Yuan the Next Reserve Currency?

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Even before he touched down in Washington, Hu Jintao had already caused something of a stir with remarks he made in an interview with The Washington Post.

Responding to questions on the global and Chinese economies, and the lessons that should be drawn from the 2008 international financial crisis, Hu listed a number of measures that China had taken, including adjusting its macroeconomic policies, adopting a proactive fiscal policy and moderately easy monetary policy, and ‘energetically’ promoting scientific innovation and technological upgrading.

But it was his remarks on the future of the dollar that really made a splash. Asked what he thought about the US dollar and the possibility of making the renminbi (yuan) an international currency, Hu said:

‘The current international currency system is the product of the past. As a major reserve currency, the US dollar is used in considerable amount of global trade in commodities as well as in most of the investment and financial transactions…It takes a long time for a country's currency to be widely accepted in the world. China has made important contribution to the world economy in terms of total economic output and trade, and the renminbi has played a role in the world economic development. But making the renminbi an international currency will be a fairly long process. ‘

Needless to say, this prompted much excitement among headline writers around the world, with the Fox News choice being perhaps a little more lowbrow than—but certainly in keeping with the tone of—many others, when it said: ‘Hu Disses the Dollar; Says U.S. System is a “Product of the Past”’

So, how realistic is it that the yuan will replace the dollar as the global currency any time soon?

It’s a question that Michael Pettis, a professor of finance at Peking University, has pondered. He shared his thoughts in an email that he said he’s happy for me to reproduce in full:

‘The expectations of the yuan being a reserve currency soon are similar to expectations about the yen twenty years ago, and in my opinion with even less justification.  Aside from all the obvious technical and governance issues that will make it very difficult, it isn't at all clear to me how the world will accumulate yuan in anywhere near sufficient amounts.  

‘Will China start running current account deficits equal to nearly 1/4 to 1/2 of 1 percent of global GDP, as the US has for the past 30 to 40 years?  Or will they suddenly change what has so far been a huge reluctance to permit portfolio inflows, and allow foreigners to buy stocks and bonds equal to perhaps anywhere from 4 percent to 7 percent of China's GDP (and of course FDI doesn't count)?  Without one or the other it’s pretty pointless to talk about the yuan becoming a major reserve and trading currency.  I just don't see either happening, at least any time during the next 30 years.’

For those interested in a more detailed take by Pettis on this issue I’d recommend a blog entry he wrote late last year on the issue here.

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