The Yuan's Rising Global Importance

There are many reasons why cryptocurrencies are becoming more prominent，but one key driver is central banks' race to the bottom in terms of interest rates，driving down the value of their own currencies. This has led many investors to look for alternative stores of value. Gold was a natural beneficiary，but cryptocurrencies offer benefits that gold cannot – speed and security of transfer，and ease of storage. However，in today's world，we believe that the Chinese Yuan (CNY) can play an increasingly significant role in a global investor's portfolio，especially as China's asset markets open up to foreign investors.

The US has one advantage that is coveted by all other policymakers around the world – the US dollar，the world's reserve currency. This gives the US much easier and cheaper access to financing，both for the US government and for US/global companies accessing this market. This can become self-fulfilling – as more and more borrowers tap the US dollar bond market，it becomes deeper and more liquid，becoming more attractive for investors and borrowers alike.

For most countries，the US dollar's reserve currency status is a fact of life and they have no chance of rivalling it. The potential exceptions to this are the Euro area and China. However，for the Euro area，the lack of a unified and liquid bond market is a significant impediment. While the pandemic recovery fund – Next Generation EU - will be financed by debt jointly backed by all EU governments，this is seen as a one-off measure rather than the first step towards an integrated Euro area government bond market.

For China，there is some fragmentation in the government bond market，with some debt being issued centrally and some by local governments，but the fact that it represents one sovereign nation (and not several countries with hugely different financial profiles) mitigates this drawback significantly. The fragmented market can also be seen as offering investors with different investment options. Meanwhile，the local corporate bond market is reasonably well developed.

Challenging the US dollar's status

This leaves us with the question as to whether the renminbi will be in a position to become a global reserve currency. We believe government policies are consistent with this objective. While this will likely take many years to achieve on a global scale，it could get there much quicker in Asia，especially if the launch of the digital renminbi gains traction.

For the renminbi to achieve reserve currency status，it will need to cater to three core user needs: the currency in question needs to be: i. a medium of exchange，ii. a unit of account; and iii. a store of value.

On the first two requirements，the authorities have been internationalising the renminbi gradually over time，encouraging trade to be conducted in CNY and increasingly opening up China's capital markets to two-way investment flows. It is true that some capital controls remain in place and that the authorities are presumably cautious about moving too far too fast. The Asian financial crisis，in the late 1990s，was exacerbated by the fact that many countries had freedom of capital movement without the depth of markets to deal with the sudden 'rush for the exits'.

However，the introduction of the digital renminbi may be a significant step towards removing these controls in the years to come. The digital renminbi will allow faster，secure payments to be made，with the authorities able to see the flows and，hopefully，get more comfortable that these are unlikely to be a destabilising force. Meanwhile，the scale of China's economy，FX reserves and increasing depth of local financial markets should provide significant comfort to the Chinese authorities. Therefore，we expect the renminbi to be used more and more for both trade and financial transactions in the coming years.

The CNY as a store of value

In this article，though，I want to focus more on the 'store of value' aspect of a reserve currency. I believe relative monetary and fiscal policies suggest that the Chinese renminbi may prove to be a better store of value than most other currencies in the world over the long run，including the US dollar and the Euro.

The value of currencies is significantly determined by relative interest rates and inflation. Nominal interest rates have been on a structural downward trend around the world since the 1980s after central banks purged out of the system excessive inflation and inflation expectations generated by the two oil crises of the 1970s. The concurrent decline in inflation meant investors did not have to worry about the potentially reduced purchasing power of deposits. In reality，interest rates remained above the level of inflation – ie. the real return on cash deposits was positive – until after the Global Financial Crisis.

The reason for inflation to decline and remain low are well documented. Demographic changes，in the form of an aging population in most Developed Market countries，and increased globalisation，particularly the rise of China as a global manufacturing powerhouse，were powerful structural sources of disinflation. This led major central banks to become increasingly concerned about the world generating too little，rather than too much，inflation.

These concerns were exacerbated by the fact that global debt levels，initially concentrated in the private sector，were soaring. As we know，there are three ways to reduce debt levels: grow your way out，inflate your way out or default. Aging demographics meant growing out of debt levels was increasingly problematic，especially in the Developed Markets. Meanwhile，as noted above，generating even modest inflation was difficult to achieve.

High debt levels to cap US interest rates

Some economists have therefore argued the only way forward would be to embrace 'creative destruction' by allowing a credit default cycle to develop to bring debt levels down to more manageable levels. However，policymakers were understandably nervous about overseeing a