club of global currencies. This means that the yuan, also called the renminbi, will join

the US dollar, the Euro, the British pound and 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 generally measured by its purchasing power, which is

the amount of goods or services that one unit of 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 how much control a government has on the currency,

whether or not it has a fair exchange rate and its long term stability. All of these

contribute to public faith in the value of a currency. For example, in 2005, the Turkish

government eliminated six zeros from its Lira overnight. This essentially converted 1 million

lira to a single lira, and people accepted this immediately, because they had faith in

the economy that was backing it. The number on the bills didn’t really matter. Overall,

people tend to have greater faith in currencies that are widely used and internationally accepted.

In that way, a currency’s value is not only based on what you can buy with it, but on

how much of the world uses it.

Currencies that are internationally trusted are often referred to as Hard Currencies.

The US dollar, the Euro, the British pound and the Japanese yen all fall into this category

because, again, the governments and economies that back them are seen as strong and stable.

In fact, many countries have abandoned their domestic currency in favor of hard currency.

Over one dozen countries and territories have adopted 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 political unrest 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 currencies would 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 with minor currencies. These nations use their

reserve currencies for international trade or borrowing foreign money. US dollars are

the most popular reserve currency, counting for roughly 60 percent of all global foreign

exchange reserves. What’s more, the dollar is included in roughly 90 percent of all international

transactions.

So, how has the Chinese Yuan made its way into this elite group of currencies? Well,

the Chinese government has recently loosened some control over its currency and built trading

hubs in other countries. As a result, market forces will play a bigger role in setting

the value of the Yuan, and the currency will be more tradeable, and less susceptible to

government manipulation. The newly powerful Yuan is already gaining ground on the Euro,

and China hopes that their currency will one day rival the dollar as the number one reserve

currency. However that prospect remains in the distant future.

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