In doing most introductory courses in economics you will have come across the four functions of money which are:
- Medium of exchange
- Unit of Account
- Store of Value
- Means of deferred payment
Since the Bretton Woods Agreement in 1944 the US dollar was nominated as the world’s reserve currency and ranks highly compared to other currencies in the above functions. As a medium of exchange the US dollar is very prevalent:
- 60% of the world’s currency reserves are in US dollars
- 50% of cross-border interbank claims
- After the GFC, purchases of the US dollar increased significantly – store of value.
- Around 90% of forex trading involves the US dollar
- Approximately 40% of the world’s debt is issued in dollars
- In 2018 banks of Germany, France, and the UK held more liabilities in US dollars than in their own domestic currencies.
Is the Yuan challenging the US dollar for reserve currency status?
In 2015 Chinese authorities were keen on the currency going global and the following points would indicate this.
- Deposits in renminbi = 1trn renminbi = US$144bn
- Yuan transactions have grown in Taiwan, Singapore, Hong Kong and London.
- Investment by Chinese firms into Belt and Road project = US$3.75bn which was in the renminbi
- China settles 15% of its foreign trade in renminbi
- France settles 20% of its trade with China in renminbi
- 2018 – Shanghai sock market launched yuan-denominated oil futures.
- The IMF suggest that the ‘yuan bloc’ accounts for 30% of Global GDP – the US$ = 40%
However as reported by the FT – see video below – the goal of reserve currency status was made more complex by the decision to maintain a loose peg to the US dollar. This means that the value of the renminbi would follow the non-specific value of the US dollar. So when the US dollar appreciated so did the renminbi and with a higher exchange rate Chinese exports became more expensive. This led the People’s Bank of China to intervene and devalue the currency by approximately 2% in 2015 – a weaker currency makes exports cheaper.
How do the Peoples Bank of China set the Yuan’s value?
Basically at 9.15am the Peoples Bank of China (Central Bank) and the SAFE (State Administration for Foreign Exchange) issues a circular to all the trading banks stating that this is the exchange of the renminbi to the US$ for today.
However this panicked investors who off-loaded their renminbi assets and sent its value downward. The reaction of China was to impose strict capital controls to stabilise the currency. But since the end of 2015 there has been a Chinese foreign exchange policy with the market forces of supply and demand being more prevalent. Nevertheless, there is still a long way to go before the renminbi is a freely floating exchange rate and the benefits that come with it.