In December 2015, the International MonetaryFund welcomed the Chinese yuan into its elite club of global currencies.
This means thatthe yuan, also called the renminbi, will join the US dollar, the Euro, the British poundand the Japanese yen as the world’s most reliable and freely usable denominations.
So, What makes a strong currency? Well, the strength of a currency is generallymeasured by its purchasing power, which is the amount of goods or services that one unitof money can buy.
Since modern currencies are not backed by a collateral like gold,their value is entirely dependent on external factors.
This would include things like howmuch control a government has on the currency, whether or not it has a fair exchange rateand its long term stability.
All of these contribute to public faith in the value ofa currency.
For example, in 2005, the Turkish government eliminated six zeros from its Liraovernight.
This essentially converted 1 million lira to a single lira, and people acceptedthis immediately, because they had faith in the economy that was backing it.
The numberon the bills didn’t really matter.
Overall, people tend to have greater faith in currenciesthat are widely used and internationally accepted.
In that way, a currency’s value is not onlybased on what you can buy with it, but on how much of the world uses it.
Currencies that are internationally trustedare often referred to as Hard Currencies.
The US dollar, the Euro, the British poundand the Japanese yen all fall into this category because, again, the governments and economiesthat back them are seen as strong and stable.
In fact, many countries have abandoned theirdomestic currency in favor of hard currency.
Over one dozen countries and territories haveadopted the US dollar as their own, a process commonly known as “dollarizing”.
Moreover,both average citizens and investors tend to prefer hard currencies during times of politicalunrest or global economic instability.
When rapid inflation hit Latin America in the 1980’s,many people there temporarily switched to the dollar, fearing that their domestic currencieswould continue to go down in value.
Because of their consistency and reliability,currencies like the US dollar and the Euro are kept in huge reserves by nations withminor currencies.
These nations use their reserve currencies for international tradeor borrowing foreign money.
US dollars are the most popular reserve currency, countingfor roughly 60 percent of all global foreign exchange reserves.
What’s more, the dollaris included in roughly 90 percent of all international transactions.
So, how has the Chinese Yuan made its wayinto this elite group of currencies? Well, the Chinese government has recently loosenedsome control over its currency and built trading hubs in other countries.
As a result, marketforces will play a bigger role in setting the value of the Yuan, and the currency willbe more tradeable, and less susceptible to government manipulation.
The newly powerfulYuan is already gaining ground on the Euro, and China hopes that their currency will oneday rival the dollar as the number one reserve currency.
However that prospect remains inthe distant future.
We can’t do videos like this without helpfrom our sponsors.
This episode is brought to you by Squarespace.
They’ll help youbuild a website even if you’ve never done it before! When you sign up for a year, they’llgive you a domain name for free.
And if you type in TestTube at checkout, you’ll getan extra 10% off.
Squarespace… you should.
Make sure to check out more TestTube Newsvideos like this one about China’s currency manipulation, and how it changed the nation’sfinancial standing.
Thanks for watching TestTube News, don’t forget tolike and subscribe for new videos every day.