FOREX – Will the Yuan Replace the US Dollar?

NEW YORK (ForexNewsNow) – The US Downgrade by Standard & Poor’s on August 5th elicited a very severe reaction from the Chinese government. An official Chinese press agency even went so far as to say that if Washington fails to make significant cuts to its “massive military spending” and its “overinflated costs of social assistance,” the S&P decision could merely be the “prelude to other devastating downgrades.”

China lectures US government

The Chinese agency even declared that China now has “the right to require the United States to address its structural debt problems.” Moreover, on August 3rd, the Chinese rating agency Dagong lowered the US sovereign debt rating from A + to A with a negative outlook.

This very aggressive tone from Chinese officials confirms the uncooperative tune China has begun humming, which has significantly intensified since the beginning of the crisis. Chinese authorities have been regularly calling into question the US dollar’s international ubiquity, going so far as to submit the idea of a new reserve currency, which could help avert an international crisis if one country’s economy (America’s) were to suffer serious financial hardships, as was experienced this summer.

The Chinese monetary strategy

Beijing still has 1.16 trillion dollars worth of US Treasury bonds as of May, 2011, which makes it the biggest US creditor. Its foreign exchange reserves, the largest in the world, reached $3.19 trillion at the end of June (+30.3% YoY).

Given that China almost avoided the recession, the country has not really been affected by the issue of global recovery: its concern in recent months has been finding a way to slow inflation. The reason China has accumulated such a massive forex reserve is because it allows the regime to undervalue its currency. And that’s a formidable weapon for export.

China controls its foreign exchange in a very calculate manner: the country accumulates foreign currencies earned by exporters and then exchanges them against dollar and other currencies in order to avoid upward pressure on its currency; lending to its customers while avoiding losing its business advantage due to an undervalued Yuan.

Conclusion

Some analysts already believe there will come a time when China will be strong enough to make the Yuan the world’s reserve currency, but will take ten years at least. Meanwhile, the US dollar will probably continue to rule as it has done since Bretton Woods in 1944.

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