What is a reserve currency?
A reserve currency is one that countries use to conduct trade (buy/sell goods and services, pay off debt, etc). For example, a Japanese company buying oil from a Russian company will likely pay in the reserve currency, as opposed to Japanese yen or Russian rubles. The US dollar and the Euro are the two most popular reserve currencies, with the US dollar holding status as the primary reserve currency since WWII.
Other currencies, such as the pound sterling, are also included in the basket of reserve currencies, but those currencies play a much smaller role in global trade.
Global reserve currencies over the last 20 years
What does China have to do with it?
The International Monetary Fund (IMF) is considering adding the Chinese renminbi (or “yuan”) to the above basket of reserve currencies. This should not be mistaken to mean that the renminbi is being considered as a replacement to the US dollar as the primary reserve currency. Just an addition to the basket. This inclusion is a logical one given China’s size as the second largest economy in the world next to the U.S., and given its importance in international trade.
Some believe the inclusion could decrease the value of the US dollar. This claim might be true if the renminbi were to replace the US dollar entirely. But a gradual inclusion—pending China’s willingness to comply with stringent requirements set by the IMF—should be a relatively smooth process.
What if the US dollar does decrease in value?
By simply investing in a well-balanced, diversified portfolio, you hedge against the risk of a declining dollar. So even if the US dollar depreciates, an investor with a well-balanced portfolio should already be positioned to manage this risk.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Economic forecasts set forth may not develop as predicted. All performance referenced is historical and is no guarantee of future results.
Investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.