World Economy

Yuan Could Bring Stability to Global Economy

Yuan Could Bring Stability to Global EconomyYuan Could Bring Stability to Global Economy

With China’s yuan taking the biggest step yet toward joining the dollar and euro as a top-rank reserve currency, the global economy may be approaching an era of greater stability.

So say economists who highlight the dollar’s role in the biggest financial crises in recent decades. Drawn to the liquidity and security of the unit of the world’s biggest economy, investors and governments relied on the dollar and produced dislocations including historically low borrowing costs in the 2000s even as the Federal Reserve raised interest rates, Bloomberg reported.

Rushes toward the safety of the dollar challenged global policy makers in 2008 as money markets seized up, prompting the Fed to open swap lines with counterparts that remain in place today. China responded in 2009 with a call for reducing reliance on the dollar, with central bank Governor Zhou Xiaochuan floating the idea of a “super-sovereign” reserve currency.

While the proposal fell flat, Zhou and his allies began a campaign to win inclusion for the yuan in the International Monetary Fund’s special drawing rights unit. The SDR, as it’s called, is a kind of overdraft account for members of the IMF, convertible into dollars, euros, pounds and yen. The Washington-based fund’s staff said Friday that the yuan has now met the qualification terms for inclusion in the SDR.

 Dollar Dangers

“The current configuration of the global monetary-financial system that is centered and increasingly dominated by the dollar is not a stable or a sustainable one,” Stephen Jen, co-founder of SLJ Macro Partners LLP in London and a former IMF economist, wrote with colleague Joana Freire last week.

Some 87% of foreign exchange trading involves the dollar, the most recent survey by the Bank for International Settlements showed. “The role of the US dollar as the world’s dominant vehicle currency remains unchallenged,” the BIS said in 2013, noting that the euro had declined in the wake of the European debt crisis.

With the world’s second-largest economy and as the number-one trading nation, China may offer the global system a currency that can complement the dollar. For now, restrictions on the ability to take money in and out of China, and on what foreign investors can buy, mean the yuan’s role will be limited.

 Coming Inflows

Winning official reserve-currency status–still something that needs approval by the IMF’s executive board, and not on the cards until late 2016–would probably spur global central banks and sovereign wealth funds to put about $350 billion into the Chinese bond market over a five-year period, according to JPMorgan Chase & Co. That’s still a fraction of the $1.27 trillion worth of treasuries officially held by China.

Building on the SDR achievement to become a true international currency for funding and investing, along the lines of the euro and dollar, may take much longer.  

The yuan would become “the first developing country currency” with reserve status, said Daili Wang, a Singapore-based economist at Roubini Global Economics LLC. “This may increase instability to the international monetary system, as we saw after the RMB FX reform in August,” he said, using the initials for renminbi, another term for China’s currency.

 Chosen Savior

It’s a stretch to think that Beijing’s plan–shifting the export-driven country from emphasizing manufacturing and infrastructure to relying on public consumption–will spread sweet prosperity over the face of the earth, CBS News reported.

Optimism about Chinese consumers remains rife in some quarters, even after this summer’s devaluation of China’s currency, a tanking stock market and slowing economic growth. Goldman Sachs predicted in a recent report that China’s flourishing middle class and their hearty spending will buoy its economy and benefit the wider world. A McKinsey & Co. analysis struck a similarly bullish note.

The irony is that the world’s second-largest economic power is largely to blame for squelching international growth in the first place. China’s economic slowdown, to 6.9% in the third quarter from double-digits not long ago, has reverberated far and wide.

Citigroup sees a 55% chance of a worldwide recession within the next two years, chiefly courtesy of China’s slowdown. Commodity producers like Brazil have suffered as Chinese demand for its materials has flagged. Developed nations like Germany, which exports a lot of machinery to China, also feel the impact. Bad news out of China also typically shakes stock markets from New York to Tokyo.

Certainly, China’s deceleration from decades of torrid expansion is to be expected. After all, the US (still the No. 1 economy) followed the same pattern of pell-mell gains from the late 1800s through the past century, only to see it taper off. Since the 2008 financial crisis, the US economy has nudged up by only 2% or so annually. At least America’s growth is better than that of many other nations. (The US economy was $17.4 trillion last year, compared with $10.4 trillion for China, the World Bank says.)

Of course, tepid growth satisfies no one, and prompts politicians to call for rejuvenation schemes, some rather dubious.

Just as several American presidential candidates claim they can rev up economic output through tax cuts, Chinese leaders say they have their own key to improving the nation’s performance. Enter their chosen savior: the consumer.

Specifically, Beijing says, the answer is to bolster people’s spending, which will have a salutary and permanent ripple effect on its economy.