The Role of the Chinese Renminbi in the Future of Global Finance – The Internationalization of the Chinese Currency

By M. Ulric Killion

People’s Bank of China Governor Zhou Xiaochuan answers a question during a press conference in March 2010. The International Monetary Fund on Friday said it will hold a high-level conference of central bank governors in Shanghai next week to discuss ways to address the global financial crisis; Photo / Xinhua / Chen Jianli.

As earlier mentioned, “China Central Bank Governor Zhou Xiaochuan’s earlier call to replace the US dollar with a new global currency seems to be slowly gaining support in the international community” (M. Ulric Killion, Growing support for China Bank Gov. Zhou’s call for new “Global Currency”, April 1, 2009).

This month the Council on Foreign Affairs (CFA), in the “Beijing Papers” or CGS/IIGG Working Papers,  presents, “A collection of papers examining the internationalization of the Chinese currency, the renminbi, as written for a symposium co-sponsored by the Council on Foreign Relations and the China Development Research Foundation in November 2011.”

As for the subject matter of the symposium, it was a much-needed venting of the issues and controversy surrounding the internationalization of the Chinese currency, the renminbi (RMB, international code id CNY, Chinese Yuan). While many Western experts may not take the issue seriously, many Chinese experts deem the internationalization of China’s national currency, the renminbi, as inevitable.

Quoting from an earlier article,

According to the economist Jing Li (Capital University of Economics and Business, China), the internationalization of the RMB is inevitable. This arguable inevitability may well be mostly attributable to the reality, as described by Jing (2006), that, “The integration of Asia, and the growth of RMB as a regional key currency will challenge the current imbalanced international monetary system. This will improve the global currency structure, reduce the overdependence on USD, and promote the resource allocation efficiency in developing countries” (M. Ulric Killion, The “Big Three” Credit Rating Agencies plus the Chinese Dagong Global – A new Asian and International Reality, 2011; Jing Li, RMB as a Regional International Currency: Cost-benefit Analysis and Roadmap, Centre for European Studies, Fudan University, May 12, 2006.).

Additionally, the Chinese domestic currency once internationalized will have far-reaching influence. For example, some of these influences will widely range from affecting on-going debt crises and/or sovereign debt crises of developed countries, to challenging the efforts of the Bretton Woods Institutions, especially the International Monetary Fund (IMF), in assisting these struggling economies. One should also add that it will also inevitably challenge the credibility of the “Big Three” credit rating agencies (CRAs), which are Standard & Poor’s (S&P), Moody’s Corporation, and Fitch ratings (Killion, 2011).

Moreover, many Western experts see merit in China Central Bank Governor Zhou Xiaochuan’s earlier call to replace the US dollar with a new global currency (Killion, 2009, presenting a fuller discussion of Governor Zhou’s proposal).

For instance, some of the earlier growing support for replacing the U.S. currency included Joseph Stiglitz, a Columbia University economics professor; Marc Chandler, who is a currency strategist at Brown Brothers Harriman; and even U.S. Treasury Secretary Timothy F. Geithner, when earlier expressing some openness about a new reserve system based on the IMF’s special drawing rights (SDRs) (Killion, 2011).

There is also C. Fred Bergsten (Director of the Peterson Institute for International Economics), who also earlier saw the merits of Governor Zhou’s proposal, especially the creation of an open-ended SDR-denominated fund.

According to Bergsten,

The substitution account would be a winning proposition for all concerned. The dollar holders would obtain instant diversification. The United States would avoid the risk of a free fall of the dollar. Europe would prevent a sharp rise in the euro. The global system would eliminate a potential source of great instability. These benefits call for the use of a global asset to make up any losses to the account from future falls in the dollar, such as creation of additional SDR or the IMF's gold holdings (including the sizeable US share of them). The main argument against such an account is that China has accumulated its dollar hoard of more than $1,000 billion by keeping its currency substantially undervalued, through massive intervention in the foreign exchange markets, and thus deserves no sympathy if it takes losses on those dollars. One might even suspect that the Chinese have mentally booked such losses as the implicit cost of the subsidy to exports and jobs achieved through their currency manipulation. But there is no sign that China will stop intervening, or that its surpluses will abate, even though the US external deficit has declined sharply, and its reserve build-up is thus likely to become even more threatening. Moreover, this is an ideal issue for China and the United States to develop the informal "G-2" partnership that is needed to provide global economic leadership to pass needed reforms at the existing multilateral institutions (M. Ulric Killion, Bergsten - We Should listen to Beijing's Currency Idea, April 15, 2009;  C. Fred Bergsten, We Should listen to Beijing's Currency Idea, April 8, 2009 (Co-Ed in the Financial Times).

In these respects, the symposium sponsored by the CFR and the China Development Research Foundation on the subject matter of the internationalization of China’s domestic currency, the renminbi, lends additional credibility or a degree of seriousness to the issues and controversy surrounding China’s national currency. While doing so, the symposium on the internationalization of China’s domestic currency, though perhaps unintentionally, also lends credibility to the plausibility of its inevitability.

For all of these reasons and more, the following “Beijing Papers” or CGS/IIGG Working Papers warrant serious consideration. This is because the “Beijing Papers” are a must read for anyone interested in the issues and controversy surrounding the internationalization of China’s domestic currency, the renminbi.

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The “Beijing Papers” - CGS/IIGG Working Papers - 2011

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November 2011

What Drives CNH Market Equilibrium?

Author: Peter Garber, Global Strategist, Global Markets Research, Deutsche Bank

Overview

The recent rapid growth of the offshore renminbi market presents a puzzle for analysts of China’s development strategy. By allowing renminbi to flow offshore uncontrolled before loosening government controls over internal financial markets, Chinese officials are straying from the normal sequence of steps toward currency internationalization. Why might that be? In this Center for Geoeconomic Studies Working Paper, produced in association with CFR’s International Institutions and Global Governance program, Peter Garber seeks to answer that question by investigating what drives offshore renminbi markets and how they are evolving.

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November 2011

Historical Precedents for Internationalization of the RMB

Author: Jeffrey A. Frankel, James Harpel Chair for Capital Formation & Growth, Harvard University

Overview

The twentieth century saw the rise of the U.S. dollar, the German mark, and the Japanese yen as international currencies. Now the Chinese renminbi is on a similar course toward reserve currency status, but its path is deviating from those of its predecessors in both aim and intent. In this Center for Geoeconomic Studies Working Paper, produced in association with CFR’s International Institutions and Global Governance program, Professor Jeffrey Frankel explains how the renminbi’s ascent is without historical precedent and why China might be pursuing such an unorthodox strategy.

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November 2011

Renminbi Internationalization and China's Financial Development Model

Author: Robert N. McCauley, Senior Adviser, Monetary and Economic Department, Bank for International Settlements

Overview

Internationalization was a spontaneous outcome of the marketplace for the rest of the world’s major currencies, but China is breaking with history by making it official policy to steer the renminbi on a path toward reserve currency status. However, this managed internationalization occurs at a time when China’s financial development is still in a transitional phase featuring capital controls and other constraints on credit growth and allocation.  In this Center for Geoeconomic Studies Working Paper, produced in association with CFR’s International Institutions and Global Governance program, Robert McCauley explores the policy challenges facing Chinese authorities as their pursuit of an internationalized renminbi threatens to undermine the effectiveness of their domestic financial market controls.

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November 2011

The Internationalization of the RMB: Opportunities and Pitfalls

Author: Takatoshi Ito, Professor, Graduate School of Economics and Graduate School of Public Policy, University of Tokyo

Overview

China is making swift strides toward internationalizing its currency, the renminbi, but it must be careful when sequencing these changes. Without the proper reforms, wide-open Chinese financial markets would be vulnerable to massive flows of foreign capital that could send China into the throes of financial crisis. In this Center for Geoeconomic Studies Working Paper, produced in association with CFR’s International Institutions and Global Governance program, Professor Takatoshi Ito examines the progress of the renminbi’s march toward international status and evaluates the possible paths forward.

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November 2011

The Future of International Liquidity and the Role of China

Author: Alan M. Taylor, Souder Family Professor of Arts and Sciences, Department of Economics, University of Virginia

Overview

Financial crises in the 1930s and 1970s showed the world that economic instability results when demand for international liquidity allows a small number of countries to run up massive debts in their own currencies. Named for the economist who first described the scenario in the 1960s, this “Triffin Paradox” threatens the global financial system again today as demand for reserves has skyrocketed among emerging market economies. In this Center for Geoeconomic Studies Working Paper, produced in association with CFR’s International Institutions and Global Governance program, Professor Alan Taylor considers whether China might play a larger role in stabilizing the world economy by supplying a reserve asset of its own—an internationalized renminbi.

Beijing Papers - Council on Foreign Relations

Copyright © Protected – All Rights Reserved M. Ulric Killion, 2011.

China’s economic growth model – A recipe for growing too fast?

By M. Ulric Killion

While China’s economic growth since 1990 is astonishing, China has a long way to go before it can beat or overtake the US economy. Despite the strong growth the Chinese economy still is relatively small compared to the US economy. So in that sense it may be premature to call China as the rising superpower. Emerging markets in Asia, Africa, etc. may not be able to consume as much of the Chinese goods as the US did simply because consumers in those markets do not have the purchasing power as Americans do. Chinese Exports: Can Emerging Markets Replace the U.S. Consumer?, Seeking Alpha, November 13, 2009; Photo / Source: Der Spiegel.

There is a recent (December 2, 2011) posting of an interesting article by Adam Ozimek, which is titled, “If there is a recipe for growing too fast forever, I have yet to see it”, at the Modeled Behavior blog. The article engendered a lively discussion on the Internet, and the comments also provide for interesting reading.

The focus of the article was on the sustainability of China’s burgeoning economic growth. For instance, an excerpt from the article reads,

Karl  [Smith] defends Andy Stern on China by making a claim about economic growth that on the one hand I think is partly true, but I think he overstates the case. His argument is that it is possible for economies to grow too fast in some sense, because economic growth is not the same thing as welfare. You can take too much from current generations in the name of stimulating economic growth.  Karl has made this point in the past more explicitly, pointing to China’s 40% savings rate outside the bounds of plausible optimal savings rate. This much I agree with, or at least I agree that it is possible and worth considering (I don’t know what the bounds of optimal savings are for China, or if they’re actually outside it). The problem is to use this to defend the notion that China can go too fast forever and use their current strategy to one day surpass us in per capita GDP.

As earlier stated the comments are also equally interesting because some of the comments even link the sustainability of Chinese economic growth with democracy. For example, according to one comment, “being a rich country requires democracy.”

For these reasons, both the article and comments are a compelling read; they also present several issues about the future sustainability of China’s economic growth.

First, the discussions challenge a seeming truism, if not tacit assumption, that China will overtake the U.S. economy in the new millennium. Quoting from an earlier article,

In the early 1990s, the World Bank predicted that in the early days of the new millennium, China would overtake the US as the largest economy in the world. In November 2006, as reported in the Wall Street Journal, former World Bank Chief James Wolfensohn warned Western countries of an economic future and altered balance of power dominated by China and India. Based on projections by investment bank Goldman Sachs, Wolfensohn predicted that within 25 years the combined GDP of China and India would exceed that of the G7 nations. China, by 2030 to 2040, would become the world’s largest economy. By 2050, “China’s current $2 tn GDP is set to balloon to $48.6 tn, while that of India, whose economy weighs in at under a trillion dollars, would hit $27 tn.” He also highlighted the recent and substantial investments of both China and India in Africa, as examples of how these two emerging giants are exercising their increasing global influence (M. Ulric Killion, “Regional Economic Integration: The Chinese Way,” The Analyst-Finance Magazine: Global Economy Special Issue, August 2008).

Second, the article and comments seem to ignore the reality that there are pristine models of neither capitalism nor socialism. All of which, in the real world, presents questions of how socialist “we” are, how capitalist “they” are, and vice versa. In this respect, there is also a problematic denial of the genuine possibility of what hails as a Beijing model, Beijing consensus, and even arguably the potential for China and its economic growth model actually presenting a possible evolution in the capitalist model (M. Ulric Killion, Post-global financial crisis: The measure of the “Beijing consensus” as a variety of capitalisms, MPRA Paper No. 26382, November 2010, discussing the varieties of capitalism theory in the context of the Chinese economy). In other words, China presents itself as a socialist-political polity pursuing capitalist-economic policies.

Third, the article and comments also arguably fail to recognize that China’s economic growth model, though many Western experts will disagree, stems from an inherent inevitability rather than choice in how best to modernize. This is because, “The initial choice of an open export-oriented strategy as the breakthrough point for reform had an inherent inevitability,” rather than being a blind imitation of other East Asian economies, and presumably other non-Asian economies (C. Pei and L. Peng, “Reform and opening up in the area of circulation: a retrospect,” Zhongguo Shehui Kexue [Soc. Sci. China], Vol. XXX, No. 1 (February 2009), 36-53).

Notwithstanding their detailed presentation regarding this inherent inevitability, Pei and Pang generally characterized both exported-oriented production and international capital investment as critical choices of China’s open strategy. Although China’s factor endowment advantage of labor (i.e., lower wages than neighboring economies) provided an incentive for international investors, the arrangements made in the course of trade system restructuring came to coincide with the investment strategies of international capital; thus, eventually presenting for China the historical opportunity of international capital’s industrial transformation (Pei and Pang, 2009).

Fourth and finally, there is the debt crisis of developed countries, which, as empirical studies suggest, will impact on the gross domestic product (GDP) of these countries. This also challenges the notion of what the article characterizes as China’s “catch up growth.” As Davide Furceri and Aleksandra Zdzienicka recently concluded, “Debt crises produce significant and long-lasting output losses, reducing output by about 10 percent after eight years. The results also suggest that debt crises tend to be more detrimental than banking and currency crises” (Davide Furceri and Aleksandra Zdzienicka, “How Costly Are Debt Crises?”, IMF Working Paper, No. 11/280, December 1, 2011).

For all of these reasons, in the end, one suspects that China will sustain its economic growth, while developed countries continue to struggle with debt crises and the aftermath of debt crises.

Copyright © Protected – All Rights Reserved M. Ulric Killion, 2011.