At its heart, money exists as a convenient medium of exchange for goods and services. Any group, any company, and any country can create de facto currency. For instance, I remember my 7th grade history teacher creating “bozo-bucks” which could be saved and exchanged for individual perks like access to extra-credit assignments or pooled together for class movie days. But currency is only useful when it’s accepted as a standard of trade; I don’t think my leftover bozo-bucks from the 7th grade are going to be useful in a grocery store.
The IMF just announced its acceptance of China’s renminbi currency as an elite reserve currency of the world – along with the dollar, euro, pound and yen - increasing its stature and access for global trade. In practical terms, what does this mean for investors? For a start, the Chinese central bank had to keep a fair amount of other currencies in reserve as hard currency to facilitate trade.
China’s long standing trade surplus has allowed these foreign reserves to grow quickly: the Financial Times reports $3.5 trillion in China’s foreign exchange reserves at the end of October. Now, China will have less of an incentive to buy or accept foreign currency since their own currency is part of the global trading club. We will be watching for a decrease in aggregate demand for US currency investments, like treasury bills or notes, and for subsequent increases in yield for those investments.
For an alternative view on China's ascendance check out this blog post "The Long Breakdown