According to a report by China International Capital Corp. (CICC) on Tuesday, May 12, China is going to open up its capital account to make its currency, the yuan, a fully convertible currency by the end of 2015. (Source: MarketWatch, May 13, 2015.)
The term “convertibility” in foreign exchange refers to how easy it is for a currency to be converted into another currency. Currency convertibility is important in international trade and finance because if your currency is not convertible, it becomes risky for foreigners who trade with you because they don’t need your currency.
Pushing Yuan as One of IMF’s Reserve Currencies
The People’s Bank of China (PBOC), China’s central bank, has been asking the International Monetary Fund (IMF) to include the yuan in its reserve currencies for a while now.
The yuan did not qualify in 2010 because it was not considered “freely usable” in trade and finance.
Last month, in a statement to the IMF steering committee, Zhou Xiaochuan, the governor of China’s central bank, stated, “China is not far from achieving its goal of RMB capital account convertibility.” (Source: Reuters, April 18, 2015.)
Currently, China has an administered peg exchange rate regime. Each day the yuan-dollar exchange rate is allowed to move by two percent to either side of a midpoint determined by the PBOC.
According to a report from China’s State Administration of Foreign Exchange on Tuesday, the country has adopted the IMF’s accounting standards for its balance of payments data. This shows another effort by China to push for reserve-currency status for the yuan. (Source: State Administration of Foreign Exchange, May 12, 2015.)
U.S. Dollar Losing Competitive Edge
Now looking at our currency, the U.S. dollar, I see that it is losing its competitive edge.
Back in 2000, central banks around the world had 71.1% of their foreign exchange reserves in U.S. dollars. According to the most recent data, our dollar only makes up 61.7% of all foreign exchange reserves. (Source: Bank of International Settlements, last accessed May 13, 2015.)
Moreover, the U.S. dollar is losing its role in international trade. In 2010, China and Russia decided to abandon the U.S. dollar as the trading currency and trade with each other using their own. In 2011, a similar deal was struck between China and Japan.
If the U.S. dollar continues to lose its reserve currency status, eventually this will be reflected in its value…and the exchange rate.
For investors who want to protect their wealth during a potential depreciation of the U.S. dollar, there is one simple solution—gold. The yellow metal has acted as a great hedge against exchange rate risks many times. This might become another one of its shining moments.