China wants its currency, the yuan, to challenge the dominance of the United States dollar in global trade, finance and reserves held by central banks. But can it? To do so it will need to take on three functions. We will explore each of these in turn:
The Yuan’s Role In Global Trade
China is pushing for its currency, the Yuan Global, to replace the US dollar in global trade. But a number of obstacles remain in its path. The yuan’s share of the world trade settlement pie has been rising. It surpassed 3 percent in July, according to SWIFT payments data. That is still far short of the dollar’s share. But it is an important step for the yuan, which will likely become a major currency in Asia and Africa. As China and other emerging economies grow, they will need a local currency for trading with each other.
In the long term, the yuan could also serve as a reserve currency for central banks around the globe and a trusted asset for private investors, companies, and financial markets. But that is a huge task, and one that will be determined by the global political climate. As geopolitical conflicts continue to flare up, it is possible the yuan will accelerate its rise.
The Yuan’s Potential As A Global Currency
Talk has resurfaced about China’s goal to make the yuan a global reserve currency. But it’s important to note that China has a long way to go before this happens. First, the yuan needs to have wider acceptance as a basis for trade contracts and import-export settlement. Currently, only 2 percent of these transactions use the yuan, compared to 75 percent that settle in dollars. Additionally, the yuan must have substantial support from financial markets. This means it must have deep, liquid and well-regulated investment options that are widely available to international investors. It also must compete with dollar-based assets in terms of price and liquidity.
The yuan is still a latecomer to the world of finance, so it will take time for it to gain recognition and momentum. Despite these challenges, the yuan’s path to globalization holds significant potential. The question is how Beijing will seize the opportunity. Will they continue to pursue de-dollarization, or will they find a new track?
The Yuan’s Potential As A Reserve Currency
China is working hard to make the Yuan Global reserve currency. But the Chinese currency is a long way from unseating the dollar from its position atop global finance. Currently, only about 2 percent of global imports and exports are denominated or settled in yuan (also known as renminbi). For the yuan to become a true global alternative to the dollar, it must achieve much wider acceptance as the basis for trade contracts, international payments, and as a form of financial asset storage for central banks. It also must have deep, flexible financial markets to support these functions.
The current state of Chinese financial markets, however, indicates that Beijing is unlikely to give the yuan such broad-based support in the near future. The yuan is still heavily restricted by capital controls and limited transparency. These factors limit its ability to play the important roles of a world reserve currency, an accounting unit for trade, and a store of value for private investors and banks.
The Yuan’s Potential As A Digital Currency
The Chinese government’s digital yuan (e-CNY) has taken the country a step closer to a “Big State” model. While the PBOC claims that it will offer users controllable anonymity, the fact remains that digital wallets are tied to individual accounts and can be traced by authorities in case of anti-money laundering and know your customer compliance checks. Domestically, e-CNY has seen relatively slow adoption. Some 261 million e-CNY wallets exist, but only a small fraction are active. This is mainly because consumers see no need to switch from their existing entrenched payment methods.
The internationalization of the digital yuan will require China to promote its use overseas and provide incentives for countries to trade using it. This would include relaxing capital controls, enabling full yuan convertibility, and providing more transparent economic data. China’s growing soft power could also help incentivize other countries to embrace the yuan as a global trading currency. This will be a complex undertaking, but the yuan’s potential is clear.
Conclusion
While the US dollar dominates global markets, China wants its currency to replace it. This would increase its clout and give Beijing more control over its economy. To achieve this, the yuan must perform several functions: be a reserve currency for central banks and a transaction currency for global financial assets like equities and bonds. But foreign investors have been dumping Chinese debt since Russia invaded Ukraine last year.
