Russia’s leaders have offered the most provocative criticisms of the dollar: Ahead of the BRIC summit, Russian President Dimitry Medvedev said, ‘There can be no successful global currency system if the financial instruments that are used are denominated in only one currency. Today this is the case and the currency is the dollar.’ The BRIC communiqué issued a more subdued call for ‘a more diversified international monetary system’ – no doubt reflecting China’s caution and concern for the value of its dollar holdings.
After China eclipsed the U.S. in April as Brazil’s largest trading partner, Beijing and San Paolo announced plans in May 2009 to settle their bilateral trade in renminbi and reals, bypassing the use of the U.S. dollar. On July 17, on the heels of the BRIC summit, Presidents Hu and Medvedev announced a similar agreement to expand use of the ruble and renminbi in their countries’ trade. Today Russia accounts for just 5 per cent of China’s trade, but that is expected to grow: Russia’s energy exports to China are hoped to reach US$100 billion over the next 20 years, and Russian officials added that energy sales in rubles are a ‘strategic’ issue for Russia. However, as none of the BRIC currencies are freely convertible, these plans are impractical in the short-term and their significance is more political than economic.
The most tangible manifestation of the BRICs’ growing financial clout is the IMF’s expected issuance of bonds denominated in Special Drawing Rights (SDR). People’s Bank of China Governor Zhou Xiaochuan, with support from Russian officials, has been the most prominent advocate of an expanded role for the SDR, making the case most clearly in his March 2009 proposal to ‘Reform the International Monetary System’. Russia and Brazil have pledged to buy US$10 billion worth of the bonds each, while China is expected to purchase up to US$50 billion, with another US$10 billion anticipated from India. The SDR bonds will not be traded on the market, and will only account for a small percentage of the BRICs’ foreign reserves, so their importance is also mostly symbolic.
Most observers remain skeptical that the SDR or any supra-national currency will ever seriously challenge the role of the dollar. Likewise, despite Russian ambitions, the ruble’s volatility and structural weaknesses in the Russian economy make it a poor candidate for significant international use.
The renminbi is a more interesting case. China’s growing economic weight and financial resources point to the renminbi playing an increasingly significant role in the international monetary system. Chinese policymakers have recently taken a series of steps to begin to reduce China’s vulnerability to fluctuations in the dollar and gradually raise the status of the renminbi in international trade and finance. In addition to the trade settlement plans with Brazil and Russia, China has announced trials to allow exporters in the Yangtze and Pearl River Deltas to settle cross-border trade in renminbi; currency swap arrangements totalling US$95 billion with six countries; reforms to increase liquidity and trading volume in the domestic currency market; and efforts to facilitate renminbi bond issuance in Hong Kong. All these plans face limitations, and are likely to have limited short-term impact. These measures are starting to add up though, and if China proceeds with gradual capital account and financial liberalization, the renminbi could start to play a meaningful international role sooner than experts anticipate.
The internationalization of a currency involves many incremental steps over time and includes multiple roles. For example, China will likely be able to invoice an increasing amount of its direct bilateral trade in its own currency, even in the absence of full capital account liberalization. China is also positioned, through its massive demand, for its currency to play an increasing role in the pricing and invoicing of commodities. Ultimately, increased availability and ease of use of short-term financial instruments, such as private money markets and bankers’ acceptances, and deep, sophisticated foreign exchange markets and commodities futures markets, will play critical roles in determining the use of the renminbi as a settlement and vehicle currency in international trade.
Many uncertainties facing the Chinese economy and political system must be addressed before renminbi-denominated assets could approach the ‘safety’ of dollar or euro reserve assets, however. Countries must have complete confidence that that they will be able to rapidly move significant quantities of money into and out of the reserve country’s markets in times of need – requiring, at a minimum, faith in the rule of law. Such international confidence also requires development of deep and highly liquid markets for short-term Chinese government securities, a condition that leads to a fundamental but often overlooked point – in a fiat currency world (unlike under the gold standard), as the principal reserve asset is a reserve nation’s debt, a dominant reserve currency nation must be a net debtor, or at least accumulate very significant external liabilities. Other countries must run current account surpluses so that they can invest in these debt securities. Such a reality would require dramatic changes to China’s growth model and trade policy. In addition it would contribute to rebalancing a global economy that is characterized today by huge Chinese current account surpluses and correspondingly large U.S. current account and fiscal deficits.
Indeed, if China’s leaders are serious about increasing the renminbi’s role as a reserve currency, this goal, with the many positive reforms required to achieve it – rather than undermining U.S. economic interests – might actually reinforce the Chinese government’s inclination to follow through on the domestic economic and financial reforms that U.S. economists and policymakers believe are essential for sustainable U.S. and global economic growth in the future.
Brendan Kelly served as Country Director for China Affairs in the Office of the Secretary of Defense from 2007-2009, and previously worked in the United States Senate and as a management consultant at Monitor Group in New York and Hong Kong. This paper is adapted from a new study, ‘China’s Challenge to the International Monetary System: Incremental Steps and Long-Term Prospects for Internationalization of the Renminbi,’. View the full paper here at the Pacific Forum CSIS website.
It is an interesting article. However, I find it difficult to understand the following argument, to quote from the article:
“Such international confidence also requires development of deep and highly liquid markets for short-term Chinese government securities, a condition that leads to a fundamental but often overlooked point – in a fiat currency world (unlike under the gold standard), as the principal reserve asset is a reserve nation’s debt, a dominant reserve currency nation must be a net debtor, or at least accumulate very significant external liabilities. Other countries must run current account surpluses so that they can invest in these debt securities. Such a reality would require dramatic changes to China’s growth model and trade policy.”
Why should that be the case that a dominant reserve currency country must be a net debtor, or at least accumulate very significant external liabilities? Has the US always been a net debtor since the US dollar became the world main reserve currency?
We can’t just simplistically use the current US external debt position and extrapolate that into other would-be reserve currencies.
Perhaps a simple question will make the point clear. Most countries have their own currency, their own default reserve. Are the governments of all those countries have always been net debtor to make their own currency their countries’ default reserve? I bet not.
The Australia government, for example, paid down all its debts and became a net creditor during the later years of the Howard / Costello government era, although that became short lived due to the current economic crisis and government deficits. During that time, Australia still had its own currency.
It is true that a central bank issuing the dominant reserve currency needs to have assets to balance its liability for the circulated currency. But that does not automatically mean that it has to become a net debtor, or does it?
Put it in another way, suppose that the central bank that issues the reserve currency to other countries by buying those countries’ official securities, or providing loans to those countries. The so called reserve currency would be in circulation as part of the international reserve in those countries. But in this scenario, the country that issues the reserve currency does not have to incur foreign debts, or does it?
My logic may be seriously wrong, although I doubt that it is the case. Otherwise, it appears the above argument by Kelly is incorrect.
Would anyone help me clear my mind? If Kelly’s argument is correct, it would be a very interesting constraint to the reserve currency country. Maybe that is the price that country has to pay. But I am not sure that is the case.