Global reserve currency and China, the rising superpower


From the colonial period to the modern era, every time a country became an economic powerhouse, it tried to influence others and used its currency as the standard for the global trade and commerce transactions. It has been true during the British Empire when Britain was the undisputed Economic Powerhouse of the world and the Pound Sterling was the Global Currency of the time. Like most of the major currencies of that period, the Pound Sterling was also backed by gold standard. However, with the breakout of the World War I in 1914, to support the food supply for the citizens and to finance the war expenses, most of the countries started issuing vast amount of paper money without full gold backing. By 1917, with three years into the war, Britain, like most of the other countries, was also having tough economic times and decided to borrow money from the United States (the best choice) in the form of the U.S. dollar sand treasury bills. In 1919, Britain decided to abandon its Pound Sterling backing with gold, too. This action devastated the international merchants who had their accounts in the Pound Sterling. As a result, the U.S. dollar became the most stable and leading currency in the world. Later, with the breakout of the 2nd World War, like previously, the United States did not join the war right from the start but served initially as the supplier of the goods, ammunition and weapons to the Allies and in return collected payments in gold. After the end of the war, the United States became the single largest owner of gold in the world.
After the war, the European countries completely delinked their currencies from gold backing, resulting into heavy devaluations. However, to bring some stability to their currencies and as part of 1944 Bretton Wood (New Hampshire) agreement, 44 Allied countries pegged their currencies with the U.S. dollar, while the U.S. dollar was still backed by gold! In return, the United States would honor redeeming the U. S. dollars for gold on demand by the member countries. Since the United States had the largest gold reserves backing, other countries (including the Bretton Wood agreement nations) started accumulating U.S. dollars and the U.S. Treasury securities as the safe Heaven for their money. And this created the right conditions for the U.S. dollar to declare as the Global Reserve Currency. Since then, the U.S. dollar has maintained its crown as the undisputed Global Reserve Currency of the world, even after its decoupling from gold backing by President Nixon in 1971 for financing the Vietnam war and to date even after going through many stagflation periods.
Since assuming the crown of the Global Reserve Currency by the U.S. dollar, there have been many attempts by the rising economies to reduce its dominance by making their own currencies as the other available choices. But all these attempts have never been able to lower U.S. dollar’s global currency share less than 50 percent. Like in the 80s & the 90s, the two economic power houses of that time, Japan, and Germany attempted to divide the world into three currency blocks (Asia, Europe and rest of the world) but the Japanese Yen ever got has been 9 percent of the global reserve currency in 1991 while the German Mark ever got highest share was 18 percent in 1998. Later, with the creation of the European Monetary Unit (EMU), it was speculated that it will dethrone the strong hold of the U. S. dollar as the most dominant currency, but these efforts also failed. The maximum share the EU block ever got has been 30 percent share of the Global Currency Reserves.
According to IMF report for 2019, United States had 61.8 percent share of the global reserve currencies, Euro shared 20.2 percent, Japanese Yen had 5.3 percent, Pound Sterling shared 4.5 percent and the other currencies’ combined share was 8.2 percent (including 1.95 percent Chinese Yuan). As of January 2020, China had reported having $3.4 trillion foreign currency reserves, followed by Japan with $1.4 trillion reserves.
With the rise of China as the Rising Superpower, the world seemed to be dividing into two distinct blocks. One block will be dominated by the United States and its allies with the U.S. dollar as the global reserve currency and with its own operating standards of the digital world (5G network, wireless operating system, technical know-how, etc.) The second block led by China and its partners with its own currency, Yuan’s dominance and with different standards than the United States for the next digital world.
Compared to the past attempts by other currencies as described before, Chinese Yuan has reasonably good potential to carve out its own position against the dominance of the U.S. dollar. There are two fundamental economic factors that are in favor for making Yuan a more successful global currency than the attempts by Japanese Yen, German Mark and the Euro zone, Euro in the past. One of them is the size and strength of the Chinese economy and the second is its shear trading (imports & exports) value that reached in 2019 to its all-time high of 31.55 trillion Yuan ($4.6 trillion), spanning to all the four corners of the globe (Asia, Africa, Europe, and the Americas).
According to a recent report by the Wall Street Banker, Morgan Stanley, with the continued economic reforms and its capital and financial markets opening, Chinese Yuan will gain considerable momentum for bilateral and multi-lateral transactions and could easily reach up to 10 percent of the global reserve currency volume within the next decade. This will be a significant increase from the current level of 2.02 percent as of end of March of this year according to the IMF data. This will also greatly help Chinese policy makers to reduce China’s reliance on the U.S. dollar. This projection could be much higher if China decides to fund (pricing, settlement, receipts, and payments) all the BRI projects with Yuan that are currently projected to reach to one trillion-dollar value by their completions. As a matter of fact, recently Chinese think tanks and advisers have recommended internationalization of Yuan to the policy makers and the financial institutions to “redouble efforts” inuse of the Yuan in global payments for every infrastructure projects across the world. Along this strategy and to reach this objective, late last year, Australian mining company, Rio Tinto and Brazilian Iron ore producer Vale corporation, both have completed their supply agreements with the Chinese Steel companies in multi-million payments in Yuan denomination. This year alone, BH Pan Anglo-Australian Mining conglomerate, Rio Tinto and Fortes cue Metals (all Australia based corporations) have already completed their 100 million Yuan each transaction in Yuan.
Recently, Chinese government approved American Express for use of its cards in China and abroad in Yuan denominated transactions. This will allow American Express to have access to China’s 27 trillion U.S. dollar payment market and will also help China in increasing Yuan’s across borders transactions. Visa and Master cards, both have also applied and are waiting for their approvals to participate in this huge consumer market.
Consistent with the strategy for Yuan’s internalization drive, Indonesia became the first country to pay its first six months trade payments of the year in Yuan worth 2.7 million U.S. dollars. Last year, China became Indonesia’s largest trading partner with a bilateral trade value of 79.4 billion U.S. dollars. In Indonesia, Yuan’s growth is in higher gears than anywhere else due to 2018 bilateral three-years currency swap arrangement between the two countries. According to the agreement, a total of 200 billion Yuan (29.6 billion U.S. dollars) will be swapped for 440 trillion Indonesian Rupiah (29.9 billion U.S. dollars) for the bilateral trade transactions and the liquidity support for the financial institutions. To encourage the transactions in Yuan, discounts are being offered to further entice the traders in making buying and selling goods and services in Chinese currency. All these events and this new emerging landscape of the global trade with BRI as its platform, Yuan is transforming into a formidable global reserve currency at a faster pace resulting into a new paradigm of multi-currency shared global reserve currencies system.