This preview shows page 1. Sign up to view the full content.
Unformatted text preview: let us see if the Yuan has the potential to grab the top currency role. Motivation
Both the US and China had/have motivation to establish their own currencies as the global
reserve currency. Shortage of raw material in the early twentieth century urged the US to look
beyond the country shores, and get involved in the international trade to a greater extent. US
started to promote dollar as the major reserve currency to benefit from increasing trade and
flourishing economy. With the weakening of other major currencies after the WWI, there was
an increased demand for the dollar worldwide that gave the US the edge of ‘dollar
China started to engage in foreign trade from 1978, particularly after joining the WTO in
2001. It has now become a major trade partner for many developed nations, both in terms of
imports and exports. Further, China has made enormous effort to secure raw materials supply
through FDI and increased participation in projects that are promoted by foreign governments. Once the Yuan is established as the main reserve currency, China expects to
reap similar benefits as the US got in the second half of 1900s.
Unfortunately for China, the decision to confer the title of ‘the global reserve currency’ is not
unilateral. The Yuan can become the reserve currency only if the rest of the world,
particularly the emerging countries: India and Russia, and developed nations: US and Japan,
are willing to hold a bulk of their foreign reserves in Yuan. Given China’s cold relations with
these major powers, the crowning of the Yuan as the main reserve currency does not seem
feasible in the near term. Economic Preparation
GNP: The US had overtaken the UK in industrial output and GNP terms by 1890. The time
span between the emergence of the US as the leading economy and promotion of dollar as the
reserve currency was at least 30 years (1890-1920). As of 2009, China accounted for 8.6% of
the world GDP. Even if we assume that it is not necessary to become the leading economy
first and then the reserve currency issuer (pound was fully dethroned in 1955), China has a
long way to go.
Continuous Trade Surplus and Huge Reserve Holdings: As with the US, China has
experienced continuous trade surplus and accumulated enormous reserve holdings. China’s
trade surplus emanates not only from economic efficiency, but also from undervalued
currency. The continuous surplus had/has resulted in accumulation of huge reserve holdings
for both countries. US’s accumulation was in gold reserves, which backed up the spread of
dollar. Various countries including the US were willing hold dollars because they knew they
could claim the Fed’s gold if required.
China’s holding is primarily in dollars, which is currently the reserve currency. As the rest of
the world will begin to acquire the Yuan to replace their dollar reserves, the value of dollar
reserves will tank. Hence, the willingness of the other c...
View Full Document
- Winter '14