The issue of the Chinese yuan as a premier international currency has been around for quite some time. Right now, only 3% of international trade transaction is conducted in yuan and, correspondingly, central banks around the world keep only 3% of their international reserves in Yuan. To most, this is quite puzzling as China is the world's second-largest economy with a GDP portion of 13.04% of world GDP and is the world's largest exporter with a global market share of 14.7%.
The "big four" international reserve currencies, so-called traditional reserve currencies, are the US dollar, Euro, Japanese yen, and British pound. As of 2021, these currencies accounted for 91% of world foreign currency reserves. Similarly, the Bank of Thailand maintains 92% of the country's foreign currency reserves in these currencies despite the fact that China is our largest trading partner.
Why does the world neglect to use the yuan for trade payments and maintain it as a major part of its reserves? Those who subscribe to conspiracy theories might believe that it is because the West wants to suppress China's role in the world economy. But the real answer is that China wants it to be that way.
The issue of the role of the Yuan as an international currency has been renewed after Russia's invasion of Ukraine. Moscow has made it clear that it wants to stay away from the US dollar as much as possible and Russia has kept 16.9% of its foreign reserves in yuan -- far higher than the 3% world average. Friends of Russia, such as Saudi Arabia, have also indicated they would move from dollar-based transactions to yuan-based transactions. Foes of the US even say that this could be the beginning of the fall of US domination.
The IMF's working paper -- the Stealth Erosion of Dollar Dominance -- seems to support such a hypothesis. The paper found the share of the US dollar in international currency reserves dropped by 12% from 71% to 59%. However, this is far from being the downfall of the US dollar and its economic power.
First, the drop from 71% share to 59% happened slowly over the course of 20 years (1999-2021). Second, the drop is primarily due to expansions of exports from non-US countries. The US, which once controlled a 12.4% share of world exports, only had a market share of 8.1% in 2021. Third, this will surprise most, US dollar loss is not exclusively yuan gain. Only 25% of the decline in US dollars as an international reserve currency has been replaced by the yuan.
Some 23% of the decline has been replaced by the Canadian dollar and 20% by the Australian dollar. The rest is taken by world smaller currencies such as the Korean won (8%), Swedish krona (6%) and Singapore dollar (5%).
Why is there switching from the US dollar to minor currencies, but not the Chinese yuan? The answer lies in the law of demand and supply.
China prefers, or rather demands, that its exports are paid for in foreign currencies. While the share of Chinese products in the global market rose from 2.9% in 1999 to 14.7% in 2021, the use of the Chinese yuan merely increased to US$272 billion or 3.3% of the world's total reserve. As of 2021, the People's Bank of China, China's central bank, keeps 94% of foreign reserves in the big four currencies. One might notice that the ratio is higher than the global average and higher than that of the Bank of Thailand.
Although China is the world's number one exporter, it is also the world's number two importer with imported merchandise valued at over US$2 trillion a year. Foreign currencies, particularly the big four, are necessary for sustaining the Chinese economy.
It might not be surprising that China naturally wants foreign currencies, not its own currency, to pay for imports. How about the rest of the world? What happens if there are more countries wanting to transact in yuan instead of the US dollar?
For a start, Saudi Arabia, the world's largest exporter of oil, is in talks with the Chinese government about selling its oil to China in yuan domination instead of the US dollar. Many countries that dislike the domination of the US dollar could follow suit.
In principle, China would not like that. Because it means that more yuan will be circulated outside China. Do not forget that China is not a market-oriented economy where everybody has free access to its economy and financial markets. In fact, the yuan is not a free-floated currency but ia managed float currency, similar to the Thai baht exchange rate system prior to the 1997 crisis.
The People's Bank of China actively manages the exchange rate to get to the desired value regardless of market demand. Chinese authorities say that the valuation of the yuan is tied to a basket of currencies. This can only be achieved when the yuan supply is tightly controlled.
Right now, out of the total yuan supply of 240.5 trillion (1,269 trillion baht), only 1.7 trillion yuan is circulated outside China and less than a trillion yuan is being used for trade transactions. If the world were to have 20% of its foreign exchange reserves in yuan, the amount of yuan circulating outside China would have to increase to 10.6 trillion yuan. Most importantly, as world demand for yuan rises, the currency will appreciate sharply which will cause serious adverse effects on Chinese exports.
The possibility of the yuan replacing the US dollar as the prime international currency is extremely remote. If possible, it would take 30-50 years. However, in the meantime, we could see a more prominent role of the yuan as trade payments and international reserve but not to the point of becoming a significant international currency.
To be a truly international currency, China will have to do two crucial things which I do not think will happen in my lifetime. First, China has to become a democratic nation. By doing so, it has to abandon its non-market economic practices and adopt a free-market system where traders and investors have full access to its domestic financial market. Second, China has to admit the fact rising demand for the yuan would result in a steep appreciation of its currency. China will have to transform from selling "cheap products" to selling "quality products".
If these two conditions are not met, the chance of the Chinese yuan outranking the US dollar is none.
