Yuan Becomes Reserve Currency But Impact Will Be Limited
Broad activity in the financial markets has been limited over the last few weeks, as holiday-thinned trading conditions have slowed volatility in most of the commonly watched assets. A large part of the reasoning behind this can be seen in the fact that market moving news headlines have not been seen and most investors are still looking for ways to identify the most likely direction to follow in the equities space.
One exception to these occurrences is the news that the Chinese Yuan will be re-categorized by the International Monetary Fund (IMF) as a world reserve currency. This has generated some added attention in the financial news headlines - especially for the economies that are centered in the Asia-Pacific region. But when we look at the specifics of the arrangement, it is still not clear that these changes will have much of a material impact in the ways that Asian currencies influence the world economy.
Central Bank Actions in China
Of course, this does not mean that the changes are insignificant. The Chinese Yuan will now join the ranks of the US Dollar, the Euro, the British Pound, and the Japanese Yen. This means that the Yuan will now be viewed as a more acceptable vehicle for international transactions. But whether or not this will extend into the realm of influencing world currency values is a completely different question. And the answer to this question will depend heavily on the ways China’s central bank, the People’s Bank of China, will conduct its monetary policy actions going forward.
The main issue at hand is the extent to which the PBoC will continue manipulating the value of its currency. The word “manipulation” is highly charged but there is not much disagreement on the fact that the Chinese central bank influences the value of its currency in ways that are not matched by the other world economies that have already been placed on the reserve currency list.
If the PBoC does not show much interest in re-aligning its reputation, it is unlikely that these latest changes at the IMF will be viewed with much validity. This ultimately means that significant moves in the Chinese Yuan will not necessarily lead to major changes in global stock indexes (as is often the case with the other currencies that are currently on the IMF’s reserve list.
For investors, this will continue to be significant because it will impact the ways hedge funds and large stock holders are likely to structure their positions. So if you are looking to base investment decisions on the changing values of the world’s reserve currencies, it still makes sense to give added what to the selections that are typically thought of as the “majors” in the foreign exchange space.
This column was written by Richard Cox, university teacher in international trade and finance, focusing on lessons in macroeconomics and price behavior in equity markets.
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