Yuan Pipe Dreams


Talk has re-emerged that China’s yuan will soon challenge the dollar as the world’s reserve currency. This time, the spark for such talk came from a visit by Chinese President Xi Jinping to the Middle East, where he emphasized the reach of China’s trade and also made clear his desire for oil contracts to settle in yuan and not, as usual, in dollars. The Saudi’s seemed to have no objection. Such actions, though they command notice, nonetheless fall far short of achieving Beijing’s long-standing ambition for the yuan to serve as the premier global reserve. To accomplish this, China will have to jump many more hurdles. The yuan today falls woefully short on every major attribute of a global reserve. Still more vexing for Beijing, success on the yuan will require change in ways that the governing communist party may find impossible.

For the yuan to replace the dollar, it will, for instance, have to gain much wider acceptance than it presently has as a basis of trade and of import and export contracting. According to the figures for the first half of 2022, only some 2 percent of global import and export contracts were denominated in yuan or settled in yuan. That is well up for five or ten years ago, but still well short of the dollar, which accounts for some 75 of world trade contracts and settlement, much of it without even an American party involved.

Nor does the yuan have anything near the necessary presence in currency trading. According to the Bank for International Settlements, the yuan did gain considerable ground this past year as a proportion of global currency trading. It received an extra fillip because western sanctions against Russia made Chinese links valuable to anyone who wanted to buy or sell in Russia. Largely because of that lift, the yuan surpassed proportions of trading done in either the Canadian or the Australian dollar or the Swiss franc. But even with this year’s special jump, the yuan still commands only some 7 percent of global currency trading and still falls far short of the amount of currency trading in euros, Japan’s yen, or the pound sterling. It remains well behind the dollar, which dominates some 90 percent of all global currency trading.

Preferences by central banks to hold each currency in reserve gets to these yuan inadequacies from a different perspective. Some 70 central banks do hold yuan in reserve, a much greater number than a few years ago, but still, according to the International Monetary Fund (IMF), these holdings amount to only 2.25 percent of the global total. That figure falls short of the euro, for instance, which amounts to some 20.6 percent of these reserves or even the yen, which amounts to 5.8 percent. The yuan’s role certainly falls far short of the dollar, which amounts to about 59 percent of these reserves. As should be apparent from the trading proportions mentioned above, the dollar on strictly practical grounds should have a higher proportion of central bank reserves than it does. The influence of diplomacy and politics in this realm explains this difference.

Perhaps the greatest of yuan’s failings concerns a third and crucial attribute needed by a reserve currency: support from financial markets. A reserve currency not only needs to be widely used and traded, but because importers, exporters, and those who support them financially must hold assets in the reserve, the markets denominated in it must offer wide range investment options — short-term deposits, for instance, longer-term bonds, stocks, options, futures, forward contracts, and the like. Acceptable financial markets must also offer people the ability to trade in and out of such investments quickly and easily, with the greatest flexibility and at the least cost. Dollar-based markets – in the United States and elsewhere — offer an abundance of such support. Yuan-based markets, by contrast, are much thinner and much more tightly controlled by the authorities in Beijing.

A sense of this difference emerges from a comparison of the relative size of financial markets in the United States and China. U.S. equity markets amount to about 33 percent of all global stocks, whereas China’s stock market equals slightly less than 8 percent of the global total. In bonds, the figures are respectively 39 percent and 17 percent. Vast as these differences are, they do not capture the still wider difference in the sorts of investment and trading vehicles offered in dollar-based markets but are limited or non-existent in yuan-based markets.

As China’s economy grows, the yuan will gain as a portion of global trade, currency trading, and even reserves held by the world’s central banks. It will, however, take a long time to challenge the dollar, especially now that China’s economy and trade will likely grow at a slower pace than previously. What is more, the undeniable communist need for control makes make it doubtful indeed that the China will ever permit the open, flexible financial markets needed to support a global reserve currency. Unless China changes dramatically, it is more likely that some other currency or system well replace the dollar before the yuan has a chance, though nothing is presently on the horizon.

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