This week's news that Brazil and China have signed a $30 billion currency swap agreement gave a renewed boost to excited chatter over the rising influence of China's currency, the renminbi (RMB). The belief, in many quarters, is that the RMB is well on its way to becoming an "international" currency -- and many, both inside and outside China, are convinced it will inevitably eclipse the U.S. dollar as the world's leading reserve currency. China is destined to surpass the U.S. as the world's largest economy, the thinking goes, so just like everyone uses dollars now, they will soon be using RMB.
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I would argue that this excitement is vastly over-hyped. China's much-heralded swap agreements with Brazil and other countries give the impression that those nations are now holding RMB as a reserve currency. They are not. After the Lehmann Brothers collapse in 2008, international markets for trade financing in dollars seized up for several days, until the U.S. Federal Reserve stepped in to provide more dollars to get the markets working again. China's swap agreements are an emergency backstop in case that ever happens again. In the meantime, no actual money is being swapped. If it ever came to that, Brazil's temporary stocks of RMB would be used for the limited (but important) purpose of keeping trade alive until a more readily traded currency, like dollars or euros, became available again. There are three basic criteria for a nation's money to serve as an attractive global currency:
1) There must be a great deal of demand to buy what your country has to offer.
2) There must be a ready place for them to put your currency, while waiting to spend it.
3) There has to be a ready way people in other countries can get their hands on your currency in the first place.
China's RMB only fulfills one of these criteria, the first: there is a great deal of global demand for what makes. Plenty of people around the world would be happy to pay in RMB to buy Chinese goods. But where would they save and invest that RMB in the meantime? About 40 percent of the world's capital markets are in dollars; China accounts for just 4 percent. Much of that is in Hong Kong dollars, not RMB, and most of it is in riskier stocks, not the safer bonds that are good for stockpiling money. Because China's domestic markets are mostly closed to foreigners, and the RMB isn't freely convertible, moving money into and out of Chinese investments isn't easy. That may be gradually changing, but it won't happen overnight, and right now there's no good place to put large quantities of RMB.
Of course, that assumes you, as a foreigner, can get your hands on large quantities of RMB in the first place. China runs large trade surpluses and, until very recently, has been receiving more investment funding than it sends abroad. Through both channels -- the current and the capital account -- China has been a net importer of currency. For the RMB to be widely accessible beyond China's borders, China must export currency. That means running a trade deficit, or opening the doors to a lot more investment money flowing out of China than China's control-minded leaders have been comfortable with so far (allowing money to flow abroad like that could pose serious challenges to the way China's closed financial system currently functions).
The main point that a lot of people miss: for the RMB to become a truly global currency, China's entire relationship with the rest of the world economy would have to change, in ways the Chinese have strongly resisted so far. (This is the main reason, by the way, that Japan, even when it was riding high in the 1980s, deliberately chose not to embrace a much larger international role for its currency, the Yen).
Patrick is of course right that these swaps and likely future currency swap lines do not mean that the RMB is anywhere near a reserve currency. He is also right that one of the fundamental criteria for achieving reserve currency status is to get your own domestic financial and economic house in order, something that the U.S. also knows well.
However, much of the discussion surrounding RMB as a reserve currency revolves around the here and now -- that is, every step that China takes, or every swap line deal is smacked down, and rightly so, as more or less a nothing burger. But China, as we all know, plays the long, long game. Did anyone think that China would have a reserve currency by 2015 or even 2020? Yet what about by 2030, 2035? Those who argue that China will never have a reserve currency that could potentially supplant the U.S. dollar is essentially making an indirect argument about the state of China's domestic financial and economic conditions now -- and assuming that it will not change much. I have no crystal ball, and I do not know the answers, but I also do not want to simply rest on straight-line assumptions that China will not make any of the necessary changes, say by 2030, that would actually achieve what it set out to do. The world also needs to prepare for a possible upside scenario for the RMB, whether it seems likely at this point or not.
Again, I do not know the answers at all. But I do think that any discussion of "will the RMB or will it not" needs to be centered around what people ultimately think about China's domestic economic prospects and what it will do to its financial markets. Focusing on these near-term baby steps potentially risks missing the forest for the trees, in my view.
I think Patrick puts the skeptical case very well and it's a convincing one to me. Damien raises some good questions, but I think those questions have answers - or at least answers that are the best we can do, given the inevitable uncertainties of the future.
First, I'm not sure that we really do all know that China plays the long, long game. Take the question of economic rebalancing. Prominent officials have been talking for years about the urgent need to shift away from an investment-led growth model, yet China has not managed to do so. Why? Short-term pain is the best explanation. I think it's hard to demonstrate that Chinese officials are markedly better than their counterparts in other countries at making and implementing policies that will pay off over the long term. Thus, it's not clear to me that we should interpret each of these steps as part of a larger plan, designed to reach fruition decades from now, to achieve reserve currency status for the RMB.