Yuan Likely To Be Third-Largest Reserve Currency By 2030: Goldman

The Chinese yuan could leapfrog the yen and the pound to become the world’s third-largest reserve currency within a decade.

That’s according to Goldman’s Danny Suwanaprutian and Michael Cahill.

De-dollarization is always a hot topic — a kind of perpetual theme du jour. (I adore the paradox of using the word “perpetual” with “du jour.”)

Beijing’s ongoing effort to internationalize the yuan is also a popular subject with macro watchers.

As it relates to everyday people (i.e., not analysts, but rather the general investing public), I attribute both the de-dollarization obsession and intense interest in yuan internationalization to market participants’ perverse fascination with calamity. De-dollarization propaganda is often associated with portals suspected of being arm’s-length Kremlin mouthpieces. The same portals traffic in cheap, tabloid-style doom narratives and demonstrate an unmistakable penchant for anti-NATO editorializing, all hallmarks of an agenda foisted on the seemingly beholden editors.

The real de-dollarization story is one of glacial change. The figure on the left (below) looks ominous.

But the figure on the right (above) puts things in context.

Goldman, citing the literature and conversations with central bank reserve managers, noted that “historically, the top five key determinants of currency composition have been (in order of importance): Currency of intervention, currency of trade settlement, currency of outstanding external debt, capital market depth and size of international trade.”

That, along with “regional trade and geopolitical linkages,” explains the dollar’s dominance. The figure (below) is a bit dated, but it makes Goldman’s point.

I’ve variously argued that the biggest risk to the dollar’s reserve status comes not from any “money printing” or policy largesse, but rather from mercurial foreign policy and the capricious use of Treasury sanctions to cripple economies, not always for very good reasons.

But, as Goldman wrote, central banks are becoming more conscious of returns, which is compelling a shift away from low-yielding DM bonds. “More than 80% of the central banks surveyed had to distribute realized gains to their governments, which underlines the relative importance of achieving a decent return to their portfolio,” the bank remarked, citing a World Bank study.

Given that, Suwanaprutian and Cahill argue that returns are a potentially compelling argument for central banks to hold yuan assets. There’s also diversification appeal. “Investing in CNY bonds would have yielded higher returns than other traditional reserve asset classes over the past five years [and] a simple correlation analysis suggests that China has historically had the lowest correlation to other markets for USD unhedged total return and local return indices, which boosts their diversification appeal,” they wrote.

As you can imagine, there’s considerably more detail in the full piece (and even more detail in another Goldman study estimating existing CNY reserve allocations), but ultimately, the bank projects the total reserve allocation to CNY assets by global central banks “should increase from 3.4% currently to around 6-7%” over the next half-decade.

More specifically, the bank’s base case is that, “central bank re-allocation into CNY over the next five years should be around USD 400 billion, which would be more than our USD 250 billion estimate for passive index flows.” Those projections help inform Goldman’s contention that the yuan “could represent around 5-6% of total reserves (including China) within the next eight years and potentially be the third largest reserve currency by 2030.”

Obviously, reserves themselves aren’t static, so the evolution of compositions will hinge in part on “reserve growth itself,” which Goldman dryly observed “can be volatile.” If you’re wondering, “volatile” in this context means fluctuating in a range between 1% and 24% YoY. The table (above) shows you a variety of scenarios, with the base case in red.

I’d be remiss not to mention that this is a perilous time to be making predictions about the trajectory of yuan internationalization and its assumed climb up the reserve currency ladder. Things are — how should I put it? — complicated right now.