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Can the yuan be a key world reserve currency?

The yuan, or renminbi, China’s currency unit, has been touted as a contender to become a key world reserve currency on par with the greenback and surpassing the euro, yen and British pound. But is this feasible?
Given that China is the biggest trading nation, with around 125 countries counting it as their biggest trade partner, the answer is probably yes.
China’s trade was valued at around US$6 trillion in 2021, according to the country’s General Administration of Customs. If China and its trade partners agreed to use their respective currencies for bilateral transactions, the demand for the yuan would be astronomical. This would accelerate the yuan toward becoming a key world reserve currency.
Indeed, the yuan being a major world currency or serving as an alternative to the greenback is not necessarily a bad thing. Trade partners using each other’s currencies for investment settlements and other interactions would reduce transaction costs, minimize exchange-rate volatility and bypass US sanctions, for instance.
Sanctions against nations deemed “unfriendly” to the United States have had a devastating effect not only on the targeted countries, but also on global economies, ironically including America’s. The latest instance is the US and its European and Asian allies sanctioning Russia for invading Ukraine.
The harsh sanctions are not only crippling the Russian economy, but also hurting other economies, including those that themselves have sanctioned Russia. Oil and food prices have shot through the roof, threatening a global recession.
In the US and Western Europe, many families are making hard choices between eating and keeping warm, for example. Though the West’s economies are growing, the numbers of impoverished and homeless have risen, suggesting that the growth is not equitably distributed.
It is perhaps because of the impact of US sanctions on their own economies that some countries are ditching the US dollar and accepting the yuan in settlements for trade. Most recently, Saudi Arabia is said to be finalizing a deal with China to settle oil transactions in yuan.
Equally noteworthy is that around 70 central banks around the world held the yuan in their foreign-reserves portfolios in 2019, according to the People’s Bank of China (PBOC), the country’s central bank. That number is sure to expand as China’s economy continues to grow. Another factor prompting countries to hold yuan is fear that they may be the next target of US sanctions.
However, some would argue that the internationalization of the yuan to the extent that of the greenback will be challenging, primarily because of China’s governance and development architectures. Single-party rule, lack of universal suffrage, and absence of an orderly and peaceful transfer-of-power mechanism cause some concern over China’s political stability.
Another challenge is that the yuan is not fully convertible, thus posing a problem for cross-border fund transfers. And China’s economic development model is not in sync with neoliberalism, including the way in which the yuan is evaluated. For example, the PBOC applies administrative measures to determine the US-yuan exchange rate.
Political stability is important in determining acceptance of a currency because that implies minimum political risk. Case in point is the US dollar.
The US seems politically chaotic with the two major parties battling each other, culminating in nothing getting done or creating divisions between ideological or racial groups. But its governance system of “checks and balances” – equal power among the executive, legislative and judicial branches – keeps everyone “honest.”
For example, the president can only implement policies that are within the power given him or her under the constitution. And the Congress controls the purse, limiting the president’s power.
Simply put, there is no reason to believe that the US government will collapse any time soon, regardless of its policies that may suggest otherwise. This is one reason that the American dollar will continue to be a safe haven for the world’s investors and savers. The greenback has proved to be a good storage of value.
So the question is, can China deliver the same level of confidence for the yuan? Many in the West would say no.
But the Communist Party of China seems to be able to sustain if not increase its popularity among the Chinese population, garnering a more than 90% approval rate, as Harvard University found. A primary reason for that high level of support is the CPC’s resilience and adaptability. That is, the party has kept “reinventing” itself since Mao Zedong’s days, responding to the people’s needs and wants.
So if the party continues to evolve, it will likely be in power for a very long time. Indeed, one can even argue that the CPC is one of the very few political parties in the world, including the West’s, that actually fulfill their fiduciary duties.
For example, the CPC vowed to eradicate dire poverty, and it did. In the West, governments talk about poverty reduction or climate change, but have not “walked the talk.”
From this perspective, the CPC has shown that a single-party system can achieve political stability. In this sense, the yuan is an acceptable medium of exchange and storage of value, paving the way for it to become a world reserve currency.
China is taking a gradualist approach in economic reforms and floating its currency freely to avoid costly policy mistakes and prevent external shocks.
In many ways, China is still on the learning curve regarding economic reforms, particularly transforming its social market economy to a private market economy. Maintaining state-owned enterprises and banks has acted as an economic and social stabilizer because they offered affordable prices and prevented financial-system collapses.
To dismantle SOEs and SOBs without a clear orderly transformation mechanism would be unwise. Privatizing SOEs, for example, could spike energy or transportation costs. That, in turn, could lead to economic dislocation and social discontent.
With regard to not freely floating the yuan, that is largely meant to sustain export growth and prevent foreign hedge funds from attacking the renminbi. A freely floating yuan could very well cause an appreciation of its value, with China thus losing a pricing advantage.
An undervalued yuan would make attacking it difficult, particularly when China has more than $3.25 trillion in foreign reserves. Besides, China’s international debt is less than $2 trillion, so it has more than enough to meet its foreign debt obligations.
Taking the analysis to its logical conclusion, the yuan as a reserve currency at par with the US is a question of when, not if.
Asia times

Apr 4, 2022 11:54
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