The Crisis and the renminbi’s international role

The Global Financial Crisis has increased the importance of the renminbi as an international currency. This column describes how the status of the remnibi has changed relative to that of the dollar and the euro. It also discusses what their future as future currencies would be. The author suggests that within 10 years, the renminbi would be at least at par with the dollar as a regional trade settlement currency in East Asia. It is also likely to become a close second to the euro as a world reserve currency.

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

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