Professional Documents
Culture Documents
1/1/2013
Table of Contents-
Executive Summary..3
Historical Ascent of Dollar...4
Historical Precedent Analysis......4
Falling Empire of Dollar..5
Internationalization
of
Renminbi;
Roadmap
towards
replacing
Dollar
.5
East Asias Local
Currency....7
Critical Analysis.9
Conclusion............10
Executive Summary
The stellar path of the Chinese economy has led Renminbi to play a prominent role in the global
trade and its potential to replace the US Dollar. With the changes in the liberalization policies,
development of financial markets, internationalization of Renminbi and backing the currency
with real asset, Renminbi has already become the East Asias Local currency. But close capital
controls, competition by other currencies and less transparent government policies may make the
road bumpier for Renminbi to rise as global currency.
The analysis in this paper is divided into two sections. The first section includes Historical
Precedent analysis with the current situation of China. The analysis illustrates the dominant
position of China in the future. As compared to America in 1920, china has huge reserves which
are not backed by real asset but are denominated in Dollar which will expose China to huge
systematic risk.
In the second section, Chinas policy initiatives towards promoting Renminbi as world currency
is analyzed and critical factors affecting the internationalization process are tested. Though
China has taken major steps towards internationalization but China is far behind the US in terms
of strong financial institutional reforms which are must for promoting Renminbi as the reserve
currency.
Currently with the pace of reforms for the internationalization of Renminbi, Renminbi has the
prospects to become an active international currency.
Ascent of Dollar
Post World War II, for the efficient international trade and stable macro economic conditions,
US pegged Dollar to gold at $35 per ounce of gold which further gave other countries an
enticement to use Dollar as reserve. This was primarily due to the acceptance of gold as the
common medium of exchange at that point of time. Furthermore, in the later half of the
nineteenth century after the World War II, all the currencies in the world were pegged to gold,
which was an advantage for the US Dollar as the gold was denominated in US dollar. Hence post
1945, rising British borrowing in American Dollars and economic weakness of the UK led to the
growing importance of Dollar in the International Trade.
This led the US Dollar to overtake sterling as suddenly every currency became denominated in
Dollar.
GDP Dominance ( 1872 )
Besides comparing the Chinese Renminbi with the transition of Sterling to Dollar, another
inclination towards Renminbi as a reserve currency is the Chinese internationalization policies.
This will further help the Renminbi to become the trade & settlement currency, a financial
transaction currency and in subsequently replacing the US Dollar in the near future.
Renminbi denominated bilateral swaps- Majority of Chinas trade with other countries has
started getting invoiced in the Chinese currency already. After the sub-prime crisis and in order
to internationalize its currency, PBOC (People Bank of China) has entered into Renminbi
denominated swaps worth $300 billion with more than 19 countries, further enhancing the trade
in Renminbi. Recently in October 2013, China entered into Forex Swap with Euro zone with the
transaction size of 350 billion Yuan and 45 billion Euros.
These initiatives have brought financial stability, enhancing liquidity of Renminbi in the foreign
markets, therefore enabling Yuan to become a medium of exchange.
Direct Trading and Financing in Renminbi- Previously, USD was required as an intermediary
currency to trade Renminbi with other foreign currencies but recently China launched a direct
trading platform with Japanese Yen, Australia dollar, New Zealand Dollar and Thai Baht.
Another important initiative has been to allow foreign companies to raise money in Renminbi in
securities market. Institutions such as ADB & IFC have raised money by issuing Panda Bonds
and local Foreign Multinational banks have also issue Bonds in Renminbi.
Foreign Direct Investments- Currently, China represents around more than 9% of the Global FDI
in 2013. More than 50% of the outward foreign direct investment from China is in Renminbi
which shows the paradigm shift of merely trade currency to investment currency. Renminbi
Internationalization and development of offshore Renminbi centers in Singapore, London and
Taiwan are creating more opportunities for Chinese Multinationals for outward FDI in
Renminbi.
Invoicing in Renminbi and establishing of swap contracts with other countries illustrate the
Chinese motivation to become the lender of last resort in times of crisis and liquidity crunch.
Furthermore, it will reduce the exchange rate risk faced by the Chinese companies in the global
markets.
Post 2010, 18% of Chinas exports has been settled in Renminbi. Renminbi has become worlds
9th most traded currency in the world in just three years but this number can take a giant forward
leap if china adopts the floating rate currency regime.
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Now, more than 10,000 banks worldwide are offering their customers to settle their trade
transactions with China in Renminbi in comparison to 900 Banks in 2011. The pool of offshore
Renminbi settlement is around $143 billion dollars which has been into existence since 2010.
Now more than 16% of the Chinese trade is settled in Renminbi. Strikingly, Chinese bond
market has grown exponentially from 69 billion Renminbi to 405 billion Renminbi. This
paradigm shift shows the potential of Renminbi to replace the dollar in the long term.
Since 2012, the Chinese Currency market (CNY Market) has become one of the fastest growing
markets worldwide.
Despite being the worlds largest trading nation and the second largest economy, Renminbis
share in the global trade compared to major currencies is insignificant. Growing CNY market
and importance of Renminbi in trade settlement are long term initiatives of China to create an
alternative to US Dollar as the world currency.
Critical AnalysisThe most important question that Chinese policymakers have to answer is: Would the Chinese
Government have more benefits in bringing flexibility in controls in exchange for
internationalization of Renminbi?
China is aggressively trying to internationalize its currency but the policies adopted to do full
internationalization are daunting for a conventional Chinese policymaker. Cost of being a reserve
currency will be higher for China as compared to US or UK because once China liberalizes the
capital controls; it will lead Renminbi to appreciate significantly. It was different in case of US
because being a consumption driven economy and leader in technology exports faced less
currency appreciation pressure. Unlike US, China has a long way before it can become a leader
in technology exports.
Chinas export comprises of 48% of the GDP and Chinese Renminbi appreciation will adversely
affect the competitiveness of its export sector and economic growth.
Chinas Trilemma- In 1960, Noble prize winner Robert Mundell inferred that a country at one
time cant have an open capital account, along with control over interest rates and currency. For
a country like China which is having a fixed currency rate and restricted capital conversion, it
will be a very tough task to decide on the tradeoff between giving up of the controls and
Internationalization of Currency.
China needs to have higher financial stability and economic integration than those of US to
replace Dollar.
Apart from the above impediments, there are other roadblocks for Renminbi to become the
reserve currency which can be imputed to the following factors1. Dollar as Safe Asset- Post subprime crisis, USD is regarded as the safe haven as it global
turnover increase from 2007 to 2013. But in 1940, post crisis Pound weakened and its
global share also reduces. This further explains the strong belief of the global investors in
the USD.
2. Competition- Earlier US Dollar had no competition other than Pound but Renminbi is
facing competition from the Euro and the SDR (Special Drawing Rights). Euro is the
second largest reserve currency with 23.8% share in the global reserves. Growing
importance of SDR will also challenge the dominance of Renminbi
3. Dollar Dilemma-. To replace the dollar as a reserve currency it is very important for the
Chinese Central Bank to exonerate the Dollar reserves with less volatility in the forex
market.
4. Low Inflation and Macroeconomic stability- To have the macroeconomic stability and
low inflation for the support of reserve currency, a country should have full currency
convertibility and free floating exchange rate.
It will be a long term goal for Chinese officials to regulate the capital controls because in
a short span, the pegged exchange rate and stringent capital control will lead to the
unsustainable monetary imbalances in the Chinese economy.
5. Depth of Financial Markets- Chinese Securities and Bond market are in its nascent stage.
In spite of the broad steps taken by the Chinese policymakers such as creation of high
yield junk bond markets, introduction of collateral debt swap transaction for private
sector, Chinese bond and securities market is far behind than the developed countries
capital markets. Further, Chinese policy makers also have to take a step to strengthen its
derivative market. Moreover, Global investors are not allowed to take part in the
derivatives or the money markets.
The above factors such as strong political, economic, social stability factors can only make
US economy and Dollar stronger as compared to the Chinese economy. China has to make
major restructuring changes in its whole system to challenge the USD. Furthermore, USD
can be called as the English language of the Forex Markets because most commodities such
as oil are priced in US Dollar just like most people interact in English with each other.
ConclusionA conventional wisdom proposes that any successful internationalization process should also
complement with the open policies of the government, relax capital controls, flexibility of
exchange rate and depth of financial reforms. Presently, China is not ready to replace USD in the
near term and if history is any guide, then possibly by the Year 2040, Oil prices reaching 600
CNY/Barrel causing inflationary pressure in countries like India. The MSCI World Index, all the
commodities and Trade will be denominated in the worlds most traded currency.
Internationalization of currency is a multi-stage process which begins with promoting local
currency as a trade currency than the investment currency before becoming the reserve currency.
China is at stage one where it is establishing itself as a trade currency. Thereafter, in the medium
term it will be an addition to the other reserve currency or basket of currencies before dethroning
the US Dollar. Renminbi will become an important reserve currency within the next decade but
prospects of surpassing the Dollar as the reserve currency in the near term doesnt look so much
probable.
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