By Arthur Kroeber
One baleful consequence of the global financial crisis has been a swarm of ill-informed commentary about the decline of the US and the dollar, and the rise of China and the renminbi. Such hyperbolic claims about a tectonic shift in global power relations are bunkum.
Since last November, the People’s Bank of China has initiated more than $100bn in renminbi swap lines with various other central banks, mainly in the developing world. There also has been lots of noise about increasing the use of renminbi in regional trade transactions.
These developments have led many to speculate that China aims to make the renminbi a major global currency, and that it is just a matter of time before the currency of the world’s largest creditor supplants that of the world’s biggest debtor as the major global reserve asset.
On the potential for the renminbi itself as a reserve currency, commentators frequently confuse three distinct concepts: currency internationalisation, reserve currency, and dominant global reserve currency.
The renminbi will clearly internationalise significantly over the next five to 10 years. Over a longer period (10-20 years) it may emerge as a secondary reserve currency like the Japanese yen, although this is not certain. But for it to replace the dollar as the main global reserve currency, many decades and a combination of improbable events would be needed.
Plenty of currencies internationalise without becoming substantial vehicles for reserve holdings (Swiss franc, Singapore dollar, etc). The renminbi will certainly become far more widely used in many countries because of China’s large role in global trade and the vast numbers of Chinese business and leisure travelers who will trot the globe.
Swaps and trade facilities may help this internationalisation, though it is worth noting that the talk of denominating trade transactions in renminbi remains mostly talk (the practicalities are inconvenient), and the total swap lines initiated by the PBoC since last September are about one-fifth of the international swap lines opened by the US Federal Reserve during the same period.
Internationalisation – ie the increased use of a currency in current-account transactions – is a necessary but insufficient condition for a reserve currency, which emerges only when people want to hold and invest large balances of that currency.
For the renminbi to become a vehicle for reserve holdings, foreigners must be able to invest freely in onshore renminbi financial assets (stocks, bonds and bank deposits), and freely repatriate both their earnings and their capital. For foreign investors to want to hold renminbi assets on a large scale, they must be convinced that China’s financial markets are trustworthy and not rigged.
For the renminbi to become even a secondary reserve currency, it must therefore fully liberalise its capital account and set up reliable financial markets that are reasonably free of government interference. Technical difficulties aside, this will require a significant retreat from the current state-dominated model of credit allocation – and this cannot happen quickly.
The US dollar’s position as the dominant global reserve currency is secure. It boils down to this: in a fiat currency world (unlike the gold- and quasi-gold standards that prevailed until 1971), the dominant reserve currency nation must be a net debtor, not a net creditor.
This is because the principal reserve asset is the debt securities of the reserve nation. Other countries must have current-account surpluses that they can invest in those debt securities, so the reserve nation itself must run a current-account deficit. (The problem of recent years was not that the US ran a current-account deficit, but simply that the deficit grew too large – nearly 7 per cent of GDP rather than the sustainable 1 per cent of GDP or so.)
So if China wants the renminbi to become the world’s main reserve currency, one condition is clear: it must abandon mercantilism and start running a current account deficit. Until it is willing to satisfy that condition, all talk about the future dominance of the renminbi is the purest hot air.