Three currencies are of greatest importance in the world. First is the US dollar, which covers a zone of about 1 billion people because that currency has a direct influence on a range of others, including the dirham and Japanese yen. Second is the euro, with a sphere of influence that includes the euro zone and the area of some other currencies, such as the British pound. Third is the Chinese yuan, with a zone of influence that encompasses 1.5 billion people, including those in mainland China.
Together, the three major currencies represent about 3.1bn people, or nearly half the world's population. Only in the past several years has the yuan started to make itself felt outside China. It is not a new currency - it has been around for 60 years - but for the first time it has begun to exert an influence outside the country. When we talk about China rising, it is important that the US and Europe understand that a place must be made for the yuan to become a more integrated and strategically critical part of the global currency markets.
The spheres of influence of the dollar and the euro are not going to be eager for the yuan to grab a piece of their territory, but the Chinese people and the Chinese economy have to have space to grow and to prosper. The rise of the yuan is partly due to China's rise as a manufacturing superpower. An important step on the yuan's path to going global took place last year when China signed swap agreements. That's a positive step but not a necessary one. There is no guarantee that it will lead to the yuan emerging as a truly global currency. Even currency swaps with all of China's trading partners will not guarantee the yuan the influence of a truly global currency.
One way China is making inroads is by signing agreements with neighbouring countries and territories to use the yuan instead of the US dollar for pricing, payment and settlement. Whether it is conducting trade with Singapore or Hong Kong or Macau, China is starting to use the yuan as the transaction currency, but the process is not moving as smoothly as it could. For the yuan to serve the Chinese economy, it is imperative that it go global, and this will eventually result in conflict with the US dollar and the euro. This is inevitable.
Another step the Chinese government has been taking to make the yuan go global has been to diversify the country's foreign currency reserves. That has included a major effort to increase the amount of euros in the reserves. The diversification of China's currency reserves is not limited to the euro. It is also accumulating Canadian and Australian dollars, among others. China is also trying to increase its stake in gold and now has 1,054 tonnes of the metal in reserve.
As of this month, however, China's foreign currency reserves total US$2.2 trillion (Dh8.08tn), of which $820 billion are in US treasury bonds, so the diversification process has not yet had a full or satisfactory effect. There are not enough euros in the reserves, and there is not enough gold. That's surprising because China is the largest producer of gold in the world, with an annual output of about 270 tonnes.
If China began putting the gold it produces into its gold reserves, its stock could compete with the US reserves of about 3,000 tonnes, which is a large proportion of the world's reserves. China's foreign currency reserves of $2.2tn are an all-time global record. It is likely that in the next year, those reserves could reach $3tn. This is not to say that other countries do not have large reserves; they are just not held in currency. The US has diversified its assets to include oil, gold and diamonds.
The vast currency reserves China is holding are leading to problems in the international currency markets. Some members of the US Senate are calling for the administration to list China as a currency manipulator. This could escalate into a currency war that would affect relations between the countries. There is a loud call for the yuan to appreciate, and I believe it will appreciate at a moderate rate - between 3 and 5 per cent - this year.
But the reason the Chinese government opposes large-scale appreciation is that the miracle of China's rise has been built on exports. The government is unwilling to do anything that would harm its exports and its investments. The authorities are reluctant to upset the delicate balance by escalating the value of the currency. There are several other measures the Chinese government could take to address the pressure. One would be to go out and spend these reserves. This has been talked about for about five years, but the idea has not gained traction. If they spent more of the reserves - investing, for example, in more infrastructure or a social security system - the Chinese authorities could earn more legitimacy. It is possible the government could disperse the reserves among the people.