Yuan’s Status as Possible Reserve Currency Remains Uncertain, Presently

In the wake of tremendous volatility in the Chinese market, due largely to Beijing’s surprise move to devalue the yuan, the prospect of that currency ascending to become one of the world’s reserve currencies seems to have become smaller; although the International Monetary Fund (IMF) had said all along that while it expected to confer that status on the yuan in the near term, it had not established any sort of deadline. Now, it appears that it may be some time before the yuan joins the elite ranks of the world’s few reserve currencies, and talk of it becoming the dominant reserve currency has altogether disappeared.

Although reserve currencies serve different roles, their primary purpose is to facilitate international payment between nations. If reserve currency did not exist, countries would be subject to exchange rate risk each time they needed to pay for something bought from one another. By holding reserve currency, countries can more easily transact with one another. The U.S. dollar has been the world’s leading reserve currency for years now. China, having long-assumed an aggressive posture in international relations, sees the granting of reserve currency status to the yuan as an opportunity to become an even more dominant force in the global economy. As a reserve currency, China’s yuan would become heavily sought-after, especially by central banks.

While Beijing has been pushing the IMF for some time to grant the yuan reserve status, there are a couple of things of which to note: first, there’s a difference between becoming one of the world’s reserve currencies, and becoming the dominant reserve currency. Right now there are six reserve currencies, with the dollar and euro serving as the two major reserves, presently. Could the yuan become a reserve currency at some point? Maybe, but even if it does, it’s not likely that it will be one of the dominant reserves. For one thing, the dollar is actually in a period of strengthening at the moment (as a matter of fact, gold is at a five-year low precisely because of how strong the dollar is right now), which makes near-term challenges to its status as reserve king less likely, but even when it was weakening, it was still the go-to reserve currency, because other, available options are just not as appealing (look at all the trouble that’s been plaguing the euro for years, for example).

The other obstacle to the yuan becoming a reserve currency in any capacity is Beijing’s tight control…aka, centralized-government interventionist tendencies. That sort of thing is not conducive to stability, and instability is about the worst of features for a reserve currency. As it stands, China will have to make numerous, significant changes to the way it does business, to including easing restrictions on money moving in and out of the country, and otherwise making the yuan freely convertible. Additionally, there is the matter of the size and liquidity of China’s bond market – not nearly big enough in either category.

The IMF’s Christine Lagarde has thrown Beijing a bone in the form of saying that the IMF will likely declare the yuan a reserve currency at some point, but there is no specific time for that laid out, and there won’t be until Beijing adopts a less-controlling posture over the currency. More recently, the IMF’s executive board decided to extend the current reserve currency configuration to September 30, 2016, so the makeup of the world’s reserve currencies will remain intact until at least that date. Still, even if the yuan comes to enjoy reserve currency status (even in the wake of the latest upheaval, it is considered just a matter of time before that happens), it’s not likely to be the dominant reserve currency anytime soon; whatever changes China makes to accommodate those seeking greater transparency and fewer controls by Beijing, they won’t be enough to get anyone to think twice about the U.S. dollar’s status as the king of reserve currencies.

The information contained here is for general information purposes only. The Financial Writer blog and Bob Yetman disclaim responsibility for any liability or loss incurred as a consequence of the use or application, either directly or indirectly, of any information presented herein. Nothing contained in this article, or any other article featured at this blog, should be construed as a solicitation or recommendation to engage in any financial transaction. You should seek the advice of a qualified professional before making any changes to your personal financial profile.

 

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