Macroscope | Why China’s yuan is poised to be the next global super-currency

China’s yuan has a great opportunity to achieve super-currency status.

The major currencies have had a torrid time in recent years, raising huge question marks about their future reliability as reserve currencies in the global monetary system. The reputations of the US dollar, Japanese yen, euro and UK sterling have all taken a heavy pounding thanks to recession, deflation, currency debasing and political upheaval since the 2008 financial crash.

It is no wonder global investors, central banks and governments are feeling bruised and looking for better options. Other reserve currencies like the Canadian and Australian dollars and Swiss franc are too small to absorb the world’s great glut of monetary liquidity so there is a unique opportunity for the yuan, as a newly fledged reserve currency, to jump in and fill the gap.

It has only been a short while since the yuan was granted reserve currency status by the International Monetary Fund late last year, so it is still early days. The yuan’s inclusion in the IMF’s basket of reserve currencies, as recently as last month, means it will take some time before China emerges as one of the leading players in the global payments and reserves system.

To reach true reserve currency status, the yuan must meet three key criteria – cementing credibility, convertibility and confidence in the currency. It will be challenging but not impossible. Governments and multinational institutions must be certain China’s currency not only satisfies these conditions, but it is also backed by credible and transparent policies, in order to feel safe about diversifying their foreign exchange reserves in any significant size into yuan.

Currency reserve managers must have confidence that China remains fully committed to let the yuan function in a fully market-driven way, free from official meddling to gain a more competitive advantage in world trade. It is also imperative for China to develop deeper and more liquid capital markets to reinforce the yuan’s growing appeal to global investors.

Some pundits believe the yuan’s emergence as a fully-fledged major reserve currency could take decades. But the odds seem to be swinging in China’s favour. The competition is not much to write home about, especially for the world’s two most popular reserve currencies – the US dollar and the euro. The dollar’s dominance as a reserve currency is in long term decline, while the euro has been engulfed in a survival struggle in recent years.