ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Yuan as a Future Reserve Currency

China's Global Economic Power

The dollar has been the world's reserve currency for decades, but it is not difficult to see it yielding place to the yuan of China, a country that is already the world's largest economy in purchasing power parity terms, and the world's largest manufacturer and exporter.

The US dollar became the dominant reserve currency after the second world war. Earlier, in the gold standard era (roughly 1870 to the start of the first world war), the pound sterling was the most widely-used currency in global markets. Broadly speaking, the United Kingdom (UK) and the United States (US) were the largest economies in most of the 19th and 20th centuries, respectively. The gold standard collapsed in the interwar years, as did the importance of sterling. Under the Bretton Woods agreement of 1944 all currencies had a fixed parity with the dollar, the only currency that was freely convertible into gold at a fixed price. After the unilateral suspension of gold convertibility by the US in 1971, and relaxation of capital controls by most major economies, the fixed parities became difficult to maintain, and since the 1970s we are in an era of floating, volatile exchange rates. But the dollar has retained its status as the principal reserve currency: central banks hold over 60% of their reserves of foreign exchange in dollars.

The dollar’s role as the principal reserve currency also gives the US enormous political power. US economic sanctions can hurt any country badly: Iran and Russia are examples of two major countries whose ability to receive/make cross-border payments has been crippled by US sanctions. Many banks have been fined heavily for infringements of the sanctions: from Arab Bank to Standard Chartered to HSBC to BNP Paribas. As for US courts, recent decisions have disabled countries like Argentina from servicing their external debts. And the US has the “exorbitant privilege” of getting its external deficits financed in its domestic currency.

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