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
- n 2018 banks of Germany, France, and the UK held more liabilities in US dollars than in their own domestic currencies.
So why therefore is there pressure on the US dollar as the reserve currency?
The COVID-19 pandemic has closed borders and will inevitably lead to more regionalised trade, migration and money flows which suggests a greater use of local currencies. However China has made its intention clear that the Yuan should become a more universal currency. Some interesting facts:
- Deposits in yuan = 1trn yuan = US$144bn
- Yuan transactions have grown in Taiwan, Singapore, Hong Kong and London.
- Investment by Chinese firms into Belt and Road project = US$3.75bn which was in yuan
- China settles 15% of its foreign trade in yuan
- France settles 20% of its trade with China in yuan
- 2018 – Shanghai sock market launched yuan-denominated oil futures.
- The IMF suggest that the ‘yuan bloc’ accounts for 30% of Global GDP – the US$ = 40%
However if the past is anything to go by the US economy has gone through some very turbulent times but the US dollar has remained firm. This suggests that how we perceive the US economy doesn’t seem to relate to the value of its currency.
Source: The Economist – China wants to make the yuan a central-bank favourite
7th May 2020
There has been much talk of the Chinese currency the Renminbi becoming the reserve currency of the world. If you were to look at the trading volumes you would think that they are not far off the mark. However the growth has been so large in the last few years mainly because it has come from such a low base. But the following points put it in perspective:
* The Renminbi is the 7th most used currency according to SWIFT a global transfer system
* The Renminbi accounts for only 1.4% of global payments – US dollar is 42.5%
* When you look at assets open to international buyers there are just $0.3 trillion of Chinese assets available compared to $56 trillion of American – this is one reason why the US dollar is liked as a global currency.
For the Renminbi to become a more dominant it has to become global. An easy way for this to happen is for China to run trade deficits as this will add to the global holdings of Renminbi on a daily basis. However China has traditional run surpluses which means that more foreign currency is coming into the economy. On the other hand the USA has run trade deficits which in effect adds to the global holdings of US$. However even if China did run deficits what could the holders of Renminbi do with it? China could open the Capital Account of the Balance of Payments which would encourage investment. There is still a long way to go before the Renminbi becomes the reserve currency.
From the Wall Street Journal – the state-controlled Bank of China Ltd. is allowing customers to trade the yuan, also known as the renminbi, in the U.S. The decision is the latest move by China to allow the yuan, whose value is still tightly controlled by the government, to become an international currency that can be used for trade and investment.
“We’re preparing for the day when renminbi becomes fully convertible,” Li Xiaojing, general manager of Bank of China’s New York branch, told The Wall Street Journal. He said the bank’s goal is to become “the renminbi clearing center in America.”
Bank of China’s move comes at a time of U.S. pressure on China to let its currency rise in value. America has blamed an unfairly valued yuan for exacerbating the U.S. trade deficit with China. But the preparations for convertibility are also a sign of Chinese strength, as China, now the world’s second-largest national economy, recognizes that as a global power it must have a global currency. In time, a globally traded yuan could emerge as a store of value on par with the dollar, euro and yen.