MARKET ANALYSIS
to date, its currency has lagged in global trade and capital markets. Prior to recent reforms the RMB was strictly a domestic currency with few international characteristics. Things are now changing the currency is internationalising at pace with the Chinese Government’s ultimate ambition to make the RMB a global reserve currency for investment, trade and settlement purposes.
A
This push is partly because China feels trapped by relying on the US dollar as the principal unit of
lready the world’s second largest economy, China is likely to be the biggest by the 2030s. It is already the world’s largest exporter. Yet
of the RMB is fortuitous because the world is keen to acquire new reserve assets and the spectrum of investors from retail to central banks and sovereign wealth funds is looking to diversify away from the US dollar over time, particularly given concerns raised over potential debasement as a result of quantitative easing.
Chinese policy makers have also mentioned the IMF’s Special Drawing Right (SDR) as a potential alternative reserve currency but this looks like a low- probability event. In terms of other emerging markets currencies playing such a role, the potential also seems to be limited. Russian politicians want a group of regional reserve currencies to replace the dollar in regional trade but little has been achieved so far. There has also been some discussion regarding using the Brazilian real to settle trade between Brazil and some of its trading partners but we are not optimistic DERXW VLJQLÀFDQW SURJUHVV LQ WKH QHDU WHUP
China has no aversion to the dollar per se but to potential dollar weakness and particularly its implications for accumulated external savings, much of them held in US treasuries and other dollar- denominated assets.
The authorities in China fear that dollar weakness could lead to substantial losses in the local currency value of these dollar assets. This also explains their vocal opposition to quantitative easing from the Federal Reserve, given the belief that it would serve only to drag the dollar lower.
exchange for its exports and the store of value for the lion’s share of its accumulated foreign exchange reserves holdings but also because – like the US and the UK in the past – policy makers have come WR DSSUHFLDWH WKH EHQHÀWV RI KDYLQJ D JOREDO UHVHUYH currency.
Reserve currencies
Reserve currencies play a crucial global role for both WKH SULYDWH DQG RIÀFLDO VHFWRUV $V WUDGH YHKLFOHV WKH\ facilitate processes such as the on-going globalisation of the supply chain and are dominant as stores of value for accumulated wealth holdings, particularly emerging markets central bank holdings of foreign exchange reserves. The on-going internationalisation
China owns so many dollars that it can’t sell them without driving the price down against itself. Given the nature of this starting point and liquidity constraints, the shift away from the dollar’s global dominance will necessarily take time. However, with such high stakes, China has been at the forefront of the reserve currency debate, actively looking for possibilities to diversify away from the dollar. Gold DQG FRPPRGLWLHV KDYH EHHQ EHQHÀFLDULHV DQG LQ RXU view, will continue to be.
*ROG DQG RWKHU SUHFLRXV PHWDOV DUH WKH RQO\ ÀQDQFLDO assets that are not someone else’s liabilities. China has increased its gold holdings rapidly in recent years and last year China and India together accounted for more than half of gold demand globally. But the JROG PDUNHW DQG ÁRZV LQWR LW DUH UHODWLYHO\ VPDOO LQ relation to global FX reserves. Less than 5% of China’s
Autumn 2011 | Currency Investor 41
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