Following the most recent shift ‘away’ from a USD-centric world (with the China-Australia direct currency convertibility), it seems the possibility of China’s Yuan as the next global reserve currency is getting closer. The Brits, Germans, and now the Swiss (who just signed a free-trade-agreement with China) are all actively vying to become Europe’s Yuan trading hub as it seems the long line of developments to internationalize the currency over the past two years. As Bundesbank board member Joachim Nagel noted in a speech entitled “Reniminbi as a potential reserve currency” this week, “the Chinese currency is well on its way to becoming one of the future global reserve currencies.” He noted that, although the USD is still the most commonly-used currency for settling trade with China; from virtually zero in 2010, the Yuan is used to settle over 12% of trading transactions now – and is likley to increase further.
Remember, nothing lasts forever:
This latest development in global currency relations should come as no surprise to those who have followed our series on China’s slow but certain internationalization of its currency over the past two years. To wit: “World’s Second (China) And Third Largest (Japan) Economies To Bypass Dollar, Engage In Direct Currency Trade“, “China, Russia Drop Dollar In Bilateral Trade“, “China And Iran To Bypass Dollar, Plan Oil Barter System“, “India and Japan sign new $15bn currency swap agreement“, “Iran, Russia Replace Dollar With Rial, Ruble in Trade, Fars Says“, “India Joins Asian Dollar Exclusion Zone, Will Transact With Iran In Rupees“, “The USD Trap Is Closing: Dollar Exclusion Zone Crosses The Pacific As Brazil Signs China Currency Swap“, and “Thanks, World Reserve Currency, But No Thanks: Australia And China To Enable Direct Currency Convertibility.”
Renminbi as a potential reserve currency
According to Bundesbank Executive Board member Joachim Nagel, the Chinese currency is well on its way to becoming one of the future global reserve currencies. This potential stems from the renminbi’s increasing convertibility, he said at a conference of the Chamber of Industry and Commerce in Frankfurt.
He emphasised that although the US dollar is currently the most commonly used currency for settling trade with China, the significance of the renminbi has increased greatly over the last few years. He underlined this by referring to figures published by SWIFT, which indicate that the percentage of trading transactions settled in renminbi jumped from virtually zero to around 12% between 2010 and 2012 – and is likely to increase further. In view of this, he pointed out that the renminbi has already achieved the status of a trading currency.
Drawing parallels to the Deutsche Mark
Mr Nagel compared China’s growing importance with the German economic miracle of the 1950s and drew parallels between the renminbi’s current growth and the development of the Deutsche Mark. Thanks to the recovery of the German economy, the country accumulated a large volume of foreign exchange reserves and the Deutsche Mark acquired the status of a global investment and reserve currency, he explained. He anticipates that “the renminbi is certain to have similar long-term prospects if market access is liberalised further”. Mr Nagel backed up his comments by citing a survey of reserve managers carried out by RBS. The survey revealed that 14% of reserve managers have already invested in renminbi, with 37% of respondents considering investing in the currency in the next five to ten years.
Mr Nagel sees the renminbi as currently transitioning from a being trading currency to an investment currency. While both inward and outward direct investment is now possible, portfolio investments will continue to be regulated, he remarked, adding that improvements are expected in this area. “The internationalisation process of the Chinese currency is taking place more gradually than was the case with the Deutsche Mark, which, at times, was subject to radical upheaval”, he added. Mr Nagel recalled, in this context, the collapse of the Bretton Woods system of fixed exchange rates and the crisis in the European Monetary System at the beginning of the 1990s.
Renminbi financial centre in Frankfurt
Mr Nagel noted that “given China’s growing economic importance, the internationalisation of the renminbi seems long overdue”. He explained the Chinese government’s decision to employ offshore trading centres, which would allow China to establish its currency internationally, while protecting its domestic financial system. Hong Kong, where around 80% of all renminbi trade is settled, is by far the most important trading centre for the currency, with London and Singapore each accounting for 4% of renminbi trade since mid-2012. He added that the expansion of the market has led to the growing significance of other financial centres for renminbi.
Mr Nagel welcomed Frankfurt’s endeavour to position itself as a trading hub for the Chinese currency, calling it a step in the right direction, towards the free movement of capital. “The high level of interaction between China’s and Germany’s real economies highlights the necessity for a more active renminbi trade”, Mr Nagel remarked, “perhaps even using Germany as a hub”
Full Speech available here.