Tag: reserve currency

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Has the yuan passed?

There is a select group of countries (areas) that have something in common: the USA, the UK, Japan and the eurozone. The currency in each of these places is one of the IMF’s reserve currencies. But is China about to enter the mix?

The growth of China has been spectacular and it is now the second largest economy in the world, behind the USA. It is on the back on this growth that China has asked the IMF for the yuan to be included in the IMF’s basket of reserve currencies. The expectation is that Christine Lagarde, the IMF’s Managing Director, will announce its inclusion and, while some suggest that the yuan could become one of the major currencies in the world over the next decade following this move, others say that this is just a ‘symbolic gesture’. But that doesn’t seem to matter, according to Andrew Malcolm, Asia head of capital at Linklaters:

“The direct impact won’t be felt in the near term, not least because implementation of the new basket won’t be until Q3 2016. However the symbolic importance cannot be overlooked…By effectively endorsing the renminbi as a freely useable currency, it sends a strong signal about China’s importance in the global financial markets.”

Concerns about the yuan being included have previously focused on China’s alleged under-valuation of its currency, as a means of boosting export demand, as we discussed in What a devalued yuan means to the rest of the world. However, China has made concerted efforts for the IMF to make this move and China’s continuing financial reforms may be essential. The hope is that with the yuan on the IMF’s special list, it will boost the use of the yuan as a reserve currency for investors. It will also be a contributor to the value of the special drawing right, which is used by the IMF for pricing its emergency loans.

Although the Chinese stock market has been somewhat volatile over the summer period, leading to a devaluation of the currency, it is perhaps this move towards a more market based exchange rate that has allowed the IMF to consider this move. We wait for an announcement from the IMF and the articles below consider this story.

Chinese yuan likely to be added to IMF special basket of currencies The Guardian, Katie Allen (29/11/15)
‘Chinese yuan set for IMF reserve status BBC News (30/11/15)
IMF to make Chinese yuan reserve currency in historic move The Telegraph, James Titcomb (29/11/15)
China selloff pressure Asia stocks, yuan jumpy before IMF decision Reuters, Hideyuki Sano (30/11/15)
IMF’s yuan inclusion signals less risk taking in China Reuters, Pete Sweeney and Krista Hughes (29/11/15)
Did the yuan really pass the IMF currency test? You’ll know soon Bloomberg, Andrew Mayeda (29/11/15)

Questions

  1. What is meant by a reserve currency?
  2. Why do you think that the inclusion of the yuan on the IMF’s list of reserve currencies will boost investment in China?
  3. One of the reasons for the delay in the yuan’s inclusion is the alleged under-valuation of the currency. How have the Chinese authorities allegedly engineered a devaluation of the yuan? To what extent could it be described as a ‘depreciation’ rather than a ‘devaluation’?
  4. Look at the key tests that the yuan must pass in order to be included. Do you think it has passed them given the report produced a few months ago?
  5. The weighting that a currency is given in the IMF’s basket of currencies affects the interest rate paid when countries borrow from the IMF. How does this work?
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Dollar’s declining dominance?

The demise of the dollar as the world’s reserve currency has been predicted for a long time now. Yet it is still way surpasses other currencies, such as the euro and yen, as the main reserve currency of most countries. Also it still dominates world trade with much of international trade being priced in dollars. Indeed, as the eurozone reeled from the Greek debt crisis in early February (see A Greek tragedy and Debt and the euro) so investors sold euros and bought dollars. The dollar gained 12 per cent against the euro from December 2009 to February 2010 (from $1 = €0.66 on 1/12/09 to $1 = €0.74 by mid February).

But a number of economists, investors and officials argue that the dollar’s dominance is gradually being eroded:

As the United States racks up staggering deficits and the center of economic activity shifts to fast-growing countries such as China and Brazil, these sources fear the United States faces the risk of another devaluation of the dollar. This time in slow motion – but perhaps not as slow as some might think. If the world loses confidence in U.S. policies, “there’d be hell to pay for the dollar … Sooner or later, the U.S. is going to have to pay attention to the dollar”, [said Scott Pardee, economics professor at Vermont’s Middlebury College and formerly on the staff of the New York Fed].

So what is likely to be the future of the dollar? Will it remain the number one world reserve currency? Will its position be gradually, or even rapidly eroded? What will happen to the exchange rate of the dollar in the process? Finally, what is the significance of the trade and budget deficits in the USA? Are these of benefit to the rest of the world in providing the necessary dollars to finance world trade and investment? Or are they a source of global imbalance and instability? The following article look at these issues.

How long can the U.S. dollar defy gravity? Reuters, Steven C. Johnson, Kristina Cooke and David Lawder (23/2/10)
Is greenback’s dominance coming to an end? Stuff (New Zealand), Tony Alexander (24/2/10)
Reconstructing The World Economy Eurasia Review, John Lipsky (25/2/10): see final part on Reforming the International Monetary System. See also the following conference paper referred to in this article:
The Debate on the International Monetary System Korea Development Institute / IMF Conference on Reconstructing the World Economy, Seoul, Korea, Isabelle Mateos y Lago (25/2/10)

Questions

  1. To what extent does the world benefit from having the dollar as the main reserve currency?
  2. What is the role of US current account and budget deficits in supporting this reserve currency role? How important is the size of these deficits?
  3. What is likely to happen to the exchange rate of the dollar against other major currencies in the coming years?
  4. What alternatives are there to having the dollar as the world’s main reserve?
  5. Does it matter if China holds $2.3 trillion in foreign exchange reserves, with nearly $800 billion in US Treasury debt?
  6. Why is the value of its currency a less urgent problem for the USA ‘than it would be for other borrowers who borrow and pay for imports with dollars’?
  7. What are ‘currency swap accords’ and why are they important for China?
  8. What are the implications of the Chinese yuan being undervalued against the dollar by as much as 40%?