China wants the yuan to rise beyond its borders, but Beijing is careful to keep capital flows restricted. That makes it hard to see how it could ever become a global reserve currency. The US Dollar’s dominance in the international monetary system can’t be questioned, but it is gradually losing influence. This is a process known as de-dollarization.
The Yuan’s Origins
Until recently, China’s currency was linked to the dollar by a peg, ensuring that most foreign payments coming into and leaving its domestic market were in dollars. This year, the yuan’s share of foreign payments to and from mainland China has risen above that of the dollar, although its proportion in trade settlements remains low.
However, China’s growing economic and political weight could challenge the primacy of the dollar. And its monetary policy has been geared towards internationalization. The yuan, also known as the renminbi or RMB, is the official currency of China. The name comes from the Chinese characters, which mean “round,” and are cognate with the Korean won and Japanese yen. The yuan is also the base unit for the Hong Kong dollar, Macanese pataca and New Taiwanese dollar. In Cantonese, yuan is called man, houh or sin (). The word Yuan International itself has a history stretching back to the Yuan Dynasty (1271-1368), which coexisted with the Southern Song and Ming dynasties.
The Yuan’s Rise
China’s currency has soared this year, even as the country’s economy struggles with factory inflation and a property market boom gone wrong. The surge is fueled by hot money chasing comparatively juicy returns on Chinese government bonds and by the yuan’s internationalization. The yuan is growing in importance as an international payment currency, but it’s still far from challenging the dollar’s dominant role as a global reserve. Only about 2 percent of global import and export contracts are denominated in yuan, and less than half of the world’s foreign exchange reserves are held in yuan.
But the yuan is on a strong upward trajectory, especially in 2021, thanks to a sluggish global economic recovery and an easing of China’s tight credit policy. As the yuan gains ground, central banks in other countries are increasingly likely to keep it in their reserve portfolios. And that, in turn, could encourage more trading in yuan-denominated assets. Moreover, the yuan’s internationalization has been boosted by the recent escalation of the conflict between Russia and the West, with sanctions in place that prevent many unaligned countries from holding dollar assets.
The Yuan’s Use
The yuan’s status as a global currency is dependent on how much foreign exchange reserves Beijing has at its disposal. This is why China has imposed strict capital controls to prevent the outflow of money from the country. Beijing is also keen to promote the Yuan International, and to have it used for more international trade contracts and settlements. Its efforts are part of a larger movement involving Russia and China to de-dollarize the world’s financial system, with both countries trying to distance themselves from dependence on the dollar amid growing geopolitical tensions with the US.
For example, Bangladesh recently settled payments to Russia for a nuclear power plant in yuan rather than dollars due to western sanctions on the country. However, despite these efforts, the yuan is still only the fifth most-traded currency globally and isn’t yet fully convertible. This is a major hurdle to overcome for the yuan to become truly global. The yuan is often abbreviated in forex trading to CNY.
The Yuan’s Future
Global investment houses slashed their forecasts for the yuan this month as it weakens against the dollar. The yuan has now lost more than 4% against the US dollar this year and is one of Asia’s worst performers as it faces rising yield differentials with the United States and signs that Beijing may roll out more stimulus to support a bumpy post-COVID economic recovery. China’s government has been busy over the past year striking deals to expand the ways the yuan is used internationally. This includes new agreements with countries ranging from Russia to Bangladesh, allowing customers in those markets to pay directly in yuan rather than through Chinese banks.
But the yuan remains far behind the dollar in terms of its overall role in international finance. The vast majority of global trade contracts and settlements remain denominated in dollars, while the yuan still accounts for only about 2 percent of such transactions. It will take years for the yuan to challenge the dollar’s dominance.
Conclusion
The yuan is gaining ground as a global currency. But is it enough to challenge the dominance of the US Dollar? While the yuan’s rise is real, it is still limited by China’s slowing growth. Beijing must focus on building a credible regional alternative to the dollar.
