Will The Renmimbi Become the next reserve currency?

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Alexandre Chavotier's picture

"There is what depends on us, and that which does not depend on us." Albeit discomfiting for its sibylline guise, Epictetus' summa divisio may well be worth a few drachma, incidentally once a valued international currency, in deciphering today's renminbi conundrum. Would the Chinese currency's status be a matter of media coverage, it would certainly rank as the world's reserve currency. Nobel Laureate Robert Mundell prophesied lately "the renminbi's rise is all but inevitable, even if the government of China does nothing about it"1. Mundell is an incorrigible eulogist of the invisible hand, whose visible effects remain yet doubtful in an economy at central leaders' hands. Nevertheless, his statement raises a critical question: is the renminbi's rise indeed inevitable? Will it become the next reserve currency or is the renminbi's importance overplayed? Broadening the issue, one might ask whether the renminbi will ascend to international currency's level, capable of playing the roles of a unit of account for residents and non-residents, a medium of exchange, and a store of value.

Predicated on P. Kenen's framework2, the pundits' consensus has come to define an international currency according to its private use in invoicing, settling trade and financial transactions, and holding assets, on the one hand, and to its public use as a pegging anchor, a currency in international reserves, and a vehicle for foreign exchange interventions3, on the other hand. Keeping these functions in mind, Epictetus provides us with a potent way to break down and address the issue of the renminbi's future. Drawing on his distinction, one can differentiate and successively examine two categories: what doesn't depend on China or what is historically possible (I), and what depends on China in internationalizing the renminbi, namely what is economically feasible (II). Yet, power without consent is powerless and renminbi's success as an international currency will ultimately hinge on its widespread adoption (III).

The past can partly foretell the renminbi's future. Between 1860 and 1914, sterling represented 60% of world trade invoices and settlements and a similar share of holdings in global currency reserves4. As R.Skidelsky emphasized, paramount to Britain's dominance were both its core function as the linchpin of a multilateral payment system, and its ability to offset its deficits with North America with surpluses from its Empire5. England's demise originated in post WWI's conditions and its corporatist paralysis, which hindered a downward adjustment of real incomes. As a consequence, it increasingly relied on overseas capital imports and collapsed when the Americans cut lending and imports in the wake of the Great Depression. The gold standard system was brought down in 1931 and the dollar replaced the pound as the leading currency in 1945. Britain had been superseded both as largest economy and largest exporter, respectively as soon as 1872 and 19156. America's net debtor situation compared to China's debt creditor status presently bear striking similarities. The US dollar is plagued by ominous fiscal and current account deficits and a lingering weakness. Plus, China has become the largest exporter and second largest economy in the world. It has reportedly accounted for 9% of world trade and for 15% world's GDP by PPP last year7. Betting on such predictions, A. Maddison estimated that China might surpass the US in PPP terms by 20158. He also contended that these developments might trigger a switch in reserve currency by 2050. After being challenged by the euro, the dollar might thus be rivaled, if not surpassed, by the renminbi. History is good omen for the destiny of the Chinese currency.

Despite their importance for a currency status, a country's economic size and share of world trade are not decisive. Four other factors hold far more sway: an open capital account, flexible exchange rate, financial market development, and macroeconomic policies. Accordingly, the renminbi's rise is contingent upon the Chinese government loosening its capital controls. This dramatic decision boils down to a cost-benefit analysis: would China have any higher interest in giving up controls in exchange of an internationalized renminbi? Hurdles stand in the way of liberalization9. First, China's financial system isn't fully developed and suffers from over monetization, as evidenced by a M2/GDP ratio of 180%. A removal of capital controls would then likely bring about considerable capital 



















































outflows.

Second, the country's capital markets lack depth so that cross-border capital flows may significantly destabilize Chinese asset prices. Third, national firms don't adjust quickly to exchange and interest rate fluctuations, which make them less competitive than their foreign competitors. Likewise, China's financial institutions are still in their infancy and need to be shielded before reaching maturity. The mistakes of the yen's internalization shall not be made again. In truth, a total liberalization and convertibility of the renminbi might leave China vulnerable to devastating speculative attacks. Thaïland and Malaysia are case in point. However, China can move on without jeopardizing its domestic economy through gradual openings of offshore markets, like Hong Kong.

Meaningful steps have recently been taken in this direction10, which are in fact consistent with a landmark report released by China's Central Bank in 200611. It concluded the "renminbi's internationalization was an inevitable choice". The benefits are numerous according to the Bank for International Settlements12. First, Chinese firms would face a reduced exchange rate risk. Second, Chinese financial institutions' cost of capital would considerably improve and so enhance their competitiveness. This could be instrumental in alleviating the debt burden of Chinese localities, a matter of concern and potential source of instability. Third, it could spur a growth of cross-border transactions. Fourth, the holding of renminbi by non-residents would empower China to collect seigniorage, an "exorbitant privilege" that brought in between $40bn-70bn a year to the US prior to the crisis13. China could finally safeguard the value of its foreign exchange reserves and cut off its dependency on the United States. It currently holds upwards of $1tn in US dollar denominated debt, which practically grants a free debt inflation waiver to the US.

A third political element conditions the renminbi's worldwide success: power. Antonio Gramsci wondrously described power as a centaur, "half man, half beast", a mixture of coercion and consent. He argued power was constantly created by rulers' hegemony. China's challenge can be accurately pictured through Gramsci's lens. Not only does China need coercion, namely economic strength, to impose the renminbi, but it must also seek and obtain other nations' consent to its hegemony. China has endeavored to promote the renminbi in soft ways: through central bank currency swap arrangements worth RMB 650bn14, within the Chiang Mai Initiative (CMI) and beyond, through formal agreements with Japan to push for a use of their currency in bilateral trade and investments15, or through financing of foreign companies such as the $1.2bn loan granted to the Indian conglomerate Reliance16. More fundamentally, China may also timely benefit from an alignment of its ambitions with its partners' broader interests. Asian companies have become aware of the necessity to diversify their funding sources, as the financial crisis highlighted their overreliance on dollars lent by foreign institutions17. Additionally, the ever-growing balance of payment deficits run by the US to meet the demand for reserve currency, a self-destructive mechanism encapsulated by the Triffin's dilemma18, widens structural imbalances. Their responsibility in the last financial crisis calls for redesigning the global financial architecture. Accordingly, many countries aspire to a sustainable multi reserve currency system and would readily consent to the renminbi as an alternative to the dollar.

The renminbi's rise to the next reserve currency won't necessarily bury the dollar. Besides, it isn't inevitable. It is only possible, desirable, and hence very likely. The broader consequences will be considerable, as a new paradigm with Chinese characteristics will probably progressively replace the embedded liberalism19 underwritten by the American hegemon. Already, the much-despised Washington consensus is being shunned in favor of the newly coined Beijing consensus. It didn't depend on the West to herald the end of history20. What depends today on China is to write it.

 

References: 

1. Barboza D., "In China, Tentative Steps Towards Global Currency", February 10th 2011, New York Times

2. Kenen, P., "The Role of the Dollar as an International Reserve Currency", Occasional Papers No.13, 1983, Group of Thirty

3. Chinn M. & Frankel Jeffrey, "Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?", p. 287, May 2007, University of Chicago Press

4. Eichengreen, Barry, "Global Imbalances and the Lessons of Bretton Woods", 2007, Massachusetts: MIT Press, quoted in Jong-Wha Lee, "Will the Renminbi Emerge as an International Reserve Currency?", p. 5, June 2010, ADB

5. Skidelsky R., "The Growth of a World Economy", 1998

6. Reisen H., "Shifting Wealth: Is the US dollar empire falling?", June 20th 2009, voxeu.org

7. Prasad E. & Lei S. Y. "The Renminbi’s Role in the Global Monetary System", p. 4, February 2012, Brookings Institute

8. Maddison, A. (2007) "Chinese Economic Performance in the Long Run", 2007, OECD Development Centre, quoted in Reisen Helmut, "Shifting Wealth: Is the US dollar empire falling?", June 20th 2009, voxeu.org

9. Haihong G. & Yongding Y., "Internationalization of the renminbi", p.8-9, August 2009, Bank for International Settlements

10. "China: Internationalization of Renminbi (RMB)", JP Morgan’s online briefing

11. "The Timing, Path, and Strategies of RMB Internationalization", 2006, People’s Bank of China’s Study Group quoted in Cohen B. J., "The Yuan’s Long March: Can an International Currency be Manufactured?", p. 3, Draft January 2012, UCSB’s online resources

12. Haihong G. & Yongding Y., "Internationalization of the renminbi", p.7-8, August 2009, Bank for International Settlements

13. Jong-Wha Lee, "Will the Renminbi Emerge as an International Reserve Currency?", p. 5, June 2010

14. Yuan W. J., "Internationalizing the Renminbi: Perceptions and Realities", February 2011, china.org.cn

15. Rabinovitch S., "China and Japan Agree Currency Push", December 27th 2011, Financial Times (FT)

16. Crabtree J.,"Chinese banks lend Anil Ambani $1.2bn", January 17th 2012, Financial Times

17. Davies P. J. & Sender H, "Asian Companies urged to diversify funding", January 17th 2012, FT

18. Money matters: An IMF Exhibit, "System in Crisis: 1959-1971", IMF.org

19. Ruggie J. G., "International Regimes, Transactions, and Change: Embedded Liberalism in the Postwar Economic Order", 1982, International Organization, Vol. 36, Issue 2, p. 379-415, International Regimes

20. Fukuyama F., "The End of History", 1989, The national Interest