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Wednesday, November 13, 2019

Move over Dollar, make way for the Yuan

by Linda S. Heard

© Shutterstock
© Shutterstock

An increasing number of countries are quietly diversifying away from the Greenback and as many as 40 central banks are engaged in buying Chinese Yuan. Could there ever be a day when the Chinese currency succeeds in shoving the dollar off its lofty perch asks Linda S. Heard?

It’s no surprise that the dollar has managed to retain its status as the planet’s dominant reserve currency when the US still boasts the world’s largest economy backed up by the world’s most powerful military. However, there was a period following the 2008 global downturn when the dollar was expected to measurably weaken - especially in light of the fact that the crises was ignited by American banks and financial institutions - but quite the opposite occurred because, in the absence of a viable alternative, it was seen as a safe haven.

That reaction evidences the reliance of central banks not only on dollars but also on US bonds as insurance against future economic earthquakes. As John Authers points out in the Financial Times, “What doesn’t kill the dollar makes it stronger”. He explains that “the dollar gained almost 27 per cent during 2008 and early 2009, as the collapse of Lehman Brothers rocked the world.”

So there’s no suggestion that we should get out our pocket handkerchiefs to bid R.I.P. to the dollar’s hegemony just yet. That said there is a serious competitor edging up on the outside track. A recent poll of 200 institutional investors, conducted by the Economist Intelligence Unit, found that 53 per cent of respondents believe the Yuan will eventually supplant the dollar as a go-to foreign exchange currency.

It’s worth noting that towards the end of last year the Yuan grabbed the second slot from the Euro in terms of its usage for global trading but it has a long way to go before being considered as a reserve currency. As of last year, over 61 per cent of the world’s currency reserve was denominated in dollars, followed by Euros (25 per cent), Sterling, the Japanese Yen, the Swiss Franc and the Canadian dollar, which, on the face of it, doesn’t give much space for the Yuan’s rise.

However, there is a clamour from some quarters for a new international reserve currency and, indeed, a 2010 report published by the United Nations Conference on Trade and Development advocates a new reserve system to secure stability in the global financial system. Leading the charge to abandon the dollar are Beijing and Moscow, whose relations with the US have visibly cooled lately. In May, Russia’s second-largest financial institution, VTB, signed a cooperation agreement with the Bank of China in the presence of President Vladimir Putin and President Xi Jinping to effect payments in their respective domestic currencies. In itself the move is more political pinprick than a mighty hammer but it does indicate which way the wind might be blowing.

What’s evident is that the People’s Bank of China (PBOC) is forging ahead with plans to give the Yuan a higher profile. It aims to start gold and oil futures denominated in Yuan with an eye to an international payment system in its country’s currency. In 2013, China signed bilateral currency swap contracts worth over 2.5 trillion Yuan with 23 foreign central banks and this year the PBOC signed a memorandum of understanding with Germany’s Bundesbank to facilitate the clearing of payments in Yuan - and in March, the Bank of England followed suit. These swaps eliminate the need for converting the Yuan into another currency, more often than not the dollar.

There’s little doubt that China is out to edge the dollar off its pedestal in the long run and to this end it has been buildingup substantial gold reserves while muttering about America’s high level of debt with the implication that if the US defaults, China, which owns some US$ 1.3 trillion worth of US debt, would cease purchasing US Treasury bonds. If Beijing seriously reduced its dollar dealings, adopted the gold standard making the Yuan a rock solid investment and free-floated the currency, Washington would be in serious trouble. However, for now, Beijing’s main goal is to remain competitive in terms of global trade which involves keeping the Yuan’s value depressed.

Some years ago, the Chinese premier publicly stated that he was worried about Chinese assets prompting a debate within China as to the wisdom of continuing to purchase Treasury bonds. In simple terms, China holds a sword of Damocles over the US administration’s head. It is currently the number one investor in US Treasuries holding 7.4 per cent of the total US debt.

For the time being, the major players in the Arab World are sticking with the tried and true. Governor of the Saudi Arabian Monetary Agency believes that while diversification should include the Chinese currency “but it’s far from being a reserve currency at this stage”.

Emerging economies, in particular the bloc known as the BRICS, Brazil, Russia, India, China and South Africa, are keen for the day when the dollar’s dominance is diminished; they are working to develop their own bond and equity markets and are establishing a joint development bank.

Geopolitics could be a major factor in the dollar wobbling sooner rather than later. For instance, as highlighted by Russian Television (RT) if the US and its EU allies make good on their threats to impose sanctions on Russia’s gas and petroleum sectors in response to Russia’s actions in Ukraine, Moscow might be cornered into relinquishing the Fiat dollar and push “for an alternative monetary system for global trade that does not rely on Fiat dollars.” The report warns that “if this alternative currency system becomes established, the Fiat dollar’s value and role as the World’s Reserve Currency will fall even faster, leading to significant inflation and further stress on the US economy.” Indeed, the FT has recently reported that large Russian corporations are preparing to switch contracts to Yuan or the Hong Kong dollar and open accounts in various countries within Asia.

Economists may disagree over the Yuan’s potential to sideline the US dollar, but they are all in accord that the Yuan is being promoted as a viable alternative and is making considerable headway. In 2012, China and Japan began trading directly in their respective currencies, followed by New Zealand in March this year - and in April, Australia’s Central Bank announced it will invest five per cent of its foreign currency reserves in Chinese government bonds. And the days when the dollar could rest upon its laurels are indisputably slipping away. The Yuan is catching up figuratively and perhaps even physically as Canadian banks and financial institutions work on establishing a trading hub for the Yuan in Toronto!

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