From Russia’s switch to the Yuan and the domiciliation of the external reserve of some African countries in Yuan, the Chinese Yuan is in a race to replace the U.S. Dollar as World’s global currency, but how possible is this? In the first place, how did the world come to accept the U.S. Dollar as the leading global currency? It happened during the First World War in 1914. Prior to the war, the gold standard was in place as countries held the volume of gold equivalent to the global supply of their currency. The British Pounds was also the leading currency at the time. To finance the war, major developed countries had to exchange their gold, and this was unsustainable to win the war. Consequently, there was a repudiation of gold for international reserves to dollar-denominated U.S. bonds. The resilience of the British Pounds fell through in 1917 when Britain had to borrow to finance the war. With the Bretton Woods agreement in 1944, countries decided to peg their currencies to the dollar, which, at the time, had the biggest gold backing.
A lot has changed since 1944 – the effect of the industrial revolution in the Americas and Europe is now second place to China’s manufacturing capacity; the collapse of the Bretton wood itself; multiple economic shock; and the resource-colonization of African economies. While the multiple play of these events has forced an evolution of global economics; the fact remains that replacing the U.S. Dollar is a herculean task. Maronoti (2022) noted that “the USD was involved in nearly 90% of global FX transactions in between 2001 and 2022, making it the single most traded currency in the FX market.” Additionally, “85% of trading in the spot, forward and swap markets features the USD in one leg of the transactions.” Considering that more than half of the global economy holds its external reserves in Dollars, the dominance of the dollar is difficult to sway. It should also be noted that the U.S. Dollar is backed by collateral mostly in the form of U.S. Treasury, federal agency, and government-sponsored enterprise securities. These collaterals are usually in high demand globally; hence, providing dedicated support for the Dollar.
Even if the Chinese Yuan were to replace the U.S. Dollar, it will take a considerable length of time for some reason. The Yuan has its offshore and onshore variant, which creates a parallel market for the currency. The onshore variant (CNY) is fixed by the state and there are difficulties converting the offshore to the onshore variant. Besides, there are only a few countries buying into the agenda of the Yuan as a global currency. The Chinese economy is equally not a completely a capitalist economy. As Man (2022) puts it, the Chinese capital market is not open. The allegation of currency manipulation is another major sabot to the Yuan’s quest to replace the Dollar. From a debt perspective, a sizable chunk of the global debt is held in US dollar, not Yuan. These factors mount a tall hurdle for the Yuan.
There is no doubt that China controls global trade, but there are varied factors affecting the global monetary system and global trade. It therefore suffices that being a global trade dealer does not suggest taking the lead in the global monetary system. While it offers some positional advantage, factors such as trust in the monetary regulator, historical evidence of the currency in supporting financial transactions, goodwill of the currency, stability of the currency, single exchange rate for paired currency, utilization by global monetary institutions, among other factors project the dollar in a good light relative to the Yuan. In the tussle for control, the US dollar still has the edge and there are a lot more requirements for the Yuan to meet to replace the Dollar.
Written by Michael Ogunremi
References
Maronoti, S. (2022). Revisiting the international role of the US dollar. BIS Quarterly Review
Man, A. (2022) The difference between onshore and offshore RMB (CNY & CNH) – and why it matters. Available at https://blog.currencycloud.com/the-difference-between-cny-and-cnh
Photo Credit
CNBC (https://www.cnbc.com/2022/09/06/why-chinas-central-bank-is-shoring-up-the-yuan.html)