Yuan Reserve? We're not Betting on It
By Staff News & Analysis - December 04, 2012

How the Yuan Could Take the Dollar's Crown … China could eclipse the United States sooner than many think as the yuan (renminbi) becomes a major player on the word stage that could put the dollar in the shade. – CNBC

Dominant Social Theme: China is a super power waiting to take over the world.

Free-Market Analysis: CNBC tells us that the Chinese yuan could soon overtake the dollar as the world's reserve currency. It's a common perception because China has expanded so rapidly over the past 40 years.

China has truly experienced a great leap forward, though we're on record as questioning how much is due to expansive monetary policy and how much is due to the innate healthiness of the socio-political, entrepreneurial and economic system. (We've often stated we think central bank monopoly money has a lot to do with China's Greatest Leap Forward.)

In a sense this issue about the yuan reserve currency is a kind of shorthand meme for the progress of China itself. The power elite wants to make clear how formidable a competitor China is to the West. The yuan provides a platform for a subdominant social theme: Even the Red Dragon's money could topple King Dollar. How powerful is that!

In fact, we don't see it. We've been expecting a "landing" that is harder rather than softer because of the immense amount of currency that has been pumped into the Chinese system. So we don't see it. The dollar may topple from its perch but not because the yuan displaces it. Reserve currencies don't work that way.

It's true that China has considerable heft on the world stage. China is now the world's second biggest economy and its currency is similarly enhanced. The yuan – also called the renminbi for international purposes – is being positioned several ways from an international perspective.

First, Chinese officials are using it for trade-settlements purposes, then for investing and, finally, they are trying to encourage other countries to use it as a reserve.

The Chinese have created swap deals agreed with Australia, Russia, Japan and Brazil, according to the article. The Japanese yen is exchangeable, as well. And the dominant economic power in Asia is no longer Japan but China.

Here's some more from the article:

In 2009 China allowed its currency to be partially convertible outside the country, setting up the offshore deliverable-CNY market for Hong Kong (the CNH) which will likely spread to other jurisdictions. RBS reports that from a basis of nearly zero four years ago CNH-denominated deposits now total some 500 billion.

"Economic prowess has clearly shifted from Japan to China," analysts at Citi said in a research note. "Hence policymakers in Asia are more wary of relative strength of their currencies versus China than Japan."

Simon Derrick, chief currency strategist for BNY Mellon, has been tracking the foreign currency reserves China holds and has kept a keen eye on policy announcements by the country's politburo.

He highlights a marked decrease in growth of foreign currency reserves the country holds. September's third quarter figure showed foreign exchange growth of 2.76 percent year-on-year. Last year the same figure showed 20.9 percent growth."

… All this suggests that the first quarter of next year could prove an interesting one. Although further clues (one way or another) will likely surface through January and February, the most likely point for an announcement will come on or around March 14," he said, adding that the date was significant as it coincides with the National People's Congress in Beijing.

There are other views, however. Larry Edelson, financial analyst at Weiss Research is quoted as saying, "The world is headed toward a new reserve currency, either backed by the IMF SDRs (special drawing rights), or some other neutral basket."

We would tend to agree with this.

The next step is not a reserve Chinese currency but a global currency.

Setting up another country reserve system is probably not going to happen. Special circumstances contributed to the dollar reserve in the first place.

The US dollar reserve system is based on the Saud family declaring to the world that oil is to be priced in dollars. For this reason, countries have had to hold dollars.

That system is eroding now. But there is still no compelling reason for the countries of the world to hold Chinese currency. It is not, strictly speaking, a "reserve."

After Thoughts

Next stop, a global SDR basket of currencies?