Why The Yuan Will Replace The Dollar As The World’s Largest Reserve Currency

China owns world’s largest consumer population, and their economy is projected to become as large as the United States within the next ten years. With that in mind, …

China owns world’s largest consumer population, and their economy is projected to become as large as the United States within the next ten years. With that in mind, many believe that China’s growing status as an economic superpower will create a global market where the yuan, US dollar and euro will become the core of the world’s currency markets. Some analysts are even going so far as to say that the yuan will eventually surpass the US dollar as the world’s chief reserve currency. See the following article from Money Morning for more on this.

Back in May, just after he’d completed his latest investing tour of China, Money Morning Chief Investment Strategist Keith Fitz-Gerald made a bold prediction: China’s currency, the yuan, is destined to dethrone the U.S. dollar as the world’s chief reserve currency.

Earlier this week, Fitz-Gerald’s prediction acquired a powerful new disciple: Goldman Sachs Group Inc. (NYSE: GS) Chief Economist Jim O’Neill.

In an essay that’s part of a report published Friday for Chatham House, a London-based foreign-affairs researcher, O’Neill wrote that China’s yuan is destined to become a global reserve currency on par with the U.S. dollar or European euro.

China’s emergence as an economic superpower will escalate the demand for the Asian giant’s currency, which is also known as the renminbi, or “people’s money.” Beijing will “eventually” permit the yuan to trade freely on foreign-exchange markets, discarding the current system under which the government controls the currency’s value, wrote O’Neill, whose essay was part of the Chatham House report titled, “Beyond the Dollar: Rethinking the International Monetary System.”

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“As China moves in this direction, other large emerging economies will presumably gradually move in the same direction and the end result will be something approximating to today’s Western monetary system,” O’Neill wrote. “Under such a system, the renminbi, dollar and euro would all form the linchpin of the world’s currency markets.”

Back in May, in a news-analysis piece titled “China Seeks to Dethrone the Dollar, Transforming the Yuan into the Dominant Global Currency,” Money Morning’s Fitz-Gerald outlined a series of high-level currency swap agreements worth more than $95 billion (650 billion yuan) that China had reached with an array of nations – a core piece of a strategy Beijing is deploying to elevate the yuan’s global status.

Fitz-Gerald was actually among the group of investing gurus who years ago predicted that China would ascend to a position of world leadership. As part of that thesis, Fitz-Gerald also said that China’s currency would move up in importance and would one day become a key reserve currency.

When China initiated the currency-swap strategy last May, he issued a formal prediction that underscored those beliefs. “The Chinese yuan is already well on its way to becoming that globally accepted standard unit of exchange,” Fitz-Gerald wrote in the Money Morning essay. “In fact, I’d even go so far as to say the dollar’s days of dominance are numbered and with each new round of bailout chicanery, the clock is winding down ever faster.”

By subscribing to this viewpoint, Goldman Sachs Group’s O’Neill has given Fitz-Gerald’s prediction even greater credibility. Back in 2001, in a research paper titled “The World Needs Better Economic BRICs,” it was O’Neill who coined the term “The BRICs” to refer to the emerging economies of Brazil, Russia, India and China. That term has become so universal – having moved beyond specialty investing circles – that it’s even used in mainstream conversations today.

Of the four BRIC countries, China is likely to have the biggest impact in the near term. Sometime this year, in fact, the Asian giant is likely to leapfrog Japan to become the world’s No. 2 economy behind the United States. In the next 10 years, China is likely to approach the U.S. economy is size, O’Neill wrote.

Referring to O’Neill’s statements about the yuan’s potential to serve as a global-reserve currency, Money Morning’s Fitz-Gerald said that “I think a statement like this is a solid endorsement of what we’ve been saying for a number of years, now.” The Chatham House “Beyond the Dollar” report makes several recommendations, including the creation of a multi-currency-reserve system, and increased use of “Special Drawing Rights,” or SDRs, as a supranational currency, Bloomberg News reported. SDRs are a unit of account, based on a basket of currencies, used in International Monetary Fund transactions.

Created by the IMF in 1969 to support the Bretton Woods [Agreement] fixed-exchange-rate system, the SDR was redefined in 1973 as a basket of currencies. Today the SDR consists of the euro, Japanese yen, pound sterling, and U.S. dollar.

The Chatham House report stated that “the dollar-based monetary system is no longer adequate for a larger and more integrated world economy. Prominent developing economies are increasingly demanding to be included in any multilateral dialogue that aims to shape the new economic order.”

This is all a very logical progression, Fitz-Gerald says. “For 18 of last 20 centuries, China has had the world’s largest GDP,” Fitz-Gerald said. “Therefore it’s only logical that this country would eventually have the world’s largest reserve currency. If anything, the notion that America – with a mere 300 million people – can have a bigger economy than China, with 1.3 billion people, is the anomaly.” This transition will take years play out. And U.S. investors needn’t fear that it will serve as the death knell for the U.S. economy. “Contrary to what some people are going to say, I don’t think this spells the end of the dollar and I don’t think that this spells the end of the American economy,” Fitz-Gerald says. “But I do believe it will prompt a complete realignment of what we know to be the currency markets of today.”

This article has been republished from Money Morning. You can also view this article at
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