China's Yuan Poised for Leadership

Michael Hasenstab, Ph.D.
Co-Director, Portfolio Manager
Franklin Templeton Fixed Income Group

We believe the global currency world order is going to become very different than it has been for the past decade. The U.S. dollar seems likely to lose its monopoly status as a reserve currency and could have to share that role with the Euro, as well as Asian currencies.

There is no immediate Asian currency to take that role, but clearly the Yuan is of growing importance, and those currencies highly correlated with the Yuan probably would follow in its path.

Before a currency can become a reserve currency, there are several important pre-conditions. The first is size. The economy of that currency needs to be massive, it needs to be important and its global trade needs to be significant. China clearly fits that category.

The economy, in terms of price stability, needs to have confidence. The events of 2008/9 represent the second global crisis that China has gone through—the first was the 1997 Asian crisis. During both periods, China maintained not only positive growth, but also a stable currency.

The final pre-condition for a potential reserve currency is that a country needs to have significant assets denominated in the currency—this is clearly where China falls short. But I believe this is more of a technical factor that can be adjusted with relative ease in a relatively short time period.

We are already beginning to see Yuan-denominated swap lines close to US$80 billion. We are also seeing a slight uptick in invoicing of trade in Asia in Yuan. In addition, we are starting to see a slight increase in Yuan-denominated assets such as panda bonds, which are sold by non-Chinese issuers such as the Asian Development Bank.

China is clearly looking for a new role in the global economy and in global institutions. It is also looking to move away from its high reliance on the U.S. consumer for export-led growth.

On a recent visit to Asia, a clear theme that played out in the countries we visited was the increased focus of policymakers toward domestically led growth. This suggests that if one is trying to promote domestically led growth to foster the wealth of the domestic consumer, then an undervalued exchange rate does not help with that objective—a stronger exchange rate is more consistent with domestically led growth. We believe that policymakers want to guide policy in that direction and that would be consistent with stronger exchange rates.

Even if this process takes five to 10 years, it can start to have important implications for capital flows, currencies, as well as spread products. All of these factors lead us to be optimistic on the Yuan and related Asian currencies.

Please click for more information on the following funds:

FTIF - Templeton Asian Bond Fund
FTIF - Templeton Emerging Markets Bond Fund
FTIF - Templeton European Total Return Fund
FTIF - Templeton Global Bond (Euro) Fund
FTIF - Templeton Global Bond Fund
FTIF - Templeton Global Total Return Fund