The Crisis and the renminbi’s international role

Alex Cukierman 07 January 2015

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The increasingly important status of the renminbi

According to the Triennial Central Bank Survey (2013) in 2007, just prior to the eruption of the US subprime crisis and two years before the emergence of the Greek sovereign debt crisis, forex deals with the US dollar on one side of the transaction represented 85.6% of total average daily foreign exchange market turnover, making it the most widely traded currency in the world.1 The comparable figure for the euro was 37%, putting it in a distant second place after the dollar. By contrast, the same metric indicates that with a meager share of 0.5%, the renminbi (RMB) was ranked in the 20th slot. In April 2013, the share of the USD had gone up to 87% that of the euro, down to 33.4%, and that of the RMB up to 2,2% of total average daily forex turnover.

Although the euro lost (and the dollar gained) some ground during the six years between 2007 and 2013, the USD and the euro maintained their first and second ranks, respectively. However, the RMB climbed from the 20th to the 9th slot. Although its share is still very modest, the rate of growth of transactions involving it is very large. If as some economists believe this trend persists, the RMB may match the Japanese yen and the British pound and achieve the status of a key currency within the next decade.

The view that the RMB will in due time become a key currency has been around for some time even before the Global Financial Crisis (Carbaugh and Hedrick 2009, Salvatore 2011). It is supported mainly by a record of fast rates of growth of the Chinese economy, by the growth of China’s share in international trade during the last 30 years, and by a somewhat similar historical precedent involving the USD a hundred years ago (Eichengreen 2011).2 Although China is already a giant on the current account side of the balance of payments, it is still behind in capital account transactions.3 In this respect, the RMB is obviously far behind major key currencies like the USD and the euro. In terms of both turnover on forex markets and use as a reserve currency, it is still dominated by lesser major currencies such as the yen, the British pound, the Swiss franc, and even the Australian and the New-Zealand dollars.                                     

The impact of the Crisis on the relative positions of the USD and the euro vs. the RMB

The Global Financial Crisis triggered a number of changes in the relative positions of the US and the Eurozone on one hand, and that of China on the other. Although to date those changes have not appreciably altered the position of the RMB vis-a-vis the other two currencies, they have put in motion processes that have the potential to establish the RMB as a regional key currency within the next five to ten years. Foremost among those are the slowdowns in real growth and in international trade activity since the outbreaks of the subprime crisis and the sovereign debt crisis in the US and in the Eurozone, respectively. Admittedly, the ripple effects of the Global Financial Crisis also slowed down Chinese growth. Nonetheless, due to the persistence of the slowdown in real growth, particularly in the Eurozone, the relative position of China in terms of both GDP and share of international trade has risen in comparison to its pre-crisis level.

About a year after the November 2008 G20 Washington Summit on Financial Markets and the World Economy the leaders of the G20 group, of which China is a member, announced that this group would replace the G8 as the main economic council of wealthy nations. Since China was not a member of the G8 this change officially opened the door to its participation in decision making regarding the international financial system.4 It is likely that this official recognition of China’s increasing financial clout prompted Governor Zhou Xiaochuan from the People's Bank of China (PBC) to propose a new international monetary system in which the IMF Special Drawing Rights would eventually replace the dollar as the world's main reserve currency (Xiaochuan 2009). Although this proposal did not take off, it signalled the beginning of China’s involvment in attempts to reshape the international monetary system.  

One of the conditions for becoming a key currency is the existence of deep and liquid bond markets in the currency. In terms of outstanding stocks, RMB denominated bonds are obviously far behind their US and Eurozone counterparts. However, by reducing the volume of new bond issues in both the US and the Eurozone, the Crisis initiated a process that is reducing this gap. In particular, the US subprime crisis dramatically reduced the volume of US net new bond issues. This volume dropped from a yearly average of about $3 trillion in 2004-2007, to about $200 billion per year in 2008-2013. The Eurozone sovereign debt crisis had an even stronger adverse effect. The net new volume of bond issues in the Eurzone dropped from a yearly average of slightly less than €2 trillions in 2007-2009 to practically zero between 2010 and 2013.5

By contrast, the issue of RMB denominated offshore bonds accelerated dramatically during those years. A RMB Road Map (2014) published by ASIFMA reports that offshore RMB debt sold in the first quarter of 2014 peaked at 31 billion USD following an increase of over 200% during the previous three years. If those relative trends continue for several more years, the yuan denominated bond market will quickly acquire a respectable (although not yet dominant) position. During the first three quarters of 2011, RMB trade settlements amounted to about 8% of China’s trade in goods and services.6 The Chinese government actively promotes such developments, particularly with trading partners within the ASEAN group of countries.7

The future of the USD, the euro, and the RMB as key currencies

It was clear even prior to the Global Financial Crisis that, in terms of GDP, China will eventually be the largest economy in the world. China is currently second only to the US. The Crisis moved the point in time at which China will surpass the US closer to the present. Jorgenson and Vu (2011) estimate that this will happen sometime between 2018 and 2020. It is clear that this change in relative size will eventually also elevate the RMB to, at least, the status of a major regional currency.

There is little doubt that the Crisis moved the time of RMB exchange convertibility closer to the present by making Chinese policymakers more anxious to attain key currency status sooner, as well as by raising the growth differential between China and the issuers of current key currencies. But this still leaves the question of precise timing open. The Chinese authorities are keenly aware of the potential international role of their currency. Subject to the constraint that their control over the domestic financial system and the exchange rate does not dissipate too quickly, they are taking steps aimed at increasing the role of the RMB in the settlement of trade transactions as well as at the creation of an offshore RMB denominated capital market.8 The current separation between on-shore and off-shore allows the Chinese authorities to foster the growth of an international RMB denominated bond market without losing control over the on-shore financial system. The offshore market has recently been growing by leaps and bound and spreading to major internationalfinancial centres beyond Hong-Kong.

Since 2006, the Chinese government has allowed a substantial but gradual and controlled appreciation of the RMB – from over 8 RMBs to one USD in 2005, to the current (November 2014) rate of 6,13. It is likely that this persistent appreciation of the RMB along with expectations  of additional liberalisation of the exchange rate nurture expectations for further appreciation of the yuan. Those expectations naturally envigorate demands for RMB denominated bonds in offshore markets and with, it the volume of RMB denominated assets in the world.

Eichengreen and Flandreau (2009, 2010) document an intriguing similarity between the USD at the beginning of the 20th century and the RMB today. In spite of the fact that, by 1914 US trade had surpassed that of the UK, the leading key currency of the time was the sterling. They convincingly demonstrate that, given this background and following active promotion of the USD as an international currency by US authorities, the USD surpassed the sterling as a leading international and reserve currency within a span of just ten years. An implication of this historical episode is that, if Chinese authorities seriously undertake the international promotion of their currency, the RMB is likely to become a key currency relatively quickly.

How vigorously will the Chines authorities pursue such a policy hinges on the tradeoff between the benefits of promoting the RMB to key currency level and the political and economic risks associated with relinquishing control over on-shore financial markets as perceived by the Chinese authorities. In tackling this fundamental question one should not lose sight of the basic ideological differences between the US and China. US norms favour minimal government intervention, free markets, and individualism. By contrast, the ideology of ruling Chinese elites is that individual behaviour should be largely subordinated to the needs and requirements of the state and to its aggrandizement (Craig 2009). This ideology implies that, subject to adequate economic development, the government should retain sufficient control in order to achieve the state objectives.

Concluding remarks

In conclusion, although the USD/sterling historical precedent supports the view that Chinese authorities have the ability to quickly elevate the RMB to major currency status, they may delay full implementation of the necessary steps because they consider relinquishment of financial and exchange rate controls as a major cost.9 On the other hand, recent experience shows that a financial crisis, such as the Global Crisis in the countries issuing major key currencies, encourages Chinese authorities to speed up the process of liberalisation in order to achieve key currency status sooner. 

My current judgment (November 2014) is that within ten years the RMB will at least be at par with the USD (and surpass the euro) as a regional trade settlement currency in east Asia.10 The RMB is also likely to become a close second to the euro as a world reserve currency. Ruling out the recurrence of a major financial crisis in the US, the dollar will maintain its position as the world number one currency for both trade settlements and capital account transactions except possibly in East Asia. The euro will continue to function as the major currency in Europe although its share of total daily forex turnover will go down and may even be overtaken by the RMB.

Looking ahead about ten years, the most likely scenario is that of a tri-polar system in which the USD maintains its primary key currency position, the euro functions as the main currency in Europe, and the RMB fulfills the same function, at least for trade settlements, in east Asia.   

References

Aubain M (2012), “Use of Currencies in International Trade: Any Change in the Picture?” World Trade Organization Staff Working Paper ERSD-2012-10.

Carbaugh R and D Hedrick (2009), "Will the $ be Dethroned as the Main Reserve Currency?", Global Economy Journal, 9(3), The Berkeley Electronic Press.

Craig J (2009), "Are East Asian Economic Models Sustainable?" http://cpds.apana.org.au/Teams/Articles/AsiaSustainable.htm#Unsustainable

Cukierman A (2010), “The Roles of Ideology, Institutions, Politics and Economic Knowledge in Forecasting Macroeconomic Developments: Lessons from the Crisis”, CESifo Economic Studies, 56 (4), 575-595, December.

Cukierman A (2014), “Euro-Area and US Banks Behavior and ECB-Fed Monetary Policies during the Global Financial Crisis: A Comparison”, Paper prepared for the SUERF Colloquium on Money, Regulation and Growth: Financing New Growth in Europe.

Eichengreen B (2011), “The Renminbi as an International Currency”, Journal of Policy Modeling, 33, 723-730.

Eichengreen B and M Flandreau (2009), “The Rise and Fall of the Dollar”,            European Review of Economic History, 13, 377-411.

Eichengreen B and M Flandreau (2010), “The Federal Reserve, the Bank of England and the Rise of the dollar as an International Currency, 1914-1939”, BIS Working Paper No 328, November.

Jorgenson D and K Vu (2011), “The Rise of Developing Asia and the New Economic Order”, Journal of Policy Modeling, 33, 698-716.

Prasad E and L Ye (2012), “The Renminbi Role in the Global Monetary System”, Brookings Global Economy and Development.

RMB Road Map (2014), ASIFMA’s 4th Offshore RMB Markets Conference, March.

Salvatore D (2011), “The Future Tri-Polar International Monetary System”, Journal of Policy Modeling, 33, 776-785.

Triennial Central Bank Survey – Foreign Exchange Turnover in April 2013: Preliminary Global Results (2013), September.

Xiaochuan Z (2009), "Reforming the International Financial System", People's Bank of China, 3 March.

Footnotes

1 The sum of the percentages adds up to 200 since, by convention, volume figures attribute the volume of any given traded currency pair to each of the currencies in the pair. 

2 In 2010, China surpassed Japan in terms of GDP and became the second largest economy in the world after the US.

3 Aubain (2012) reports that although the share of China in international trade (at 11.4%) is similar to that of the US, the share of the RMB in world trade payments is only a quarter of a percent (see, in particular, his Figure 1).

4 There is little doubt that the decision to replace the G8 with the G20 was influenced in no small part by the financial panic cum credit arrest following the downfall of Lehman brothers in mid September 2008. 

5 Details for the US and the Eurozone appear, respectively, in Figures 6b and 6a of Cukierman (2014). 

6 Further details appear in Prasad and Ye (2012), pp. 37-38.

7 The ASEAN group includes: South Korea, Indonesia, Thailand, Malaysia, Singapore, Phillipines, Vietnam, Myanmar, Brunei, Cambodia, and Laos.

8 Box 5.1 in Prasad and Ye (2012) provides examples of specific measures. They include allowing overseas institutions to apply for RMB accounts for trade settlements, signing currency pacts with Brazil and Japan to promote the use of their currencies for bilateral trade and investment flows, allowing the Bank of China to offer RMB deposit accounts in NY, and allowing J.P. Morgan to create a 1 billion RMB denominated fund in November 2011   

9 Cukierman (2010) discusses the role of ideology, institutions and politics for macroeconomic forecasting.

10 Salvatore (2011) expresses a similar view.

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Topics:  International finance

Tags:  renminbi, foreign exchange turnover, currency status, China

Professor emeritus, Tel Aviv University; Professor of Economics, Interdisciplinary Center; CEPR Research Fellow

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