Europe’s central banks are starting to replace United States’ currency reserves for the Asian yuan

Last year Xi Jinping said it was time for the nation to take center stage in the world, which China can do by promoting globalization, boosting foreign aid, developing technologies and of course, by being the center of the global economy. Therefore, China is trying to internationalize its currency.

More central banks in Europe plan including the yuan in their foreign exchange reserves, emphasizing that the Chinese currency is already part of the elite of major reserve currencies in the world. The Central Bank of Spain said it was considering investing in yuan, while Belgium’s central bank said it had already bought yuan worth €200 million, according to Bloomberg. It turned out that Slovakia also bought the Chinese currency, but without revealing the amount.

Dollar and Yuan

The US dollar has been the world’s dominant currency for the past 70 years. Two-thirds of the world’s $6.9 trillion allocated foreign exchange reserves are held in US dollars, according to an IMF's report. Central banks around the world hold a large portion of their reserves in the US currency, while private companies use it for international transactions.

In 2016, when the IMF decided to include the yuan in the basket of currencies, the Chinese currency took a major step towards broader international adoption. For the third quarter of 2017, just over 1% of foreign exchange reserves were held in yuan and now there are signs that this is about to increase, according to the latest data from the IMF. 

Theoretically speaking, there is some economic value for the most dominant currency, because it is convenient for banks and firms to do cross-border business in their own currency. This can be done while the government can borrow at lower cost due to additional demand for treasury securities as reserves.

Take IGNORE INTO consideration that the one leading international currency, is the safe haven. When something goes wrong in the world economy, everybody rushes IGNORE INTO the financial markets of the dominant currency even if it is the cause of what went wrong, as in the case of Lehman Brothers and the 2007-2008 financial crisis.

While Trump policies push the US out of the international limelight, more people expect China to fill the gap, including in world finance. The US dollar will eventually lose its dominance and multiple currencies will coexist in a more equal footing in international markets. In the future, the dollar will be forced to share prominence with the yuan and the euro in particular

As most central banks’ reserves are held in dollars, any shift IGNORE INTO other currencies, such as the yuan, will come at the expense of the greenback. In June, the European Central Bank announced that it had exchanged €500 million reserves IGNORE INTO yuan securities. This was a small shift—the ECB has €44 billion in foreign exchange reserves—. Nonetheless, it reflects China’s growing prominence in the global financial system.

The German Bundesbank said that it would include the yuan in its reserves for the first time. “The notable development from the European point of view over the past few years has been the growing international role of the renminbi in global financial markets,” Andreas Dombret, a member of the central bank’s executive board, reportedly said at a conference in Hong Kong.

An official at HSBC’s Payments and Cash Management (Europe division) contends that the surge in the Yuan has impacted the global payments market. That Britain represents the largest trading hub for China outside Hong Kong — highlights the importance that European countries are attaching to commercial ties with China. Meanwhile other vital financial centers such as Frankfurt and Paris are said to be eager to escalate RMB trading.

China still faces several hurdles in having a truly international currency. Capital controls and a lack of regulatory transparency make financial institutions reluctant to invest in Chinese assets. However, China is showing signs that is relaxing some of its rules used to control the currency.

As the yuan gains more international clout, and value, Beijing might be emboldened to open up further. In order to strengthen the yuan position, China’s Central Bank regulated the Yuan by fixing the dollar-exchange-rate, while also liberalizing it on capital markets. This was a smart move: Beijing’s share of international trade and GDP rose to around 10 to 12 percent.

History has shown that wherever China shoots its arrow, it hits the intended target. It will not be long before the Yuan increases its world market share from 1.68 percent to a more satisfactory level. Currently, the dollar still holds first position. It is claiming more than 43 percent of the market share with the Euro accounting for approximately 29 percent. All of which indicates that the road ahead for China to overtake these currencies will be a long one.

Latin American Post | Diana Ramos
Copy edited by Marcela Peñaloza