Investing in the Chinese Yuan: World's Reserve Currency by 2030?

Includes: CNY, CYB
by: Brian Foglia

Reuters reports that MIT economist Simon Johnson has predicted the Chinese yuan will replace the dollar as the world’s reserve currency within the next twenty years. He added that the US will see its dominance ebb during this period. China’s rise as a global power is virtually undisputed, and no one seriously doubts that China will one day eclipse the US as the world’s most important economy. While this news may sadden us as citizens, it should motivate us as investors.

The bullish case for the yuan is very strong. For years, the Chinese government has kept its currency pegged to the US dollar in order to make Chinese goods less expensive for American consumers. In order to maintain the artificial exchange rate and prevent the yuan from appreciating, the Chinese central bank continuously purchases dollars.

Nowadays, the USD is steadily losing value because of the Federal Reserve’s “quantitative easing” (i.e. money-printing) policy. As a result, the Chinese have had to accelerate their dollar purchases to prevent the yuan from rising against the ailing dollar. This has led to unprecedented inflation. Food prices alone rose nearly 12% last year. In an emerging economy where food comprises a large portion of per capita income, this situation cannot last long before public unrest sets in. Eventually the Chinese will have to depeg from the dollar and allow their currency to appreciate against the USD.

Let’s explore some ways to benefit from this.

Despite the restrictions placed on the yuan by Beijing, there are numerous ways for Americans to invest in the currency. The first and easiest way is through a currency ETF. WisdomTree offers a Chinese yuan ETF (CYB) that bases its returns on Chinese money market rates available to foreigners and the exchange rate between the yuan and the US dollar.

Another way to bet on the yuan (and against the dollar) would be an exchange-traded note, or ETN, which is a senior, unsecured debt security. Market Vectors offers just such a product (CNY). This particular ETN is issued by Morgan Stanley. ETNs differ from ETFs in that they are debt instruments instead of stocks. This eliminates the risk of tracking error but exposes you to the risk of default if the issuing bank goes bust. ETNs can be sold for their market value or redeemed at maturity. This particular ETN seeks to replicate the performance of the S&P Chinese Renminbi Total Return Index.

As the Chinese government continues to relinquish its control over the currency, more and more options are becoming available to Western investors. According to the Wall Street Journal, the Bank of China will begin allowing Americans to open accounts in Chinese yuan. The minimum balance requirement for a savings account is $500. CDs are offered as well, although the minimum deposit is $1000. You can’t draw checks on the accounts, but they are insured by the FDIC according to the bank’s website. No more than $4000 may be exchanged into yuan on any given day. Keep in mind that the Bank of China is owned by the Chinese government, so these accounts are not necessarily risk-free. Accounts are available through two branches in New York and one in Los Angeles.

Although China’s rise to the top may not be as smooth as some expect, the country’s long-term outlook is promising. The largest exporting nations of the world have always maintained the strongest currencies. We can be certain of very little in the realm of investing, but the yuan’s appreciation against the dollar may be one of those events.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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