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posted on 27 November 2015

How Yuan Devaluations Could Hurt China's Reserve Currency Aspirations

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It is no secret that China has recently suffered a heavy economic downturn in recent weeks. Their stock market has gone from 5166 on 6/6/15 to 3436 on 11/27/15. While the Shanghai Composite has increased YTD, and is up from 2682 since this time last year, the past 4 months have seen massive decreases in stock prices. This has led the government to take on policies to attempt to prop up the Yuan against other currencies following 2 recent devaluations, one on August 11th and another on August 25th.

This will most likely cause more capital to flow out of China as investors look for more secure areas. Much of this will depend on how the US dollar does in coming months as the dollar appears stronger compared to the Yuan. Along with the Yuan depreciating we are seeing capital outflows reach record levels such as in August ($93.9 billion). This continued into September, where investors pulled another $194 billion from the country. As of November 1st, the total outflows from the country for the entire year have totaled $669 billion, which would be more concerning if China did not have their $3.5 trillion in foreign exchange reserves to uphold their currency.

A secondary issue arises strictly within the US, where 40% of foreign exchange reserves are held as US government treasuries. If China is suddenly forced to sell this could cause a price drop in the treasuries and a rise in yield. The Chinese prime minister has claimed that the yuan will not be devalued again to boost investment as he does not want to create a currency war.

China has also been hoping to become a global reserve currency, recognized by the IMF, as of recently. Many have become worried about this status recently as the Yuan has been unstable and there has been a lack of communication about reforms, though support from the US has helped their case. China’s president Xi Jinping has also claimed that there is no basis for a long-run devaluation of the Yuan as it should stabilize and gains strength again later on.

Other countries to hold this status are the US, UK, Japan, Switzerland, and those who trade with the Euro. The biggest advantage of having this status is the ability to import cheaper as there is no need to exchange currencies. The main criteria the IMF uses to judge whether a country is worthy of reserve status is its currency’s ability to trade freely as well as its impact and volume on the global market.

While there is no doubt China is a large player in the global economy, the renminbi may not be as freely usable as the IMF would like. Much of this concerns lies with capital controls, the lack of transparency by its central bank, and worries of liquidity in times of need. If China is to win this status they will have to wait some time as the IMF has delayed their case due to the Yuan devaluation earlier this year. Russia has decided recently that they will hold the Yuan as a reserve currency, and plans to buy around $1 billion in bonds issued from China, which further strengthens their case.

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