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Tuesday, December 7, 2010

Yuan As a reserve currency

The People’s Bank of China has ended a two-year peg to the dollar and manage the yuan or renminbi (RMB) with reference to a basket of currencies. As a result of this the currency closed at its strongest level since 1993. The Yuan is permitted to rise or fall 0.5 per cent from daily reference rate. It has been felt that Yuan has been kept at an artificially low level and has significantly contributed to the global financial crisis.
In order to mitigate the possibility of third recession, the Asian Development Bank (ADB) has proposed the Yuan as an alternative to the US dollar. The ADB study, entitled “The Future Global Reserve System — An Asian Perspective”, recommended having Asia’s vast currency reserves play a more important role in stabilising the global financial system, through swap lines, the International Monetary Fund’s Special Drawing Rights (SDRs) and other borrowing. As per the ADB report undertaken by 11 economists including Joseph Stiglitz and Barry Eichengren, once the Yuan becomes more convertible, it can gradually grow to become an international currency and by 2035, it can be expected that Yuan may share about 3 to 12 per cent of international reserves. ADB says that a new global reserve system is absolutely essential if the global economy could be restored and sustained to prosperity.
A stronger yuan should boost consumption in China, while reducing its dependence on exports, thus helping the process of “global rebalancing. China is the world’s second largest oil consumer, using one in every 10 barrels produced. China is also the top consumer of iron ore, copper and aluminum and the world’s largest buyer of soybeans. As per the data of IMF, since 2000, global foreign exchange reserves have grown by staggering $6.15 trillion and stood at $8.09 trillion at the end of 2009, or 14 per cent of the world’s gross domestic product. China and Japan together hold about 43 per cent of global reserves. It has been understood that a stronger Yuan would also mark the end of an epoch for the Bretton Woods II strategy of governments trying to use a depreciated currency to facilitate export-led growth.
It is pertinent to point out that China had let the Yuan to rise by about 20 per cent beginning in 2005, but halted its rise in 2008. China has kept the Yuan at about 6.83 per dollar since July 2008, aiding the nation’s exporters and fuelling tensions with trade partners.
Argument against Yuan as global reserve currency:
1.       China has only $4 trillion economy whereas the USA has a $14 trillion.
2.       Yuan still is a pegged currency and dollars are free-float. China would continue to “manage” its currency through its heavy intervention by its central bank. It is necessary to go all-out for free-float for a global reserve currency. It is important to note that without full capital account convertibility, the currency cannot be called fully convertible.
3.       China cannot be accepted as a super power like USA and mutual political relations and equations with most of the countries with China would not permit the global transaction in the form of Yuan.
4.       Most of the countries are capitalist and they would never trust Chinese socialist government in major developments and at the theoretical level they still view their economic interests as diametrically opposed to the socialist countries.
5.       There is an absence of a large market for yuan-denominated bonds. One key sign of acceptance as a reserve currency would be if Western countries such as the U.S. purchased bonds denominated in yuan and sold at market rates. Until now, yuandenominated bonds have been sold only by Chinese banks, along with multilateral banks such as the Asian Development Bank and International Finance Corporation, and the bonds have been sold only in China.
Argument for Yuan as global reserve currency:
1.      The dominance of US has been considerably reduced and the relevance of Bretton Woods’s system needs to be re-evaluated. It has to be mentioned that Bretton Woods’s system had provided the basis for US dollar as the reserve currency. The world needs an alternative reserve currency. The U.S. trade deficit with China reached $71 billion for the first four months of the year, up 5.8 percent from the same period of 2009.
2.      The US dollars ravaged by the global economic recession, despite the fiscal stimulus package of Obama administration, still not able to retrieve its old position.
3.      There has been a perceptible trend in shifting the trends of economic dominance from West to East.
4.      China has maintained a growth rate of 8.5 per cent despite the global recession and this indicates the strong foundation of Chinese economy. China’s economy surged 11.9 per cent in the first quarter of this year and exports jumped to almost 50 per cent over a year earlier despite the Greek crisis. China is the biggest trading partner of European Union.
5.      China holds as much as $2 trillion in reserves and recent step to permit Yuan to appreciate signals towards Chinese ambition of making Yuan as global reserve currency. China has unleashed an era of flexible currency.
6.      It has been argued that a world in frequent phases of slowdown needs multi-currency reserve structure.
7.      Noble Laureate Joseph Stiglitz has opined that if China goes for improved and flexible monetary regime, then Yuan may play a role a stabililizing role at the global and regional level. Commodities and oil also surged, as a stronger currency would give the world’s third-biggest economy more purchasing power to buy foreign goods, which would be positive for world trade, especially for commodity exporters such as Australia, Brazil, Canada and New Zealand. Crude rose more than 1 per cent, while copper and zinc traded in Shanghai both rose by their daily limits.
8.      World Bank President Robert Zoellick has said in 15 years the Chinese yuan can become an alternative to US dollar as a global reserve currency, with China’s fast economic growth and efforts to internationalise the currency. Robert Zoellick, agreed: “Ultimately, that’s a good thing. And ultimately it’s good if you’ve got, I think, some multipolarity of reserve currencies to create, to make sure that people manage them well.”
9.      Since mid-December 2008, Beijing has signed currency swap contracts worth 650 billion yuan (about $95 billion) with central banks in South Korea, Malaysia, Belarus, Indonesia and Argentina and Hong Kong. These swap accords allow other overseas central banks to sell yuan to local importers who want to buy Chinese goods.

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