Page 2 of 2 Yuan in the ascendancy
By Pieter Bottelier
The US dollar would undoubtedly remain the most important component of the new
SDR for many years and would continue to serve as a reserve currency, depending
on country preferences. Zhou believes that his proposal would also serve the
long-term economic interests of reserve currency countries such as the United
States, as it would promote international financial stability.
At the end of his proposal, Zhou suggests that countries with large dollar
reserves should be permitted to delegate the management of part of their
reserves to the IMF. This suggestion aims at reviving the IMF "substitution
account" idea that was
negotiated in the late 1970s but never implemented.
Under that concept, countries with a lot of dollar reserves would be permitted
to convert part of their reserves into SDRs, reducing the exchange risk to
which they are exposed. It would allow reserve-rich countries such as China to
off-load a portion of their dollar reserves without depressing the market value
of the US dollar or increasing the market value of alternate reserve currencies
such as the euro.
None of Zhou's proposals are unworkable in principle - his main idea echoes
efforts by Keynes in the 1940s to create a synthetic reserve and settlement
currency - but they require international agreement, which will be extremely
difficult, if not impossible, to obtain.
As custodian of the world's premier reserve currency, principal beneficiary of
the present international monetary system and largest debtor country, the
United States has little incentive to change the system and de facto veto power
over proposals such as Zhou's. Besides, many in the United States see Zhou's
proposal as an attempt to undercut US global power and are opposed to it for
political reasons.
Although the US dollar will probably remain the world's premier reserve
currency for a long time, the use of the renminbi as trade settlement currency
is likely to increase.
Prospects for wider use of the renminbi Initially, international use of
the renminbi for transaction purposes was more the result of spontaneous
developments in the region than of deliberate actions by the Chinese
government, except in Hong Kong and Macau, where local renminbi use is governed
by inter-governmental agreements.
Local use of the renminbi in some neighboring countries in Asia - mainly for
transaction purposes - has been growing for years (for example in northern
Thailand, northern Vietnam, Myanmar and eastern Russia). Driven by
considerations of convenience, it was neither encouraged nor discouraged by the
Chinese government as no policy on this appears to have been articulated. In
areas where the local use of the renminbi is spreading, it is usually at the
expense of the US dollar as transaction currency, not as reserve currency.
In response to the current international financial crisis, the Chinese
government is taking steps to facilitate the use of the renminbi as a
settlement currency for trade and other current account transactions in Asia
and beyond.
Renminbi-denominated lines of credit have been extended to several neighboring
countries and bilateral local currency swaps totaling about $95 billion have
been negotiated with Malaysia, South Korea, Indonesia, Hong Kong, Argentina and
Belarus. Banks in six eastern Chinese cities have been assigned to try out
renminbi trade financing. On May 18, 2009, it was announced in Beijing that the
central banks of China and Brazil will work out an arrangement under which
China's imports from Brazil can be paid in renminbi, while Brazil's imports
from China can be paid in Brazilian real, bypassing the use of the US dollar as
settlement currency, as in the case of local currency swap agreements.
Because of the large accumulation of renminbi balances in Hong Kong banks in
recent years, one mainland commercial bank, the Bank of China (BOC), has been
issuing renminbi-denominated bonds there since 2007. It is expected that
Chinese corporations will be allowed to open renminbi accounts in Hong Kong and
elsewhere before long.
The potential for increased international use of the renminbi as local
transaction, invoicing and international settlement currency is significant.
The increased regional use of the renminbi for invoicing, transaction and
settlement purposes will probably also enhance its potential use as a store of
value, even before full convertibility has been reached.
Increased use of the renminbi as trade settlement currency will make it easier
for China to promote exports and to protect its exporters from exchange risk.
It also reduces transaction costs and avoids the need for hedging. Potential
benefits for corporations will vary, depending on their underlying business
model.
Another important aspect of increased international use of the renminbi is that
it would make it easier for China to "flexibilize" its exchange rate management
and thus reduce the need for large-scale domestic sterilization of excess
liquidity in domestic banks. Greater exchange rate flexibility would in turn
facilitate the gradual opening of China's capital account and movement toward
full convertibility. It would also reduce the need for US dollars and other
reserve currencies for transaction purposes.
All in all, it seems likely that the financial crisis will lead to more hedging
by Beijing of the US dollar through increased international use of the renminbi
and accelerated movement toward full renminbi convertibility. Once that
milestone has been reached, which could happen in five to 10 years, one big
obstacle to the use of the renminbi as an international reserve currency will
have been removed.
Another requirement is that China's domestic capital markets become much
larger, diversified and liquid than they are at present and free themselves
from government intervention. This will probably take decades, even if China
continues to develop at a high rate.
Notes
1. Zhou Xiaochuan is (since 2002) governor of China's central bank, People's
Bank of China (PBC). He has been involved in designing and managing China's
economic and financial reforms since the mid-1980s in several senior positions.
His monetary reform proposal was published on the website of PBC:
www.pbc.org.cn
2. These observations are based on meetings with senior financial officials in
Beijing in January and March 2009.
3. Keith Bradsher, "China grows more picky about debt", New York Times, May 21,
2009. Because of its large dollar holdings, China cannot diversify away from
the dollar without risking a drop in its value.
4. China does not publish the composition of its reserves; the dollar component
is generally estimated at 65-70%
. 5. Fred Bergsten of the Peterson Institute for International Economics made a
similar proposal in "How to solve the problem of the dollar", Financial Times,
December 10, 2007. In "We should listen to Beijing's currency idea", Financial
Times, April 8, 2009, Bergsten explains why Zhou's currency reform proposal has
to be taken seriously and why the creation of an IMF substitution account is a
good idea.
Pieter Bottelier is a senior adjunct professor at The Johns Hopkins
University's School of Advanced International Studies (SAIS). Prior to this, he
served at the World Bank from 1970-1998 and was the Chief of the World Bank's
Resident Mission in Beijing from 1993-1997.
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