade with China, and surviving SWIFT sanctions, the world is observing and learning.

In the last decade, Russia has established China as its number 1 trading partner, prepared for methods to overcome dependency on SWIFT, and are now having Russian exports paid for in Rubles.

Despite being bombarded with international sanctions that could have affected more ordinary Russian citizens than businesses, Russia has survived thanks to one move. The intelligent step taken by the Russian Federation to wean off the dollar has helped weather potentially crippling sanctions.

Why Russia will Survive International Sanctions

The Future of The Renminbi

Many experts believe that adopting the Yuan as a Global Reserve Currency can help “heal” the international economy. Given China’s position in world trade, this is only natural and obvious.

It should be noted that the Chinese Government is the only establishment currently prepared to cater to future international transactional needs with the testing of the Digital Renminbi.

In the future, we will discuss in detail why the Yuan is on the fast track to becoming a foremost Global Reserve Currency.

That is, apart from the glaring signs already plain to see.