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China One Step Closer to Global Reserve Currency

Blog Dec 28, 2011

The currency agreement that Japan has reached, to purchase Chinese sovereign bonds as part of its foreign-exchange reserves has been referred to as a currency pact and may indicate the dawn of China’s yuan as a new Global Reserve Currency, according to analysts.

In the move to add the yuan-denominated bonds to Tokyo’s holdings, the majority of which are believed currently to be held in U.S. dollars, Japan joins a growing number of countries that is, so far believed to include only Nigeria, Malaysia, Thailand and Chile, according to the French bank Societe Generale.

The purchase — in the which, Tokyo will add about $500 million in value of Chinese government bonds next year — helps confer “hard-currency” standing to the Chinese currency, raising it to the status of the U.S. dollar, Swiss franc and British pound sterling as stores of value, the French bank said.

“Markets seem not to have made much of the news, but this is an important step toward wider diversification of the foreign-exchange reserves away from the U.S. dollar, not just for Japan, but also for other nations,” said Societe Generale chief Japan economist Takuji Okubo, referring to the weekend announcements between China and Japan.

Okubo said it’s probable that Japan’s Ministry of Finance will slowly add Chinese yuan to its forex reserve over the next five years, building to an amount of around $10 billion worth.

Still, he said the rate of accumulation would be limited by the relatively small size of the Chinese bond market, making it hard to meaningfully diversify forex holdings in which the U.S. currency is thought to make up 80% to 90%.

He said Japan’s decision significantly raised the yuan’s international presence, calling it a “starting point” in a trend to diversify, that would, very likely be embraced by other nations.

Large private Japanese investors such as pension funds and insurance companies might also come forth as buyers of Chinese government bonds after the government’s announcement, Okubo said.

The agreement also raises for the U.S. the uneasy likelihood that currencies of other emerging Asian nations could be lifted into the area of investable assets in the near future, he said.

Positive side-benefits for Japan could include elevated status for Tokyo as a foreign-exchange trading hub, the status of which has been going downhill in recent years, according to Okubo.

Marc Chandler of London-based Brown Brothers Harriman pronounced the currency move as the “main financial development” over the Christmas holidays, though he saw it more as a strategic shift in dealings between the two economic rivals in the fight to be the global reserve currency.

Sources & References In This Article

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