There is renewed speculation that China’s yuan will soon challenge the US dollar as the world’s reserve currency. This time, the impetus for such discussion was Chinese President Xi Jinping’s visit to the Middle East, where he stressed the reach of Chinese trade and also stated his wish for oil contracts to be settled in yuan rather than dollars, as is customary.

The Saudis appeared to be unconcerned. Such steps, while noteworthy, are by far short of Beijing’s long-standing goal of making the yuan the world’s leading reserve currency. China will have to overcome many more obstacles in order to achieve this.

Today, the yuan falls terribly short of meeting every major need of a global reserve. Even more difficult for Beijing, victory on the yuan will necessitate changes that the ruling communist party may deem unthinkable.

Global Recognition

For the yuan to replace the dollar, it will need to achieve considerably greater recognition as a commerce and import/export contracting currency than it already has.

According to data from the first half of 2022, just about 2% of worldwide import and export contracts were denominated or resolved in yuan. That is far higher than it was five or ten years ago, but it is still far short of the dollar, which accounts for roughly 75 percent of global trade contracts and settlement, much of it without even an American party participating.

Furthermore, the yuan lacks the requisite presence in currency trade. According to the Bank for International Settlements, the yuan gained significant momentum in terms of global currency trading this year. It received a boost since Western sanctions against Russia made Chinese connections desirable to anyone looking to buy or sell in Russia.

The yuan has eclipsed proportions of trading done in the Canadian, Australian, and Swiss francs, owing largely to that development. Despite this year’s remarkable surge, the yuan still accounts for only around 7% of global currency trading, and falls far short of the amount of currency traded in euros, Japan’s yen, or the pound sterling. It is still far behind the dollar, which controls almost 90% of all global currency trade.

Reserve Currency

Central banks’ preferences for holding each currency in reserve illuminate the yuan’s shortcomings from a different angle. Despite the fact that 70 central banks have yuan in reserve, a substantially higher number than a few years ago, the International Monetary Fund (IMF) estimates that these assets account for only 2.25 percent of the global total. That figure falls short of the euro, which accounts for 20.6 percent of these reserves, or the yen, which accounts for 5.8 percent.

The yuan’s role is unquestionably inferior to that of the dollar, which accounts for approximately 59 percent of these reserves.

As should be obvious from the trade proportions mentioned above, the dollar should have a bigger proportion of central bank reserves than it does. This distinction is explained by the role of diplomacy and politics in this domain.

One of the most serious shortcomings of the yuan is its lack of backing from financial markets, which is a third and critical requirement for a reserve currency. Because importers, exporters, and those who support them financially must own assets in the reserve, markets denominated in it must offer a diverse variety of investment possibilities – short-term deposits, for example, longer-term bonds, equities, options, futures, forward contracts, and the like.

Acceptable financial markets must also allow consumers to move in and out of such investments swiftly and conveniently, with maximum flexibility and at the lowest possible cost. Dollar-based markets, both in the US and elsewhere, provide enough of such support. Yuan-based markets, on the other hand, are significantly thinner and much more strictly controlled by Beijing officials.

Still Needs to Grow

A study of the relative sizes of financial markets in the United States and China reveals this distinction.

The US equities markets account for around 33% of all worldwide stocks, while China’s stock market accounts for slightly less than 8% of the global total. In the case of bonds, the figures are 39% and 17%, respectively. As significant as these disparities are, they do not convey the much more significant difference in the types of investment and trading vehicles available in dollar-based markets but are limited or non-existent in yuan-based markets.

As China’s economy expands, so will the yuan’s share of global trade, currency trading, and even reserves held by the world’s central banks. It will, however, take a long time to threaten the dollar, especially as China’s economy and commerce are expected to rise at a slower rate than previously.

Furthermore, the inescapable communist demand for control makes it highly unlikely that China will ever allow being open, flexible financial markets required to underpin a global reserve currency. Unless China substantially changes, it is more likely that another currency or system will replace the dollar before the yuan has a chance, but nothing is on the horizon at the moment.

For More Stocks And Investment Related News, Click Here.