The Future of the Yuan: China's Struggle to Internationalize Its Currency

By Mallaby, Sebastian; Wethington, Olin | Foreign Affairs, January/February 2012 | Go to article overview

The Future of the Yuan: China's Struggle to Internationalize Its Currency


Mallaby, Sebastian, Wethington, Olin, Foreign Affairs


According to a growing chorus of pundits and economists, China-already the world's most prolific exporter, largest sovereign creditor, and second-largest economy-will someday soon provide the world's reserve currency. According to this view, just as the dollar dethroned the British pound in the interwar years, so the yuan will soon displace the dollar, striking a blow to U.S. interests. As the economist Arvind Subramanian recently wrote, the yuan "could become the premier reserve currency by the end of this decade, or early next decade."

This view has gained traction as Chinese leaders have launched a concerted effort to internationalize the yuan. During the g-20 summit in November 2008, at the height of the financial crisis, Chinese president Hu Jintao called for "a new international financial order that is fair, just, inclusive, and orderly." Beijing soon began to encourage the use of its currency in international trade, swap arrangements between central banks, and bank deposits and bond issuances in Hong Kong. During the first six months of 2011, trade transactions settled in yuan totaled around $146 billion, a 13-fold increase over the same period during the previous year. By mid-2011, yuan deposits in Hong Kong equaled $85 billion, a roughly tenfold jump since Hu's 2008 statement. The yuan is already accepted as a form of payment in Mongolia, Pakistan, Thailand, and Vietnam. Chinese authorities have indicated that as soon as 2015, they want the yuan to be included in the basket of major currencies that determines the value of Special Drawing Rights (sdrs), the reserve asset issued by the International Monetary Fund. And Beijing has announced its intention to transform Shanghai into an international financial center by 2020.

There is also no denying that the dollar is vulnerable. Central banks traditionally hold foreign currency reserves to ensure their ability to buy imports. But today, more of the world's imported goods come from China than from the United States. Central banks also hold reserves to ensure their ability to service debt payments to foreigners. Yet such payments flow increasingly to China, and although China's lending is largely conducted in dollars, dominant creditors ultimately tend to insist on lending in their own currency. To make matters worse for the dollar, it is losing value- instead of storing it, as reserve currencies are expected to do. Meas - ured against the currencies of the United States' main trading partners, the dollar has lost a quarter of its value since the advent of the floating currency system in 1973. Over the past four decades, it has lost four-fifths of its purchasing power as measured against a basket of consumer goods. This decline makes central bankers in emerging economies understandably nervous about holding dollar reserves.

Yet the emerging narrative about the yuan's ascendance is mostly wrong. The global rise of China's currency will be slower than commonly predicted, and the yuan is more likely to assume a place among secondary reserve currencies-the euro, the yen, the Swiss franc, and the British pound-than it is to displace the dollar as the dominant one. Nor is it even clear that China wants the yuan to replace the dollar. Beijing's steps toward currency internationalization reflect not a fully formed, coherent long-term strategy but rather an evolving process shaped by splits among China's policymakers over the scope and speed of financial reform. Far from confirming the inevitability of the yuan's rise, China's uncertain effort to internationalize its currency has exposed the profound struggles that lie behind the country's larger push to transform its economic model.

THE RELUCTANT RISE OF INTERNATIONAL CURRENCIES

One might assume that as a country approaches great-power status, it will naturally attempt to internationalize its currency. In fact, rising powers have often done just the opposite. As the economist Jeffrey Frankel has shown, that is what the United States did in the interwar period and what Germany and Japan did in the 1970s, even though the currencies of all three countries later became international. …

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