ADB Distinguished Lecture Renminbi Internationalization: Tempest in a Teapot? Asian Development Review, Vol. 30(1), pp. 148-164

Abstract

Internationalization of the renminbi is a stated goal of the Chinese government, its brief flirtation with Special Drawing Rights and an Asian Currency Unit notwithstanding. Chinese officials understand that a dollar-centric international monetary and financial system is a mixed blessing. Doing cross-border business in their own currency confers convenience value and efficiency advantages on United States (US) banks and firms. It frees them from the costs of converting currencies and hedging exchange rate exposures, something that Chinese banks and firms will enjoy only when they are similarly able to conduct international transactions in their home currency. Relying on the dollar for international liquidity and reserves lays the People’s Republic of China (PRC) open to the foibles of US policy, whose downside was made clear by the incipient liquidity shortage that followed the failure of Lehman Bros. in 2008. It exposes the PRC to the risk of capital losses on its foreign security holdings. Renminbi internationalization is part and parcel with Chinese leaders’ efforts to rebalance their economy from investment to consumption, from exports to domestic absorption, and from manufacturing to services, including financial services. This explains why Chinese policy makers have set their sights on “basic capital account convertibility” within five years and on elevating Shanghai to first-class-financial-center status within ten, at which time the renminbi will be a leading international and reserve currency.1 In earlier writings I staked out a relatively positive position on the prospects for renminbi internationalization.2 Currency internationalization, appropriately implemented, is in the PRC’s interest. Chinese officials have a carefully calibrated approach, beginning with authorization for domestic and foreign companies to settle their merchandise transactions in the currency, followed by permitting a limited but growing range of financial transactions to be conducted in it, and culminating in the use of the country’s currency in a range of additional financial roles, not least as a form for countries to hold their reserves. This is not unlike the PRC’s incremental and experimental approach to other reforms which involves “crossing the stream by feeling the stones beneath the water.” So far, so good. That said, in this lecture I consciously take a more skeptical view and see how far I can push it. The PRC will encounter major challenges in the course of currency internationalization. Capital account decontrol, which is an unavoidable concomitant of currency internationalization, is a process fraught with dangers, as history generously reminds us. The more flexible exchange rate that should accompany further liberalization of the capital account will be resisted by powerful interests. Success should not be taken for granted. What are the conditions for that success? An international currency that is widely used in private commercial and financial transactions and held by central banks and governments as reserves has three essential attributes: scale, stability, and liquidity. Scale means that there is a large installed base of international transactions between the country issuing the currency and the rest of the world. Stability means that its users have reason to be confident that its price will not fluctuate erratically and that it will hold its value. Liquidity means that significant quantities of assets denominated in that currency can be bought and sold without noticeably affecting its price. “Scale, stability, and liquidity” will be my mantra in this lecture. Of course, these are just proximate determinants of international currency status.We will need to explore the deeper determinants of these proximate conditions. History offers precisely one example of a national unit that acquired the status of a first-class international and reserve currency in a period as short as ten years. That example is the US dollar, which went from not being used internationally in 1914 to being the dominant international currency in 1924.3 It will be useful therefore to consider how the dollar came to meet the conditions for international currency status in such a short time. This is not to imply that the renminbi will have to mechanically repeat its predecessor’s experience. Still, the precedent may be instructive.