Can China’s renminbi be a leading foreign reserve currency?

The US dollar is still the king of foreign reserve currencies, followed by the euro at a distant second.

On the other hand, many are dismissing the Chinese renminbi as a possible major reserve currency to rival the dollar. Although it is already a reserve currency by itself, it is held at levels much lower than the Japanese yen and the British pound sterling in terms of global holdings.

So why is the renminbi being dismissed? This is mainly because it is managed under a fixed-exchange rate system, so the amount of renminbi in circulation has to be controlled in order to better manage the peg. This simply means that, for the naysayers, there cannot be enough Chinese currency for economies to hold due to the constriction of supply.

However, this argument rings hollow when one considers the fact that the US dollar itself surpassed the British pound sterling as the biggest reserve currency in the previous century at a time when the dollar was still pegged to gold.

Break away from the gold standard

This means that while the dollar was under a peg, it became the dominant currency reserve all the same. It was only in 1971 when the US broke away from the gold standard and the dollar became fiat money, with the US able to simply print more money whenever it needed without having to be constrained by anything. So clearly, having fiat money and printing so much money at will is not a prerequisite to being a dominant reserve currency, as the dollar was before 1971.

So why did the US dollar not lose its status when it was not tied up to the value of gold anymore and the US was printing dollars like mad?

The main reason for that is because there was demand for the dollar per se, initially because there was a real need for US output and, later, because Saudi Arabian oil had to be paid in US dollars (the “petrodollar”).

Real demand

All told, all the printed money by the US could simply flow outside and get stored as reserves for products paid in US dollars because there was a real demand for it.

Now consider China. Currently, it is still considered the world’s manufacturer, and its manufacturing output is sought globally. This means the renminbi has value because it can purchase desirable Chinese output.

Additionally, Saudi Arabian oil can now be purchased in renminbi, making the case for the “petroyuan” and creating more demand for renminbi, as was the case previously with petrodollars. With more countries moving out of US dollars as a result of the moves to diversify currency reserves, the renminbi is a natural candidate to replace whatever the dollar cedes in global reserves.

Likelihood of multipolarity

So, will the renminbi overtake the dollar?

Perhaps this question only matters in a “there can only be one” mindset, that is, if it is not the dollar, then it must be the renminbi, or vice versa. This need not be so. In the days before the absolute dominance of the US dollar, the norm was more of a multipolarity of major reserve currencies.*

Given the rising demand for the renminbi, it can likely take its place alongside the dollar and the euro as leading global currencies, and, if so, this might just be a return to an old normal of multipolarity rather than an overthrow of the US dollar by the renminbi.

* The Rise and Fall of the Dollar, or When did the Dollar replace the Sterling as the Leading International Currency? by Barry Eichengreen and Marc Flandreau (2008)

MARC BAUTISTA, CFA, is Vice President and Head of Research & Business Analytics at Metrobank, in charge of the bank’s macroeconomic, industry, and financial market analysis and research. He loves teaching finance and investments, portfolio management, statistics, financial derivatives, economics, etc. in a university setting. He plays guitar in a rock band and loves learning other languages, especially Spanish, promoting its recovery as a heritage language in the Philippines.