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December 15, 2011

The Yuan as The World’s Reserve Currency

by marcobuchbinder

The most hotly debated topic between the US and China has been the undervalued Chinese Yuan, but an equally important development has been quietly developing over the last year– its internationalization. Having made more than 12 trips to China throughout the last two years, this topic has been by far the one discussed most with various Chinese executives and officials and I believe it will have major implications.

So why is the government pushing the globalization of the Yuan? My contacts tell me that it is due to the government’s focus on quality of growth instead of absolute growth. There are two specific goals: 1) raise the standard of living by getting the Chinese to save less and buy more, 2) increase wages by dramatically increasing the value-add part of China’s manufacturing industry.

A convertible, international Yuan will support China’s growth strategy in the following ways:

  1. It will allow the Chinese to invest their savings at home and abroad. This in turn should boost the rate of return on their savings, and their disposable income, thus increasing their willingness to spend.
  2. It will help China’s economy to balance trade and investment flows, an essential requirement as the economy becomes more sophisticated.
  3. It should lead to the further development of China’s local capital markets and modernization of its monetary policy, including continued liberalization of interest rates. This would also become an effective tool to control inflation, particularly as wages rise.

How serious is the Chinese Government to globalize its currency? Here are some impressive data points:

  •  In July 2010, the offshore Yuan market launched in Hong Kong, recently becoming the fastest growing currency market in the world.
  • There are also plans to expand the offshore Yuan market to Singapore and eventually to London.
  • According to Global Finance, in Q3 2011 alone, more companies issued Yuan denominated bonds than in Euros ($31b vs $26b).   
  • Yuan-settled trade now accounts for ~10% of China’s total trade (as compared to less than 1% in early 2010). Analysts at Deutsche Bank AG predict that Yuan-settled trade will amount to 3.7 trillion Yuan ($587.84 billion) this year, or 15% of China’s total trade.

At the end of the day, the internationalization of the Yuan will undoubtedly represent a decline of the US Dollar as the world’s reserve currency and I am sure that this event will generate more press and debates. But the global economy will be much better off with a stronger China, one that will be driven by greater internal consumption, innovation and modernization of capital, its markets and monetary policy.

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