The IMF just named the Chinese yuan to its basket of reserve currencies, a move hailed by many as a sign that the yuan is finally a major global currency, up there with the US dollar, euro, British pound and Japanese yen.
The IMF’s case for inclusion centers on China being the world’s third largest exporter, and, it says, the yuan being ”freely usable” (even though the yuan is not fully convertible into other currencies). The IMF’s able to perform that magic trick because it defines this as whether a currency is widely used for both global trade payments and currency-exchange trade.
Is the yuan either, though?
A closer look at the data reveal the yuan hasn’t truly become much more widely used than the Norwegian kronor. In fact, its recent rising popularity more likely reflects speculators’ one-way bet on the yuan’s appreciation against the dollar—an appeal that is now dimming fast.
Those who argue that the yuan should be eligible as a global reserve currency usually point to the fact that the yuan is now the fifth-most used currency for international payments, according to SWIFT, a firm that tracks global transactions.
If you look closer at the data, though, you’ll find that seven-tenths of those supposedly international yuan transactions are done in Hong Kong, says Ho-Fung Hung, professor at Johns Hopkins University and author of The China Boom: Why China Will Not Rule the World.
Hong Kong doesn’t exactly reflect overall international demand for the yuan. Though it has a separate legal and financial system, Hong Kong is also the primary financial channel through which mainland China interacts with the outside world.
“Beijing policy is to designate HK as a ‘wholesale’ center of RMB trade,” says Hung, “with HK being a safe offshore financial market for China under tight political control of Beijing.” That makes most of Hong Kong’s yuan transactions an extension of China’s economy, he adds, reflecting “the RMB-ization” of the territory’s economy (RMB is another term for yuan).
However, strip away Hong Kong’s influence, and the yuan claims only about 0.8% of international transactions—less than the Thai baht—notes Hung. Plus, SWIFTs don’t reflect a growing global use of the yuan so much as they do the appetite for speculation, says Logan Wright, economist at Rhodium Group.
“The point that everyone takes away from the SWIFT data is that the yuan is more commonly used in international finance and trade,” he says. “Maybe. But just as likely it reflects… RMB speculation or hedging of that speculation.”
One sign of speculation is sharp month-to-month variation in yuan use—for instance, though the yuan ranked fourth in SWIFT’s data in August, it fell to fifth place in September.
Another even more glaring sign that offshore yuan demand has been driven by speculation, says Wright, is the precipitous drop in yuan deposits held in Hong Kong banks, which plummeted in both September and October—”RMB internationalization in reverse,” he calls it.
The context here is key. The drop came immediately after China’s Aug. 11 change to the way it controls the exchange rate, causing a slump in the yuan’s value. That sparked concerns that the yuan was overvalued and would depreciate still more. Since then, the government (and, it seems, its state-owned banks proxies) has been selling dollars like crazy to keep the yuan’s value stable.
If overseas demand for yuan was genuinely about the rising status of the currency as a unit of trade—and not about betting on how the yuan’s value will change—those offshore yuan deposits shouldn’t have shriveled so abruptly.
This is important because the yuan’s going global would be a good thing for China—and for the world. Some analysts argue that it will support the yuan’s value in the near term, taking pressure off the government to defend the currency. Demand for yuan-denominated assets should also cheapen financing for Chinese companies—an attractive possibility for a country with nearly $17 trillion in corporate debt.
Meanwhile, the IMF and the US government hope the yuan’s graduation to reserve currency status will encourage the Chinese government to continue to loosen its control over its financial system. Since China’s leaders view the yuan’s becoming a global reserve currency as a source of prestige, inclusion may encourage more cooperative leadership on sources of international tension.
Once the prestige wears off, however, it’s not clear the Chinese government will be willing to suffer the unpleasant side effects that come with being a global reserve currency—namely, providing the world with a large amount of yuan. For one, before the yuan becomes a true reserve currency, China must first stop effectively pegging to the dollar, says Derek Scissors, economist at the American Enterprise Institute. A sharp depreciation that would likely follow would widen the trade surplus, making it harder for China to send yuan overseas. The second step would be allowing the free flow of capital, particularly in and out of China’s bond market, which is currently mostly closed off to foreigner buyers. However, doing so would leave the value of state financial assets to the whims of global investors.
“The chances of the RMB becoming a true reserve currency in the next three years: 0,” says Scissors. “Chances in eight years: 1 in 50.”
What the data imply is that it’s going to be much harder to drum up foreign demand for yuan that one might have assumed, say, a year ago, when markets expected the yuan’s value to keep rising. And that may well leave the IMF with egg on its face.