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China steps closer to giving dollar a run for its money

An employee counts money at a branch of Industrial and Commercial Bank of China Limited (ICBC) in Huaibei, Anhui Province of China.
ChinaFotoPress | Getty Images
An employee counts money at a branch of Industrial and Commercial Bank of China Limited (ICBC) in Huaibei, Anhui Province of China.

In its battle for global economic supremacy, China has scored a key point.

The IMF changed its opinion on the value of China's currency, the renminbi, more commonly called the yuan.

"While undervaluation of the Renminbi was a major factor causing the large imbalances in the past, our assessment now is that the substantial real effective appreciation over the past year has brought the exchange rate to a level that is no longer undervalued," IMF staff members wrote. (Tweet This)

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The statement, released Tuesday, represents a symbolic step in China's longtime goal of propelling its currency onto the global stage and eventually moving away from a dollar-based international monetary system.

As former central bank Gov. Zhou Xiaochuan famously declared in a 2009 essay entitled, "Reform the international monetary system," the financial crisis highlighted "inherent vulnerabilities and systemic risks in the existing international monetary system."

For years, American officials including President Barack Obama and Treasury Secretary Jack Lew complained about China's artificially weak currency, driven by incessant foreign exchange market intervention by its central bank. As recently as last summer, the IMF also suggested that China needed to let its currency appreciate.

And China is heeding those calls.

The yuan has appreciated nearly 13 percent against the dollar in the last seven years, making it the best-performing emerging market currency over that period. In the past 12 months, it's the only such currency that actually strengthened against the dollar.

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The yuan's recent strength could pave the way for China's desired inclusion in the IMF's basket of reserve assets called special drawing rights, or SDRs. IMF board members will vote this fall on whether to add it to the basket, composed of dollars, euros, yen and British pounds. While that designation doesn't necessarily have a direct impact on China's economy, it would be a leap forward for China in its pursuit of a global reserve currency.

"Adoption into the SDR currency basket would be a strong stamp of approval for the CNY. A stamp China clearly craves as it struggles to open its economy to foreign inflows and strives to compete with the US on a geostrategic level," Sebastien Galy, senior foreign exchange strategist at Societe Generale, said in an email.

"China has some chance of getting in this year with a small weight but will likely have to reveal its holdings of US Treasuries to do so. All other reserve currencies reveal their holdings under the latest IMF statistical standard. The price to pay may well be higher than this as the Western response in the Asia Pacific to encroachments is ramping up. The path between cooperation and conflict remains a difficult one at a time when most economies world wide adjust to lower potential growth," he added.

This doesn't mean the dollar's reign is ending.

In fact, today's market action signals the opposite: traders can't get enough dollars. The U.S. currency currently trades at its highest level in eight years against the Japanese yen. Over the last year, it has experienced one of its strongest and most persistent rallies.

But one significant barrier to further dollar strength in the long term remains: a gradual shift by big money reserve managers like central banks and global institutions away from the dollar toward other major reserve contestants like the euro and the yuan.

China's not there yet, but it is gaining credibility and getting closer.