The financial press and market commentators focus on China's stock market gyrations, tottering exchange rate, capital flight and imminent credit collapse as elements in an ongoing narrative of impending financial crisis. Meanwhile, the process of internationalising the renminbi (RMB) continues. If you want a balanced account of this underlying story without the daily drama, you should read Renminbi Rising, authored by William Overholt, Guonan Ma and Cheung Kwok Law for the Fung Institute in Hong Kong.
Three measures of internationalisation are analysed.
First, the RMB is being used more frequently as the invoicing and funding currency for China's international trade. In the 2008 global crisis, China came to recognise that its dependence on foreign banks for trade finance made it vulnerable when these international institutions came under pressure. As well, there are efficiency gains to be had from simpler transactions and reduced currency risk for China's traders (although probably more currency risk for overseas suppliers). Around 20% of China's trade is now denominated in RMB, compared with 50-60% denominated in the home currency for the euro area, and 30-40% for Japan. This process will continue without drama, reaping modest but worthwhile efficiency gains along the way.
Second, the volume of RMB transactions in foreign-currency markets provides a general measure of acceptability of the currency. There is not much to show here: the RMB accounts for a tiny 1% of global FX turnover, well behind the Australian dollar.
Third, how is the RMB faring as a 'reserve currency' (ie. routinely held by foreign central banks in their foreign-currency portfolios)? Over the years, this idea has created angst and envy. French Finance Minister Valéry Giscard d'Estaing opined that America had 'exorbitant privilege' through being able to fund an external imbalance using its own currency. More recently, this privilege seems less clear-cut: other major countries such as Germany and Japan have seen no advantage is attempting to achieve this status.
Renminbi Rising is quite explicit in seeing no advantage — nor any real prospect — of the RMB attaining widespread reserve-currency status. More than 30 central banks now hold the RMB in their reserve portfolios, but the amounts are small; just enough to 'hedge trade and curry favour with China'. Nearly two-thirds of global reserves are currently held in US dollars, and as the authors note 'it would take a major catastrophe for this to change'.
The RMB's acceptance as part of the IMF's SDR basket occurred after this book went to press. It represents a strong political signal that China has arrived on the global financial stage, but has very little substance. As Charles Kindleberger once noted, SDRs are like Esperanto — a nice idea but of little practical importance.
Analysed in this mechanical way, the globalisation of the RMB might be judged to be of marginal importance for China and the world. This would, however, be too narrow a perspective. It has importance both for the development of China's own financial sector and for the world monetary order.
Perhaps the greatest advantage comes from the pressure that globalisation puts on Chinese financial institutions to increase their efficiency so that they can cope with the openness. Part of this pressure is on the policy makers, supporting those who want a deeper and more sophisticated financial sector with a wider range of instruments. The factors which facilitate internationalisation also facilitate financial deepening. A deeper bond market and well-developed hedging market are needed for internationlisation, but are also needed for the much more beneficial process of domestic financial development.
An analogy with Australia might illustrate the point. There was never any prospect of the Australian dollar becoming a globalised currency in terms of $A-invoicing, large-scale $A-trading, or becoming a reserve currency. But the process of integration with global financial markets was hugely beneficial in raising productivity.
What are the implications for the global monetary order? Globalisation of the RMB is an element in the process of China becoming a responsible global stakeholder. In general, China has been a well-behaved participant. Avoiding depreciation during the Asian crisis was helpful for world stability. True, China's overly competitive exchange rate gave it an unfair advantage in its push into export markets early this century, but the inflation-adjusted value of the RMB has appreciated 30% since 2010 and is now generally accepted to be fairly valued (or even, perhaps, overvalued).
China's entry into the global monetary order is a two-sided process and China might well feel that it has received a rather icy welcome. The US Congress has opposed IMF governance changes which would give China a greater voice: the US worked hard to undermine the Asian Infrastructure Investment Bank initiative; China has been excluded from the TPP; and the US has been very ready to accuse China of currency 'manipulation' while at the same time finding no fault elsewhere.
So far China has done nothing to suggest that its ideas on global monetary order would be very different from the existing system. China has, after all, done well out of the current arrangements, unrepresentative though the governance may be. China's initiatives have been generally compatible and helpful. For example, central bank swap facilities have proven to be the most effective form of response to foreign-exchange crises, and the Chinese central bank has now put in place more swap arrangements than the US Fed; some 28 active swaps, compared with the Fed's five standing liquidity facilities. Thus, as China finds its new and more important place in the international monetary order through the globalisation of the RMB, 'schism is hardly inevitable'.
Overholt, head of the Fung Institute and respected veteran of Asian finance, puts these issues frankly in an interview publicising this book:
To retain monetary leadership, and to sustain a unified global monetary system, the next US administration must quickly improve the capital and governance of the Bretton Woods institutions and join the AIIB. To be taken seriously by the rest of the world, the US needs to get its politicians to eschew the dishonest rhetoric about currency manipulation and its effect on the US economy. Over two decades the RMB has appreciated more than 60% in real effective terms, more than any other emerging market currency. Rapidly rising Chinese wages have magnified the effects of that appreciation. For four years the RMB has been well within the range the IMF uses to judge a fairly valued currency — trade surplus of 4% or less — and recently it has been clearly overvalued. The Chinese authorities have spent a sixth of China's reserves in less than half a year to keep the RMB overvalued. In 2015 the IMF formally announced that the currency was not undervalued. But US politicians continue to denounce China for predatory undervaluation. Such nonsense eventually leads our allies to walk away, as most did on the AIIB decision.
Photo by Zhang Peng/LightRocket via Getty Images