Yuan Investment: Worth The Risk?

China's economic growth has piqued the interest of investors in the country's currency, the yuan (or renminbi). The yuan is now widely used, from London to Singapore, and is ranked as the eighth most heavily traded currency. The International Monetary Fund (IMF) added the yuan to its list of reserve currencies, and dozens of countries are using it to buy everything from oil to weapons. The yuan is gaining greater acceptance worldwide, and investors are seeking ways to obtain exposure to the currency. However, there are still tight restrictions on foreigners buying Chinese assets, and the Chinese government closely manages the yuan's value. So, should you invest in the Chinese yuan right now?

The yuan's history and future as a global currency

The Chinese yuan, also known as the renminbi, has seen increased acceptance worldwide in recent years. This is due in part to the country's growing dominance in international trade and its commitment to attaining a prominent position in the global financial economy. China established the Asian Infrastructure Investment Bank (AIIB) and the Contingent Reserve Arrangement, reflecting its aspirations for a larger role in global economic affairs.

The yuan's internationalization was accelerated in 2020, despite the global pandemic and the US containment of China's growth. The yuan internationalization index reached 5.02 at the end of 2020, a sharp increase of 54.2% from the previous year, surpassing the internationalization levels of the yen and the pound. This growth was driven by several factors, including the steady recovery of the Chinese economy, the opening-up of the financial sector, stable monetary policy, and increased international currency cooperation.

As of 2024, the yuan is the world's third-largest global currency, and it has been predicted that China will overtake the US as the world's largest economy as early as 2030. The yuan has become a significant international reserve currency, with central banks of more than 70 countries holding it in their reserve assets. As of the end of 2020, the yuan accounted for 2.25% of global foreign exchange assets, an increase of 14.8% year-on-year.

For the yuan to fully establish itself as a global currency, several things need to happen. Central banks worldwide would need to hold a substantial amount of yuan in their foreign exchange reserves, and the People's Bank of China (PBOC) would need to allow free trade of the yuan and relax its peg to the US dollar. Additionally, China's financial markets would need to become more transparent, and its monetary policies would need to be perceived as stable.

While some experts argue that the yuan will not replace the dollar as the predominant world currency, it is undoubtedly gaining traction and becoming a more significant player in international transactions. China's efforts to internationalize the yuan and its increasing economic might indicate that the yuan is likely to continue its trajectory towards becoming a more widely used global currency.

China's economic growth and its impact on the yuan

China's economic growth has been impressive, with the country becoming the world's second-largest economy by nominal GDP and the largest economy since 2016 when measured by purchasing power parity (PPP). This growth has been driven by investment and export-oriented manufacturing, with China becoming the largest manufacturer, merchandise trader, and holder of foreign exchange reserves. China's real GDP growth has averaged 9.5% through 2018, enabling the country to double its GDP every eight years and helping raise an estimated 800 million people out of poverty.

However, as China's economy has matured, its real GDP growth has slowed significantly, from 14.2% in 2007 to a projected 5.5% by 2024. This slowdown has been referred to as the "new normal" by the Chinese government, which acknowledges the need to embrace a new growth model. The new model aims to rely less on fixed investment and exporting, and more on private consumption, services, and innovation to drive economic growth.

The Chinese government has made innovation a top priority in its economic planning, with initiatives such as "Made in China 2025" aiming to upgrade and modernize China's manufacturing in key sectors through extensive government assistance. However, such measures have raised concerns about China's intentions to decrease its reliance on foreign technology and potentially dominate global markets.

China's economic growth and reforms have had a significant impact on the yuan. As China's economy has grown and become more open to foreign trade and investment, the yuan has gained greater acceptance worldwide. The International Monetary Fund (IMF) added the Chinese renminbi to its list of reserve currencies, reflecting China's commitment to attaining a prominent position in the global financial economy.

While the Chinese government still controls and closely manages the value of the yuan, there are increasing opportunities for investors to gain exposure to the Chinese currency. Investors can take positions in the yuan through various investment options, including purchasing yuan directly, investing in funds that hold the currency, and buying yuan futures contracts.

Overall, China's economic growth has had a positive impact on the yuan, increasing its acceptance and providing investors with more opportunities to invest in the currency. However, the Chinese government's continued management of the yuan's value and capital controls may prevent it from fully replacing the US dollar as the world's reserve currency.

The yuan's acceptance in global trade

The yuan, or renminbi, has been gaining wider acceptance in global trade in recent years. This is due to China's resilient economic growth, booming trade, and measures to facilitate foreign investment. By the end of 2020, the RMB Internationalization Index (RII) reached 5.02, a sharp increase of 54.2% from the previous year. This trend continued into 2021, with the Standard Chartered Renminbi Globalization Index reaching a new high of 2,698 in August.

China has also been taking steps to reform its bond market and join regional and global trade pacts, shorten negative lists, reduce tariff levels, and improve the business environment. Regulators have boosted two-way opening up by expanding offshore RMB markets and opening the interbank bond market to global financial institutions and sovereign funds. These measures have attracted more foreign investment and contributed to the yuan's wider acceptance in global trade.

The yuan has also gained ground as a proportion of global currency trading. However, it still has a long way to go to challenge the US dollar, euro, or Japanese yen. As of 2022, only about 2% of global import and export contracts were denominated or settled in yuan, compared to about 75% for the US dollar.

The yuan's role in global trade is expected to continue to grow as China's economy expands and seeks a larger role in global economic affairs. However, it is unlikely to replace the US dollar as the world's reserve currency anytime soon, as China still has capital controls in place that prevent the free movement of capital investment in and out of the country.

How to invest in the yuan

There are multiple ways to invest in the Chinese yuan, including directly purchasing the currency, buying currency ETFs or mutual funds, and investing in emerging Chinese stocks.

Direct Yuan Investments and Cash Holdings

With a forex account or a brokerage account that supports direct forex trading, you can convert your dollars into yuan directly. Be aware that currency markets operate around the clock and can move quickly. As with futures and options, this is considered a risky investment strategy and is not suitable for the typical investor.

You can also buy and hold physical yuan. Some banks and currency exchange businesses offer this service, but beware of fees when using a dedicated in-person currency exchange store. If you do hold physical yuan, use a fireproof safe or bank safe deposit box to keep your money safe and secure.

Currency ETF or Mutual Fund

The easiest way for most investors to get exposure to yuan in their portfolio is through an exchange-traded fund (ETF). You buy an ETF through your brokerage account just like buying a stock. But instead of buying a company, you buy yuan or a basket of currencies that includes the yuan. For example, the WisdomTree Chinese Yuan Strategy Fund (CYB) allows you to invest in yuan through your brokerage account.

Emerging Market Stocks and Bonds

If you prefer to stick with stocks and bonds, invest in a Chinese company or a Chinese bond. Doing so gives you investment exposure to both the underlying asset and the Chinese yuan.

For more diversity, buy an emerging market ETF that either includes China among its target investment countries or focuses on Chinese stocks or bonds.

Gold Mining and Energy Stocks

Among Chinese stocks, the energy sector has performed particularly well. China's enormous population leads to massive demand for natural resources and fuels like oil. Even as China slowly moves to sustainable energy, fossil fuels will remain in high demand for many years to come.

Mining stocks are also a good place to look. Gold mining is a major Chinese industry, as are rare earth metals. These metals are located in just a few places around the globe, with a heavy concentration in China. That makes Chinese miners an even more likely high performer in the future.

The yuan's performance against the US dollar

In June 2018, the yuan fell more than 3% against the dollar in just two weeks due to escalating trade tensions between the US and China. Both countries threatened new tariffs on each other's exports, causing investor worry about the potential impact on China's already slowing economy. The strength of the US economy, coupled with the Federal Reserve's decision to raise interest rates, also contributed to the yuan's decline during this period.

Historically, the yuan's exchange rate with the US dollar has been a contentious issue. The US has long claimed that the yuan's exchange rate was too weak, giving Chinese exports a competitive advantage and boosting the trade imbalance between the two countries. In 2019, the US Treasury Department designated China as a "currency manipulator" after the yuan weakened past the key threshold of 7.0 to the dollar. However, China's central bank refuted this accusation, stating that the yuan's decline was driven by market forces.

Despite the fluctuations, the yuan has been gaining greater acceptance worldwide. China's economy continues to expand, and the country is a major player on the world economic stage. The International Monetary Fund (IMF) added the Chinese renminbi (another name for the yuan) to its list of reserve currencies, allowing it to be used more frequently in global trade and international financial transactions. However, the Chinese government still closely manages the yuan's value and has capital controls in place, limiting its potential to replace the US dollar as the world's dominant reserve currency.

Frequently asked questions