Author: Barry Eichengreen, Berkeley
The big financial news in the run-up to Chinese President Hu Jintao’s recently concluded visit to the United States was Beijing’s decision to allow the state-controlled Bank of China to offer renminbi-denominated bank accounts and currency conversion services in New York.
Some observers hailed this as an important step in positioning the renminbi to become a true international currency. Others dismissed it as a mere publicity stunt designed to deflect attention away from China’s refusal to let its currency appreciate against the dollar.
My view is that this is another small but significant step in the internationalisation of the renminbi, even if President Hu’s visit explains the timing. There has been an important shift in Chinese strategy and rhetoric since March 2009 when PBOC Governor Zhou made some much-commented-on remarks calling for an enhanced role for the IMF’s Special Drawing Rights, or SDRs, as an alternative to the dollar in the international sphere. Chinese officials speak now not of an international monetary system centred on SDRs but on a system that rests on a handful of existing currencies: the dollar, the euro, and the renminbi.
What are Chinese officials after? They want to give their companies the security of being able to invoice and settle their cross-border transactions in their own currency, thereby eliminating the risk that comes with doing business in other people’s money. They want their companies to be able to raise funds abroad by issuing bonds in renminbi. They want to be sure that Chinese banks get a slice of the global foreign exchange market. This means making the Bank of China a platform for renminbi-trading in New York, further liberalising renminbi transactions in Hong Kong, and transforming Shanghai into an international financial centre. These are not alternatives. China is intent on pursuing all three.
Moving in this direction will be a good thing not just for China, but for the world. One way of understanding our recent financial problems is in terms of the imbalance between the real and financial economies. On the real side – that is, in terms of trade and production – the era of US dominance is now over. We are moving toward a more multi-polar world dominated by three large economies: the US, Euroland and China. But on the monetary and financial side, the dollar still dominates international transactions. When the residents of other countries need more international liquidity, they have virtually no choice but to accumulate dollars. This allows the US to finance its twin deficits more freely than otherwise. And that in turn means that when we in the US succumb to financial excesses – when we engage in frenzied real estate speculation, for example – foreigners give us more rope. It is no coincidence, in other words, that the recent financial crisis originated in the United States or that it coincided with the widening of global imbalances.
This kind of external finance will be less freely available to the United States when there exist attractive – that is to say, stable and liquid – alternatives to the dollar. The resulting intensification of external discipline on the US will make the world a safer financial place. One potential alternative to the dollar, namely the euro, is already here, although its stability and liquidity obviously leave something to be desired. But I remain convinced that when European leaders find themselves with their backs to the wall, not too long from now, they will undertake the necessary reforms. They will fix Europe’s banking system. They will restructure the unsustainable debts of the European periphery.
Part of this will entail issuing ‘e-bonds’: bonds backed by the full-faith and credit of Euroland countries as a group. e-bond issuances may be limited at first, but the very fact of their creation will be an important step toward developing an integrated market in standardized euro assets attractive to international investors.
The other potential alternative to the dollar, the renminbi, is coming faster than many observers realize. The last year has seen a quadrupling of the share of bank deposits in Hong Kong denominated in renminbi. 70,000 Chinese companies are doing their cross-border settlements in renminbi. Dozens of foreign companies have now issued renminbi-denominated ‘dim sum’ bonds in Hong Kong. And then there is the decision to allow the Bank of China to provide renminbi-deposits to foreign investors in New York. To be sure, Hong Kong and New York are not the same as Shanghai. But practices that are successfully test driven in Hong Kong and New York will be licensed in Shanghai next.
China has a long way to go, admittedly, in order to internationalise the renminbi. It will have to make its financial markets more liquid. To create a bond market of the requisite size, it will have to ‘overfund’ its debt, issuing more sovereign debt securities than would be necessary otherwise. To gain the confidence of foreign investors, it will have to make its financial markets more transparent and strengthen rule of law. To accommodate a larger volume of capital inflows and outflows, it will need a more flexible exchange rate. Above all, it will have to avoid serious financial problems.
Merely listing these perquisites makes them sound daunting. But then, who 10 years ago who would have thought that China would be as open to foreign direct investment as it is today?
The Chinese have set 2020 as the target date by which Shanghai should be transformed into a true international financial centre and, by implication, the renminbi into a true international currency. I wouldn’t bet against them.
Barry Eichengreen is the George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley. His new book, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, will be available in Australia in February through Oxford University Press.