Renminbi

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.

By Tom Miller and Will Freeman

“Rebalancing the global economy” is the mantra of the day – and China, we are told, must play its part. That means shifting China’s economy away from an unhealthy reliance on exporting goods to foreign consumers and instead boosting consumption at home.

Last week, we argued that China’s fast pace of urbanisation, which is projected to see the urban population rise from 600m today to more than 1bn by 2030, would keep demand for commodities high. It seems a small leap of logic to conclude that growing urbanisation – and the accompanying rise of an “urban middle class” – will have a similar impact on consumer goods.

Last week we wrote that China was unlikely to make a substantial contribution to discussions about reorganising global economic governance.

Hours after our post went up, it was neatly contradicted by Zhou Xiaochuan, governor of the People’s Bank of China (PBoC), who published an essay on the bank’s website suggesting the creation of a new supra-national reserve currency to replace the US dollar. This was followed later in the week by another essay on how to secure global financial stability, and an article by a PBoC research institute on how to improve global economic regulation.

This was a salutary reminder that the Chinese government (or at least some members of it) can be a bit more agile than foreigners typically believe. It also sent a signal that China, unlike Japan, will not be satisfied with the status of a second-rate power. Japan in the 1980s expended enormous energy in fighting bilateral battles with the US but did little to make itself relevant to global economic decision-making. China has a long-term vision of its rightful place in the world and will work on a variety of fronts to secure that place.

That said, the PBoC papers are interesting more for their political than for their economic content. Their immediate aim was to establish a stance ahead of this week’s G20 meeting in London. The essence of that position is:

  • the root cause of this and previous financial crises was the special position of the dollar as the world’s reserve currency (and not, therefore, the “Asian savings glut”)
  • the self-regulation model for financial supervision touted by the US has been proved bankrupt 
  • global financial regulation (eg the Basel II accords on bank capital) needs to be made less pro-cyclical.

The second and third points fall well within the realm of conventional wisdom these days. But discussing them enabled Chinese officials to exact a little payback for all the sanctimonious hectoring they have had to endure from arrogant US officials over the years about the superiority of the American financial system.

Invoking a supposed principle of “oriental philosophy” that self-criticism is essential to self-improvement, the PBoC research department paper called on the US to exhibit remorse for its errors, stop blaming other countries for its problems, and reject the “prevalent complacency” that allowed its financial excesses to overwhelm the world. Such sermonising, though excusable, adds little to the sum of world knowledge.

Mr Zhou’s global reserve currency idea is more interesting. This is not because the proposal is likely to lead anywhere. There is almost no chance of that – as we suspect Mr Zhou knows.

But as a political statement it is ingenious. By arguing that the IMF should become the issuer of a new global reserve currency, Mr Zhou cleverly positions China as a champion of strengthening a rules-based multilateral system of global economic governance, rather than as a bare-knuckled aspirant hankering to knock off the current kingpin bully. Many have feared that China’s rise must be de-stabilising and that China will have no stake in “playing by the rules.” By identifying – accurately – the moral hazard and instability risk inherent when a single national currency serves the global reserve function, Mr Zhou articulates China’s national interest in promoting and participating in a rules-based, multilateral system.

This argument is directed at a domestic as well as an international audience. Some in the Chinese government fantasise that China’s big surpluses give it power, and that the renminbi can swiftly replace the dollar. Mr Zhou knows better, and is trying to steer the domestic debate in a more useful direction.

The second political purpose of Mr Zhou’s paper was presumably to suggest some conditions for China’s participation in the expansion of the IMF’s capital, which is a keenly-desired outcome of the G20 process. The rich countries want China to stump up US$100bn-US$200bn, largely to enable the IMF to bail out the bankrupt economies of eastern Europe. China rightly questions what benefit it would derive from paying such tribute. An expansion of its voting rights in the IMF is a paltry prize, both because it would take at least a decade under current rules to give China a voting share commensurate with its economy’s size, and because the IMF is marginal to global economic decision-making. By proposing a vastly stronger role for the IMF, Mr Zhou indicates that China deserves and seeks real influence, not meaningless trappings.
 
The global currency idea itself, however, is impracticable. Mr Zhou proposes that the IMF’s special drawing rights (SDRs) be converted into a global reserve currency, supported by large-scale issuance of SDR-denominated bonds. One obvious question is who would decide on the volume of SDR issuance – ie the size of the global money supply? The IMF is not set up as a central bank. The Bank for International Settlements is another possibility; but any multilateral institution would suffer from a diversity of masters with different political agendas and thus would find it difficult to shift monetary conditions decisively in times of crisis, which is an indispensable attribute of a central bank.

This points to deeper objections: reserve currencies are a reflection of political as well as economic power, and they are determined not by negotiation but by market activity. They are subject to “network effects” similar to those that apply for computer operating systems – the more people gravitate to a standard, the more incentive other people have to follow. Once a standard is established it is exceedingly difficult to dislodge.

Despite the current crisis, America’s political hegemony is secure and its ability to guarantee the long-term value of its debt securities is still superior to that of any imaginable political collective overseeing a global currency. The dollar’s position as the main reserve currency is still secure. But China has served notice that the US will need to work a bit harder to justify its “exorbitant privilege.”

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