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Renminbi: The Next Global Currency?

Ligang Liu outlines steps by which China could or would "internationalize" its currency, the renminbi. (1 min., 38 sec.)
by wpoon
7 October 2010

October 6, 2010 - China's growth trajectory will, at the very least, require fundamental changes to the international monetary system and
financial architecture, according to a panel of eminent economists who met here to discuss the potential for China's renminbi
to replace the US dollar as the global currency.

Speaking at
the inaugural event of the Asia Society-ANZ China Series, panelists agreed
that Beijing
considers the internationalization of the RMB to be a desirable, albeit
long-term, goal. Guonan Ma,
Senior Economist at the Bank of International Settlements (speaking in his own
capacity), said: "It would contribute to a number of Beijing's priorities, including greater
monetary autonomy, a stable and reliable monetary system and the development of
domestic onshore financial markets." He added that internationalization would
also enhance China's
standing as a responsible participant in the international monetary system.

This global system
remains dominated by the US dollar. Quoting figures from the Bank of
International Settlements, panel moderator Andrew
, writer at The Wall Street
, noted:  "The US dollar
accounts for about 85 % of all foreign exchange transactions that take place in
the world; by contrast, the Chinese renminbi
accounts for 0.1%."

Nonetheless Joseph Yam, distinguished
Research Fellow at the Chinese University of Hong Kong
and former Chief Executive of the Hong Kong Monetary Authority, questioned
the extent to which this situation was sustainable. "The international monetary
system is pretty wobbly. Although the US continues to be the largest economy in
the world, the use of a particular currency as a global currency—as a medium of transaction and a store of wealth—depends upon the
credibility of that currency and on whether the economic fundamentals and
macroeconomic policies are sound," he said. "There seems to have been a high degree of freedom whereby the US has actually practiced less-than-prudent economic policies. One wonders at what point the credibility threshold will be breached."

addition to concerns about the stability of the international monetary system,
Yam added: "China is encountering difficulties with its domestic monetary and financial policies, as well as the management of foreign reserves. China holds approximately US$2.5
trillion in reserves. As it embraces globalization and market freedom, the
problem China will inevitably face is that the real effective exchange rate will need to
appreciate. That can only take the form of either a high inflation rate—which
China would prefer to avoid, due to the destabilizing influences of inflation—or an
appreciation in the nominal exchange rate. We therefore have to accept that
over a long period of time the Renminbi will appreciate."

Ligang Liu,
Head of China Economic Research at ANZ Banking Group, identified a number of
important preconditions to internationalization: "In order for a currency to be
issued internationally, a jurisdiction must have very good core institutions, a
very good rule of law, clear property rights, good corporate governance, and
stringent prudential regulation. There is a very high correlation between
institutional quality and per capita income," he said. "Policymakers in Beijing must be careful to use sequencing steps. At this stage, the major emphasis should be on making China's financial system more sophisticated, creating a long-term bond market, and liberalizing China's capital account.

"With such preconditions," Liu continued,  "renminbi
internationalization would be very natural. In addition, China needs to focus more on its domestic structure and to fundamentally reduce the precautionary savings motive among
Chinese residents so that domestic demand can be the driver for China's
economic growth."

noted, "China still imposes fairly extensive capital control, and therefore part of the China strategy to internationalize the RMB is to leverage offshore first. Hong Kong, as one of the most efficient and free financial systems and markets in the world, is a natural choice."

Reported by Natali Pearson, Asia Society Hong Kong Center