Washington Versus Beijing: Curbing The Yuan

By Valentin Katasonov

There has been a rise in tensions in relations between the U.S. and China in all directions. Some of the problem issues relating to the monetary and financial sphere include: the yuan’s status as a reserve currency; the convertibility of the yuan; the artificially low exchange rate of the yuan against the U.S. dollar; China’s inferior role in the IMF given its position in the global economy; restrictions on the access of U.S. capital to China’s banking sector; and the curbing of Chinese investments in the U.S. economy.

One of the monetary and financial tensions between China and the U.S. is the possibility of the yuan becoming a reserve currency. According to the accepted definition, a reserve currency is a currency that makes up part of a state’s international reserves. More often than not these are central bank reserves, but they can also be Treasury reserves. Information on the currency structure of the world’s international reserves is given below (Table 1).

Table 1.

The world’s foreign exchange reserves broken down into types of currency (as of 31 December 2014)

Source: International Monetary Fund

Many countries do not reveal, or do not reveal in full, the make-up of their international reserves. Nearly half of the total amount of international reserves is “unallocated”. In the section of the foreign exchange reserves that contains information on the types of currency, the yuan is not there at all. Besides the U.S. dollar and the euro, the table also provides information on the Japanese yen, the British pound sterling, the Canadian and Australian dollars and the Swiss franc, but there is no Chinese currency.

Yet in 2014, the Chinese economy overtook the U.S. economy to become the largest in the world. Such is the official assessment of the International Monetary Fund. China has passed the U.S. in terms of GDP measured in dollars at purchasing power parity (PPP). In 2014, China’s PPP GDP was $17.6 trillion, and U.S. GDP was less for the first time at $17.4 trillion. According to the latest IMF data, China’s share of global GDP has grown to 16.48 per cent compared to U.S. growth of 16.28 per cent. This trend is irreversible: according to IMF forecasts, by next year the gap in the size of the two global economic leaders’ PPP GDP will be more than $900 billion in China’s favour and by 2019, China’s PPP GDP will have outstripped America’s by almost $5 trillion.

The list of currencies included in the IMF statistics feature the monetary units of countries whose GDP is immeasurably small in comparison to China’s GDP (Table 2).

Table 2.

GDP of China and other countries in 2013 (calculated at PPP)

Source: International Monetary Fund

It is clear that there is an extreme asymmetry between the GDP of individual countries and the distribution of international reserves by currency type. This asymmetry is striking evidence of the inequitable global financial order that the West, led by America, developed in the decades following the Second World War. Those countries who gain reserve-currency status for their monetary units get undeniable benefits. The issuing country of a reserve currency is able to use its national currency to cover its balance of payments deficit. Since the beginning of the 1970s, the U.S. has been using the dollar to cover its trade balance deficit. Reserve-currency status also helps to strengthen the position of national corporations when competing on the global market.

Western countries are parasitic on others due to the special status of their currencies. This parasitism is particularly noticeable against the paradoxical discrepancy between the status of China’s currency and China’s position in the global economy and global trade. This discrepancy is partially mitigated by the fact that a number of countries are building up the Chinese currency in their reserves, but are not advertising the fact. IMF member countries are disguising the practice by taking advantage of their right not to fully disclose the foreign exchange structure of their international reserves. Judging by fairly sketchy data, at least thirty countries hold the yuan in their reserves.

The accumulation of yuan in reserves is still going on. This is being facilitated by steps taken by China and its partners such as the signing of bilateral currency swap agreements (at the beginning of 2015, there were 27 of these agreements in effect), the organisation of yuan trading on a number of currency exchanges around the world, and the creation of offshore clearing centres (for yuan transactions) in Singapore, London, Paris, Frankfurt, Luxembourg, Seoul and Hong Kong. In addition, a number of countries in the West, including Great Britain, have issued bonds in the Chinese currency. In other words, demand for the yuan is growing throughout the world, and there is nothing that Washington can do about it.

As well as a de facto reserve currency, there is also the concept of a de jure reserve currency. This status is awarded to a monetary unit by decision of the International Monetary Fund. The IMF is establishing a narrow circle of monetary units to be included in this so-called reserve currency basket. And it, in turn, is necessary to establish the rate for a supranational monetary unit known as special drawing rights (SDR).

The issue of SDRs began in 1969 when the Bretton Woods system had already more or less stopped functioning. The basket initially included five currencies, but with the advent of the euro, the German mark and the French franc were withdrawn. Today, the basket includes four currencies: the U.S. dollar, the euro, the yen and the pound sterling. The SDR exchange rate is calculated on the basis of the weighted average cost of these currencies. The inclusion of a currency in the basket raises its influence noticeably. Talk that the yuan should become the fifth currency in the basket has been going on for a long time, but Washington has done everything it can to stop it from happening, having realised that replenishing the basket with the yuan will be yet another severe blow to the dollar.

Every five years, the IMF carries out a review of the reserve currency basket. The next review is due at the end of 2015. Experts believe that the Chinese currency meets all the requirements of a reserve currency. In March, the managing director of the IMF, Christine Lagarde, noted in an interview with Western media outlets that the decision to include the yuan in the basket was overdue and that it was only a matter of time. In this instance, Lagarde was probably reflecting the interests of European countries. The volume of trade between China and Europe is huge, and the yuan is needed in the reserves of European countries. This would require a formal decision by the IMF, however, since a natural build-up of the Chinese currency by Europeans would give rise to constant peremptory shouts from Washington.

Washington is trying to be proactive and is already putting pressure on its allies, convincing them that the yuan cannot possibly be included in the reserve currency basket. This was stated by the U.S. Secretary of the Treasury Jacob Lew at the beginning of April. Lew did not really delve into the finer points of the issue, but merely gave his latest helping of ‘recommendations’ to Beijing. Allegedly, to comply with international requirements, China will need to carry out more wide-ranging reforms in the monetary sector, including weakening its control on the movement of capital and shifting to a floating exchange rate for the yuan. These are the usual platitudes in the spirit of economic liberalism that Washington habitually addresses to all countries outside of the ‘golden billion’. For a long time, these platitudes were usually repeated by the IMF, but it is going through a crisis at present and is no longer able to treat Beijing so dictatorially.

According to some reports, a number of countries (most notably Germany and Australia) might support China during the currency basket review in December 2015. That such a scenario may happen is also evidenced by the fact that in March of this year, despite pressure from Washington, many countries in the West applied to participate in the capital of the Asian Infrastructure Investment Bank (AIIB), set up under the aegis of China.

Washington could obviously vote against granting the yuan the status of a currency in the reserve currency basket. For the time being, the U.S. has the controlling share (around 17 per cent), but it is worth bearing in mind the overall setup of the IMF. Since the end of 2010, Washington has been blocking a reform of the Fund that would bring the IMF members’ quotas, and primarily China’s quota, in line with reality. Washington’s vote against the yuan could put paid to the International Monetary Fund once and for all, and this would lead to a radical restructuring of the global financial order that would not be to the benefit of Washington and the U.S. dollar.

The statements, views, and opinions expressed in this article are solely those of the author and do not necessarily represent those of EMerging Equity.

Courtesy of Strategic Culture Foundation, © 2015

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