The Chinese Yuan is in a race to dislodge the United States of America’s dollar, which has been the global dominant currency since the end of World War I. Will this happen? Given that both the US and China practise protectionism, what does this rivalry portend for the two currencies as a store of value? SULAIMON OLANREWAJU looks at these issues and more.
China has never veiled its intention to have its currency, the Yuan, take the centre stage in shaping global economy because of its belief that this would enable it have a better control of its domestic economy as many of the countries and companies that trade with China usually go through a third currency, especially dollar. As far back as 2009, former Governor of China’s central bank, Zhou Xiaochuan, while delivering a speech at the Council on Foreign Relations, said, “The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations.” So, having the Yuan as a major player on the global scene is a strong state policy for the communist country.
The dream inched close to becoming a reality on November 30, 2015 when the International Monetary Fund (IMF) gave the Yuan the status of a reserve currency. A major success was also recorded on October 1, 2016 when the Bretton Wood institution included it in its Special Drawing Rights (SDR) basket, which determines currencies that countries can receive as part of IMF loans. The basket is also a collection of reserve currencies that serve as an alternative to the US dollar. The inclusion of Yuan marked the first time a new currency had been added to the basket since the Euro was launched in 1999. The basket already includes the Euro, Japanese yen, British pound, and U.S. dollar.
According to Bloomberg, one major benefit of being a reserve currency is that the Renminbi, another name for Yuan, would be used to price more international contracts. Most of the commodities exported by China are priced in the U.S. dollars which means that the wellness of the Chinese economy cannot be divorced from the value of its currency vis-à-vis the dollar. Another benefit is that the currency would be in higher demand as many central banks would have to hold it as part of their foreign exchange reserves. This would result in the lowering of interest rates for bonds denominated in the currency.
Speaking on the decision to include the Chinese currency in the SDR basket, Siddharth Tiwari, former IMF’s Director of Strategy, Policy, and Review Department, said “The Renminbi’s inclusion is an important milestone in the integration of the Chinese economy into the global financial system. The IMF’s determination that the Renminbi (RMB) is freely usable reflects China’s expanding role in global trade and the substantial increase in the international use and trading of the RMB. It also recognizes the progress made in reforms to China’s monetary, foreign exchange, and financial systems and acknowledges the advances made in liberalizing, integrating, and improving the infrastructure of its financial markets. We expect that the inclusion of the RMB in the SDR basket will further support the already increasing use and trading of the RMB internationally.”
In its response to the development, the Peoples Bank of China (PBOC) stated that, “The inclusion into the SDR is a milestone in the internationalization of the Renminbi, and is an affirmation of the success of China’s economic development and results of the reform and opening up of the financial sector.”
Yuan’s coup against dollar
Before the eventual inclusion of Yuan in the SDR, China had taken deliberate steps to push the deployment of its currency in international transactions. On March 23, 2015, it backed the Renminbi Trading Hub for the Americas, which made it easier for North American companies to conduct Yuan transactions in Canadian banks. China took its strategy a step further on June 9, 2016 when it granted the United States a quota of 250 billion Yuan ($38 billion) under China’s Renminbi Qualified Foreign Institutional Investor program. It also appointed one Chinese and one U.S. bank to conduct RMB clearing business in the United States. China has opened up similar trading hubs in Singapore and London.
In furtherance of its ambition to internationalise the Yuan, China has entered into currency swap deal with many countries. It recently entered into a swap deal with the Euro Zone for a maximum of 350 billion Yuan ($57.2 billion) and a maximum of 45 billion Euros ($60.9 billion). The validity of the deal is three years.
In its comment on the deal, the European Central Bank stated in a release that “From the perspective of the Euro system, the swap arrangement is intended to serve as a backstop liquidity facility and to reassure Euro area banks of the continuous provision of Chinese Yuan.”
After the European Central Bank converted 500 million Euros worth of its U.S. dollar reserves into the Chinese currency last year, a number of countries in the zone have expressed their plans to hold Yuan as part of their foreign currency reserves.
The National Bank of Belgium bought about 200 million Euros ($244.5 million) worth of the Yuan, Slovakia said it has bought an undisclosed amount of the currency, while the Bank of Spain said it is considering an investment in the Yuan.
China has also signed a currency swap deal with the United Kingdom for a maximum value of 200 billion Yuan, the Swiss National Bank is already managing Yuan assets, while the Deutsche Bundesbank said plans were underway for such investment. However, Sweden’s Riksbank and the National Bank of Slovenia both said they hold no Yuan and plan no investment in the Chinese currency.
Europe currently accounts for 14 per cent of China’s trade.
Two years ago, during a state visit by President Muhammadu Buhari to China, the Central Bank of Nigeria (CBN) and the Peoples Bank of China (PBOC) signed a currency swap deal. The deal became operational on May 3, 2018.
The CBN governor, Godwin Emefiele, while commenting on the development said, “With the operationalisation of this agreement, it will be easier for most Nigerian manufacturers, especially small and medium enterprises (SMEs) and cottage industries in manufacturing and export businesses to import raw materials, spare parts and simple machinery to undertake their businesses by taking advantage of available RMB liquidity from Nigerian banks without being exposed to the difficulties of seeking other scarce foreign currencies.
“The deal, which is purely an exchange of currencies, will also make it easier for Chinese manufacturers seeking to buy raw materials from Nigeria to obtain enough Naira from banks in China to pay for their imports from Nigeria.
“Indeed, the deal will protect Nigerian business people from the harsh effects of third currency fluctuations.”
China is also into currency swap deal with three other African countries, including South Africa.
Being the world’s leading importer of crude oil, China plans to leverage that to effectively make its currency primus inter pares by proposing a new pricing system for oil. Beijing seeks a shift from petrodollar to petro-yuan by promoting oil contracts which are not based on the dollar but the Yuan. This, it hopes, will give the Yuan an edge over the dollar. Already, China has an ally in Russia which wants to limit its exposure to the dollar.
So, across almost all the continents, the Yuan’s profile keeps rising.
Is the stage set for Yuan to upstage dollar?
Given the rising popularity of the Yuan, is the world about to witness the displacement of dollar which has been the reserve currency for over eight decades?
Before dollar became the reserve currency, the ace was held by the British Sterling. The reason was simple; the United Kingdom’s economy was the largest in the world. But by 1914 when the USA Federal Reserve Bank approved the introduction of the dollar, Britain’s hold on the global economy was already slackening and the American economy was steadily pacing ahead of UK’s.
During World War I, countries needed to borrow money but the only country that had thought of the need was the United States which had before the commencement of the war lifted the ban on the establishment of foreign branches by American banks. With that, it was easy for American banks operating abroad to issue debts in dollars for countries desirous of it. This made the dollar the currency of preference for foreign-debt denomination in many countries. As countries depended on American lending, they became more inclined to buy American products. This buoyed the American economy and boosted the American currency. So, effectively the American dollar became the numero uno currency after WWI.
However, since becoming the global reserve currency, other countries have not gone to sleep. The world had always wanted a counterbalance currency to challenge dollar dominance because this has conferred on the US the symbol of the most powerful country in the world. That is one of the factors that propped up the Euro but the Euro only reduced the influence of the dollar, it has failed to dethrone it. At the moment, according to SWIFT (the Society for Worldwide Interbank Financial Telecommunication), a payment services provider, the Euro is used in 30 per cent of global payments, while the dollar controls 40 per cent, making it the number one currency for international trade. The Yuan, which controls only 1.78 per cent, is ranked fifth after US dollar, Euro, British pound sterling, and Japanese yen, according to the monthly RMB tracker released by SWIFT.
Despite the failure of Euro, which is supported by an economic bloc, to dethrone the dollar, some experts are of the opinion that the Yuan is set to dethrone dollar. One of the reasons cited is the ever growing Chinese economy, which is the second largest economy in the world, after the US economy, as well as the growing influence of China across the globe. China, say the experts, has extended its tentacles to Africa, Europe, Asia and both the North and South America, surmising that it is only a matter of time before RMB becomes the reserve currency.
Other experts opine that while there is no doubt that the increasing popularity of the Yuan will affect the profile of the dollar since any shift into the Yuan is at the expense of the dollar, the Chinese currency still has a long way to go in becoming the reserve currency.
One factor militating against the Yuan’s rise to the number one position, according to Michael Moon, SWIFT’s head of payments markets for Asia Pacific, is the Chinese government’s excessive control of its financial system, particularly regulatory measures to stem the movement of Chinese money overseas for property and other purchases.
Another reason advanced by Chris Leung, an economist with DBS, is the convertibility difficulty of the Yuan, which is strongly controlled by the government. He adds that while it may be easy for RMB to get state support, getting a buy-in from the private sector would be herculean.
“It will take a longer time for the private sector to completely accept RMB as a settlement currency,” Leung says.
Trump’s America First policy pushes Yuan acceptance
However, President Donald Trump’s ‘America First’ policy may provide the RMB the needed platform to upstage the dollar.
Becoming a reserve currency is not just an economic issue, it is also political. Unless the right politics is played a currency may lose its relevance. The slide of the Sterling started when the United Kingdom balked from its leading role in world politics. In the same vein, President Trump’s ‘America First’ policy may push America out of the global stage, making it possible for its currency to be upstaged. As observed by Daryl Guppy, CEO of the Guppytraders, “No longer is the U.S. dollar the only haven of safety. There is an alternative in Renminbi.”
This is what happened in January when Pakistan’s central bank, in its reaction to the accusation by President Trump that Pakistan was harbouring terrorists, announced that it would replace the dollar with the Yuan for bilateral trade and investment with China.
Similarly, some economists are of the opinion that the recent embrace of the Yuan by a number of European countries is consequent on their disapproval of some of the policies of the American president.
However, in the book, How Global Currencies Work: Past, Present, and Future, Professor Barry Eichengreen, Arnaud Mehl and Livia Chițu posit that the world has gone past the era of a dominant reserve currency. They write that it was the absence of alternatives in the second half of the 20th century that enabled the dollar to become the reserve currency.
According to the authors, “The dollar’s days as the dominant reserve currency will end sooner rather than later.” They submit that in the near future the dollar will be forced to share prominence with the Yuan.
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Gold to the rescue?
But the dollar sharing dominance with the Yuan will spell doom for investors because it would mean the world having two major currencies from states steeped in protectionism.
Since President Trump assumed office, he has been advocating ‘America First’, a euphemism for protectionism. In pursuit of the agenda, he withdrew from the Trans-Pacific Partnership, demanded a renegotiation of the North American Free Trade Agreement, increased tariffs on goods imported to the United States of America and has generally been taking a tough stance on global trade deals. So, while America prides itself as the defender of the liberal economic world order, in the last 18 months, it has retreated to the pre-World War II, when the U.S. used protectionist policies to build up its manufacturing base.
On the other hand, Beijing is still largely, a government-controlled economy. The value of Renminbi is not market-determined; it is fixed by the PBOC. There is a lack of regulatory transparency in China and this makes financial institutions reluctant to invest in Chinese assets. The Chinese government owns the biggest companies that dominate its stock market. Consequently, many Chinese investors often try to make money by outguessing the government’s strategies. This is one of the reasons President Trump accused China of currency manipulation during his presidential campaign.
Speaking about the effect of protectionism on a currency, David Rosenberg, the chief economist of Gluskin Sheff, a Canadian investment company, said one of the effects of protectionism is devaluation of currency. His words: “Because you have a protectionist government, and as part of that protectionism seeks to make money from tariff. What is a better tariff than just depreciate your currency?”
Speaking in a similar vein, Mark Yusko, Chief Executive of Morgan Creek Capital Management, a US-based privately owned investment company, said, “In the last 10 years, we had the worst growth in the history of America, 1.4 per cent real growth for the last 10 years. And we have indebted our future to the tune of $20 trillion for nothing.”
He added that the increased money supply had resulted in the devaluation of the dollar. “This is what dictators do. They systematically acquire the assets, and then they devalue the currency and boost the price of assets.”
Both Rosenberg and Yusko suggested buying gold as the hedge against a weak currency.
Rosenberg said, “If you want to hedge against the U.S. dollar as opposed to inflation… you have to have some gold in your portfolio.”
Yusko said, “The purchasing power of the currency is being destroyed right before your eyes, and you’re just not paying attention. Gold is money. Go for gold.”
Oman Yuseff, a financial analyst, said, “While the fear about dollar’s eventual collapse may be unfounded, what is not in doubt is its consistent depreciation due to inflation. The way out is not to save money in banks or put it in stocks. It is not even advisable to put money in mutual funds, money markets or a pension scheme because they are doomed to fail due to the depreciation of currency. The best thing to do to mitigate the effect of the crash of money value is to invest in gold. When all else fail, gold will not fail because it performs best in an inflationary environment.”
So, as the supremacy battle between Beijing and Washington rages, neither the Yuan nor the dollar provides a haven. Gold is the new haven.
and then