Global Currency Dollar: What Next? Is Yuan Currency to Replace or Other

Global Currency Dollar: What Next?
                         Is Yuan Currency to Replace or Other

Name of Author: Rajan J.Nandola
Designation: Asst.Prof.
Organization: Thakur college of Science and Commerce.
Address: Thakur College of Science and Commerce, Thakur village, Santa Nagar, Kandivali (E),
Mumbai-400101
E-mail ID: rajan20202000@yahoo.com, rajan20202000@live.com.

Name of Co-Author: Dipti. Deshpande
E-mail ID: dipti6us@gmail.com

Abstract: The global reserve currency is the one which forms the largest proportion of the
holdings of central banks. More broadly, it is also the currency most likely to be accepted by
merchants worldwide. The debate about whether the dollar will be replaced by the yuan is a bit
of a red herring because such a shift will not occur quickly. As of 2010, about 60% of all
foreign-exchange reserves were denominated in dollars, giving the US currency a critical mass.
Investors are still comfortable with holding it; despite the country's fiscal problems, in times of
crisis, the dollar is regarded as a haven. It will take a long while for international investors to
become confident that a Communist-led government will always respect their rights. The Yuan
has the potential but it will take another decade or two if china starts promoting the currency
strongly. If we see the macro-conditions it is in favor of china but have to improve the law. Even
euro was having the same view but the current crisis going on in European countries may not be
favourable for the currency in the international market. Well this had to be look after in the
further analysis.
Purpose – The purpose of this research paper is to find out whether Yuan or any other currency
may replace dollar in terms of reserve currency or trading currency or whether the Bretton woods
system would be revisited if crisis occurs.

Design/methodology/approach –
   1) The Research will be mainly based on secondary Data collection, analysis and
      interpretation.

   2) Use of examples, charts and tables will be made to explain the intricacies of the Concept.

3) Article from Journals and Reference Books will be referred for understanding the reasons
      and the facts for the depreciation of the Indian Currency.

Findings – The findings would depend upon the analysis done, but according to the literature it
is found that the dollar would remain a reserve currency more 15 to 20 years but still the opposite
could be expected.

Research limitations/implications – The limitation of this paper is that the findings may
or may not happen if the macro economic conditions of the countries change dramatically.
Practical implications – The implication of the paper is to just understand whether there
will be drastic change over an international currency market or will remain the same

Originality/value – The charts and analysis will be used by taking into consideration by
using some econometric model.

Keywords: Bretton Woods pact, multipolarity, hyper-efficient markets, etc.

Executive Summary:
   The paper is apropos, if any probability of Yuan becoming the next world reserve currency?
As we know dollar has played a dominant role as a reserve currency. After the 1978 and 2007
World Crisis, dollar’s position has changed as Current account deficit and US debt has increased.
In 1980 the US debt as a percentage of GDP was 25.777% which increased to 45.936% in 1990
and in 20th century increased to 73.101% for 2010. Meanwhile, Yuan’s exports to all Asian
countries and World have increased because the labour is cheap in china and products are
exported at very lower prices. This has affected the local markets production of different
countries as Chinese products are cheap. With this GDP of china has been increasing in 1990 it
was 3.8% which increase to double in 2000 which was 8.4% and in 2011 it was 9.1% (GDP
Growth Annual, The World Bank). China’s currency Yuan or (REINMIBI) has a long way to
become a World reserve currency because even after dollar, Euro, SDRs the country has to be
politically strong, Economic size, Trade and External Financial Strength, Economic reforms also
play an important part. China’s relationship with major economies such as US, Japan, India and
Russia will also determine the success of Yuan. If China is unable to garner the support of these
economies, which are expected together constitute around 60% of World GDP in 2030, the
crowing of the Yuan as the global reserve currency would be next to impossible. (Nishant, 2010)
We will support our thought with some data and facts.
Preamble
       Since 1940s, U.S. dollar has served as a main reserve currency of the world. Dollars are
used throughout the World as medium of exchange and Unit of Account, and many nations store
wealth in dollar - denominated assets such as Treasury Securities. (Carbaugh and Hedrick, 2009).
The acceptance of Global currency reserve is generally determined as one of the form, largest
proportion holdings of central bank (which is accepted by Merchants Worldwide). A reserve
currency is determined by these fundamentals – the economic size of a country – includes GDP,
trade and external financial strength – the currency’s value should be preserved through low and
stable inflation by a country i.e macroeconomic stability. Even though Switzerland is a small
country Swiss Franc is used as a reserve currency. In today’s situation China has a chance to

overcome America reason being the rising US indebtness and china’s strong financial and
economic prowess. To put it other way China’s trade is large, although the economy is small, it
has become a net creditor to many nations and US has become a net debtor. As a store of value
Yuan exchange rate is expected to rise over a period of time and dollar’s value will decline.
Nations like Nigeria and Chile want to use Yuan as a reserve not only as asset but want to satisfy
private – public sector demand.
 China will take some 10 – 15 years to become a reserve currency, as it has to create a market
environment and policy to have Yuan as a global currency. Capital account is closed and that is
why Yuan is still not convertible and freely available. The financial system is repressed and
government controlled, with this the financial markets lack the sophistication to provide liquidity
for currency to be attractive.
Many economists are commenting that there are chances of Yuan appreciating by 1% and others
are arguing that if would depreciate by 1% for year 2012.
Dollar Dominance as a Global Currency:
The transition of dollar – pound, where US had started focusing on imports of raw materials and
exports of manufactured goods. Pound was playing the role of international reserve currency
built on the gold standard. After the World War I pound became very weak and Federal Reserve
was established in 1914. At that time US had high hopes of replacing Pound, but the aftermath
might have affected the overall stability of countries holding Pound as the reserve currency. In
1924 and 1927 US had helped Britain to restore the gold standard by lowering its discount rate.
The interest rate change was done to open the gap between dollar and Pound. With this interest
changes Britain could return to Gold Standard at Pre – war Parity in 1925 and 1927. The reason
for The Great Depression (1929 – 1933) was because of Stock market crash as Britain could not
maintain the convertibility of pound, for this reason it left the gold standard in 1930. The fear of
dollar devaluing increased the conversion of dollar into gold by different countries. US
abandoned gold standard in 1933.
In the year 1934 dollar was most attractive currency because it was convertible in gold. In 1944
the Bretton Woods System was formed and dollar became the major reserve currency. According
to Mundell, the Bretton Woods System was neither a gold standard nor a dollar standard
(Mundell, 2003) it was both. When different nations started using dollar as a comfortable
exchange reserve currency dollar became stronger than any other currencies. About 64 percent of
World’s official foreign exchange reserves are held in dollars, and about 86 percent of daily
foreign exchange trades involves dollar (Bank of International Settlements, 2007).
The question is why was US eager to replace Pound?
Firstly, Compared to the 19th century US economy had relatively started opening in the 20th
Century. The involvement in World Trade and Capital markets increased.
Secondly, for dollar as a World dominant currency it was very convenient and cheap to get the
resources in its own currency. The concept of Seignorage {Seignorage is the revenue that the
government makes from the gap between the cost of printing notes and minting coins and there
nominal value. (Mc Neill, 2005)}. This means the risk of exchange rate fluctuation and
transaction cost for third party transactions.

Does Yuan have a chance of becoming next global currency?
In the developing countries China has performed well and a decade it will become a high income
country. The GDP growth is be almost same at US. From the fiscal management point China has

already performed similar or more than Europe and US. China’s economic prominence may shift
from exports to domestic consumption, as it has wealth has educed. China should float its
currency to have major economic power.
During the 1997/1998 Asian Crisis and the 2007- 2010 World Financial Crisis and Economic
Crisis, China has proved to be stabilizer for East Asia and the World (Gunther Schnabl, 2010).
Global Financial Crisis gave a fair chance of cross – border use of Yuan. Currency used
internationally provides lots of advantages. Firstly, it reduces the risk of exchange for private and
public sectors and transactions of domestic currency can be done internationally.
Secondly, financing of debt can be done by issuing its own currency. As the World’s banker, it
can also borrow “Short “at low rates and lend “long” at higher yields, earning the spread, while
as the world’s “venture capitalist”(Gourinchans P – O & H Rey, 2005), it can sell liquid,
domestic - currency – denominated high - debt domestic grade to finance (domestic – currency –
denominated) illiquid high return assets (Hausmann & Sturzenegger, 2006). Sustainability of net
debtor position could be achieved in long run.
Thirdly, International competitiveness could be beneficial by increasing the no of investors in
financial market.
Fourthly, the international use of reserve currency benefits as the value purchased per unit of
commodity is raised.
Comparison of China and US:
The inspiration of US and China is the same. In the past, switching of the reserve currency from
Pound to dollar shows a guideline, that chances of Yuan becoming reserve currency are by the
mid of 20th century. In the year 1870 Britain lost its position to US as a largest economy and
largest exporter. After this scenario, US became the net creditor and Britain became the net
debtor. In 1945, dollar became the World reserve currency replacing the Pound. Comparing to
the past at the time of Britain Pound and US dollar transition similar case is now with China
being the net creditor and US has become the net debtor. China is on its way to become the
largest exporter. The historic correlation doesn’t say that the addition of Yuan as a reserve
currency is not mind – boggling.
As the capital markets and foreign investment are concerned China’s opening has to be done,
which is already done by US and Britain way back.
China has to make currency fully convertible for transactions, by decreasing the restrictions on
money entering and leaving the country.
Continuing with the domestic financial reforms and making bond markets more liquid.
In 2009, selected companies used Yuan to settle transactions in Hong Kong, Macau and Asian
countries. China and Russia have entered in bilateral agreement for increasing the use of their
currencies. Countries like Malaysia, South Korea, Indonesia and Hong Kong have made
currency swap – agreements with China for making the import payments.
The US General government net debt Figure 1 which is percentage of GDP indicates the healthy
state of the economy. The debt – GDP ratio was 25.777 % in 1980 and in 2009 the debt – GDP
ratio was 58.83% by the year 2017 it is estimated to increase about 88.422 %, according the
IMF. The long term soundness of US debt is a question because the fiscal pressures are
increased. The international role of dollar has become uncertain due to the fiscal bearings. Large
scale deficits are there because under the perception of US treasury securities that dollar is the
World’s only safe and liquid asset. This is the reason why there is long – term unemployment
and hindered the progress of fiscal reforms. After a period US treasury will be less attractive in
the market because of such reasons.

Figure 1

Source: IMF,
In the year 1980 the current account balance of US was 0.083 % which increased to – 4.184 % in
the year 2000 and is expected to be – 3.53% by the year 2017, according to IMF. The reason is
US had spent more on imports compared to exports. Broadly speaking there are two main
theoretical explanations for the persistence of this deficit, as well as diverging views of its
seriousness. One focuses on the rise of export – oriented economies in Asia and the desirability
of investment in US capital markets. This explanation posits that there is a “global saving glut”
which sees emerging economies wishing to park their export revenues in a stable and liquid
currency, creating a surplus of capital inflows that must necessarily mirrored by a matching
deficit in the current account. The other main explanation focuses on the high level of US
government debt and dis – saving by US households, arguing that the current account deficit is
driven by profligate household spending that will persist in the absence of policy reforms (World
Economic Forum , 2012)
                                            Figure 2

Source: IMF
The International Investment Position shows the direct investment abroad has increased. The
dollar diplomacy was achieved by US as it became the net creditor in the 19th century.

                                        International Investment Position (End-Period Stocks)
                                                                                                                           In millions of U.S. dollars
                                           2000   2001   2002    2003    2004     2005    2006    2007    2008    2009         2010          2011
Assets
  Direct investment abroad                66,655  70,758  76,850  84,096  91,265 103,332 122,727 151,157 163,530 170,021        190,803       213,062
  Portfolio investment                    28,682  38,601  58,200 101,568 122,057 147,342 197,791 248,951 188,909 253,016        315,934       314,906
           Equity securities              12,478  18,516  22,895  38,466  40,127  46,350  89,251 138,580  70,296 119,306        150,981       137,036
           Debt securities                16,204  20,085  35,305  63,102  81,930 100,992 108,540 110,371 118,613 133,710        164,953       177,870
  Financial derivatives                        1     －       －        20     117   2,531   1,949   3,555  13,606  10,089         11,359         9,090
  Other investment                        67,343  73,944  68,727  72,686 109,340 128,564 149,038 180,399 191,273 206,076        220,390       259,573
           Monetary authorities              ….      ….      ….      ….      ….      ….      ….      ….      ….      ….             ….            ….
           General government                260     250     249     218     187     185     189     178     181     182            225           210
           Banks                          45,257  52,022  45,644  49,667  57,563  57,922  64,204  77,222  97,474  98,934         99,504       123,936
           Other sectors                  21,826  21,672  22,834  22,801  51,590  70,457  84,645 102,999  93,618 106,960        120,661       135,427
  Reserve assets                         111,370 126,572 166,046 211,139 246,561 257,952 270,840 275,027 296,389 352,967        387,206       390,590
  Total assets                          274,051 309,875 369,823 469,509 569,340 639,721 742,345 859,089 853,707 992,169      1,125,692     1,187,221
Liabilities
  Direct investment in R.O.C.(Taiwan)   19,521  34,746  30,069  37,262  38,283  43,175  50,211  48,640  45,458  55,756           64,203        56,154
  Portfolio investment                  30,064  43,014  38,237  81,390 100,805 141,605 189,749 215,235 110,114 203,000          253,475       195,669
           Equity securities            25,716  38,599  32,091  71,175  89,236 134,132 183,160 209,425 104,408 197,540          243,469       186,258
           Debt securities               4,348   4,415   6,146  10,215  11,569   7,473   6,589   5,810   5,706   5,460           10,006         9,411
  Financial derivatives                      5       －       －       －      84   3,126   2,504   3,850  15,250   9,890           10,139        10,000
  Other investment                      31,972  35,448  43,208  54,752  89,817 106,929 114,605 122,977 119,439 122,055          152,225       184,814
           Monetary authorities            ….      ….      ….      ….    4,476  13,727  10,416   3,116        －       －               －            －
           General government               23      16      10       4       3       3       2       2       1       1                －            －
           Banks                        26,396  27,311  34,205  46,985  60,619  58,843  62,491  77,978  78,243  68,708           85,607       107,038
           Other sectors                 5,553   8,121   8,993   7,763  24,719  34,356  41,696  41,881  41,195  53,346           66,618        77,776
   Total liabilities                   81,562 113,208 111,514 173,404 228,989 294,835 357,069 390,702 290,261 390,701          480,042       446,637
Net International Investment Position 192,489 196,667 258,309 296,105 340,351 344,886 385,276 468,387 563,446 601,468          645,650       740,584

Chinese Government's Official Web Portal

This diagram shows even though the position of population which will increase to about 1.47
billion in 2050 and for US it would be 419.9 million. From the trade point of view exports was
1.201 trillion for china which is still less than the exports of US. The imports are also less for
China. But a persistent growth in the economic reforms and politically strong relations with
different Asian and Developed countries would give a chance of Yuan replacing the dollar.

Source: Returers 2010

Conclusion:
      If the United States continues to spend and borrow at its present pace, and the Federal
Reserve maintains an easy monetary policy with low interest rates, the dollar’s status as a reserve
currency likely will continue to erode. When the world’s growing demand for liquidity subsides

as economic conditions return to normal, the United States could eventually lose the privilege of
being able to have the world’s main reserve currency. In spite of these uncertainties, there is a
shortage of currencies that could replace the dollar as the main reserve currency. To retain the
dollar’s reserve status, the Federal Reserve must be prepared to tighten its monetary reins. Doing
so will not be easy, particularly since large federal deficits probably will force lawmakers to
increase taxes, thus slowing future investment and growth. The demand for reserve currency has
increased over a decade and dollar doesn’t have a dominant role. Still China has a long way to
become the global currency.

Bibliography
Reports and Articles
   1. Will Chinese Yuan be the next reserve currency? Nishant
   2. Cost and benefits of running an international currency, by Papaiouannou and Portes
   3. The Yuan charge, by Reuters
   4. Yuan as reserve currency, by DB Research
   5. Will the dollar be dethroned as main reserve currency? , Global Economic Journal,
      Robert J. Carbaugh and David W. Hedrick
   6. The future of reserve currencies, by Benjamin J. Cohen, Professor of International
      Political Economy at the University of California, Santa Barbara
   7. China’s Yuan: The next reserve currency? , by Steve Le Vine
   8. CRS Report for congress China’s currency : Economic Issues and Options for U.S Trade
      Policy, Wayne M. Morrison and Marc Labonte

Websites and databases
  1. International monetary fund, IMF
  2. World Trade Organization, WTO
  3. World Bank
  4. Bank of International Settlements, BIS
  5. Social Science Research Network, SSRN
  6. HIS Global Insight