USD Yuan in Swissquote — TradingView

A structural imbalance in a financial market is a permanent gap between supply and demand within a specific financial market. In the long run – at least for a few years – the yuan is undoubtedly a major imbalance in foreign exchange markets. However, the yuan is not completely free in the foreign exchange market as it is still controlled by the Central Bank of China (PBoC). However, betting on the yuan’s long-term upward trend is a logical strategy, and I’ll explain why.

oneFirst of all, the reasons for such a serious imbalance in the RMB exchange rate are as follows:

• Today, based on PPP-adjusted GDP, China has become the world’s largest productive economy, while the United States has fallen to second place.

• However, the United States still ranks first in terms of nominal GDP. The truth lies between nominal output and purchasing power-adjusted output, so it can be considered that China and the United States are tied for first in the world today.

• In terms of pure industrial production, China is considered the world’s factory, accounting for 32% of global industrial production, while the United States only accounts for 16%.

• Herein lies the imbalance: Although China’s economic power is similar to that of the United States, China still ranks only fifth, far behind the United States as a global monetary and financial power.

The table below shows the position of the United States and China in the global economy based on a number of criteria, including nominal gross domestic product, output adjusted for purchasing power parity, and global industrial production.

In the long run, this imbalance will gradually narrow, and in a few decades the Chinese yuan (CNY) will gradually catch up with the US dollar. However, it will take a long time for the RMB to finally become equivalent to the US dollar in the global monetary system. The most important thing is that it requires a series of basic structural factors.

The first factor is the gradual opening up of China’s financial system. Even today, the yuan is not considered a fully convertible currency and capital flows are still largely controlled by Beijing. While any dominant global currency would need to be freely traded internationally. As long as foreign investors do not have complete free access to the Chinese market, the yuan’s global expansion will be limited.

The following data reveals the five largest global currencies within the global financial and monetary system based on several key criteria. In terms of market share in the foreign exchange market, the RMB ranks only fifth.

The second major factor will be the development of a massive Chinese bond market capable of competing with U.S. Treasuries. The U.S. dollar dominates primarily because the U.S. provides the world with the ultimate financial safe haven: U.S. Treasuries. For the yuan to continue to appreciate, China must build a deep, highly liquid bond market that is trusted by central banks around the world.

The third factor is the yuan pricing of commodities, especially oil. Even today, the vast majority of global oil trade is conducted in U.S. dollars. If more and more Russian, Gulf or African energy exports are settled in RMB in the future, this will automatically increase the global structural demand for RMB.

The fourth factor is the rise of China’s geopolitics and the gradual formation of an Asian economic bloc centered on Beijing. The more trade flows between Asia, the Middle East, Africa and BRICS countries, the greater the international role of the RMB.

Finally, the most important factor is trust. Global currencies depend not only on economic strength but also on the political, legal and financial stability of the issuing country. The U.S. dollar still enjoys a huge historical advantage in this area.

Therefore, the yuan may become equivalent to the US dollar within the next 20 years, but only if all these structural factors align at the same time.

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