That’s the title of a new working paper by Xiaoli Chen (Shandong University) and Yin-Wong Cheung (UCSC). Readers might recognize Cheung as a co-author with G. Ma and R. McCauley on a 2010 BIS paper, discussed in this May 2010 Econbrowser post, and just published in Pacific Economic Review. For anybody who is interested in the latest developments in the Chinese government’s attempts to internationalize the Renminbi, this is essential reading. From the summary of the paper.
The paper evaluates the international status of the Chinese currency, the renminbi (RMB), by examining its use in the global market. Specifically, the discussion focuses on the recent developments of RMB trading in the global foreign exchange market, cross-border trade settlement in RMB, the Hong Kong off-shore market and China’s policies relating to the RMB. The evidence suggests that the use of the RMB overseas, especially in trade financing and in the off-shore market, has increased rapidly in recent years. However, compared with the size of the Chinese economy, the current scale of the use of the RMB is quite small.
It is not clear whether the measures introduced in the past few years have been motivated by economic pragmatism in the midst of a dollar shortage, are components of an ongoing modernizing process, or have been initiated to develop the international supremacy of the RMB. Perhaps these policies have been implemented to prepare for the use of RMB in the global market rather than to push the RMB to become an international currency.
It is fair to say that China has taken small first steps that prepare for full convertibility and the internationalization of the Chinese currency RMB. Although the RMB has great potential to become an international currency, its acceptance in the global economy is affected by both economic and political factors. While attaining a fully fledged international RMB is still a distant goal, China and its currency have great potential to play a more positive role in the global economy.
One graph, from the BIS paper, that I thought was particularly useful for placing into perspective the long road ahead for the RMB is below:
Source: Cheung, Ma and McCauley (2010).
News on RMB internationalization: [1] [2] [3] Eichengreen.
Menzie, Can you help me understand this?
Here’s an excerpt from ex-Fed governor Kevin Warsh in the WSJ who sees problems with continuing QE. He says,
“The Fed’s increased presence in the market for long-term Treasury securities poses nontrivial risks that bear watching. The prices assigned to Treasury securities—the risk-free rate—are the foundation from which the price of virtually every asset in the world is calculated. As the Fed’s balance sheet expands, it becomes more of a price maker than a price taker in the Treasury market. If market participants come to doubt these prices—or their reliance on these prices proves fleeting—risk premiums across asset classes and geographies could move unexpectedly.”
If Bernanke goes from QE3, to QE4, 5, 6 etc, are we going to see big moves in Treasuries that will send the dollar plunging?
Warsh is mumbling. Not only is the FED not having much impact on long range securities, they aren’t even in them AT ALL.
When is the “herd” going to figure out the hoodwink and liquidity mean. Look to the private sector because that is what it running things.
I miss Brad Setser’s blog.
Rage, So the Fed is not buying 30-year Treasuries?
Raskolnikov: If expectations regarding the path of Fed purchases were subject to large revisions (say due to lack of transparency about the path of future purchases), then I could understand the statement. However, the Fed’s communications have been quite explicit about the amounts involved in each phase, and has telegraphed the thinking ahead of each decision.
It seems to me that the possibility of sudden changes of Treasury prices has been with us all the time (due to cessation of foreign official sector purchases, e.g.), and not just specific to the period over which quantitative easing has been implemented.
With respect to the dollar, I tend to think of multiple asset classes responding to a common shock, rather than interest rates moving inducing exchange rate movements.
The whole set of papers may not be read,without addressing the whole global financial structures,functions, places and systemic risks attached.
After the great leap forward,China is keeping a modest policy of small steps,when it comes to the internationalization of its domestic currency.
The leap was large as the hereunder BIS study may recall, the export volume was 65.7 % of China GDP in 2005,7.7% of the world trade the same year.
“China The evolution of foreign exchange controls and the consequences of capital flows” People Bank of China (BIS)
When it comes to identify the structure of capital inflows,wild swings are noticeable between capital accounts (FDI) and current accounts (trade surplus) 2005 2006. BIS (P3)
Should China be willing to bill its customers in RMB it may have to make more RMB available to the international market.
Should China be willing or be driven to offer supplier credit to its customers, China may be better off supplying RMB to the international market.
Should China not be willing to see its international trade exposed to currencies gyration, foreign currencies availability, China may be better off increasing the international availability of RMB.
It is worth noticing that Taiwan made in proportion to its size a similar leap in the 90s.A currency (NT$) that was not traded in the international markets,a money supply not sterilized as they were no domestic government bonds issued.
From above, the inner weaknesses of the financial markets can be perceived:
Are the places and countries hosting the financial markets,sound and crisis proof?
Are the macro accounts of the countries providing hospitality to foreign assets and their prices quotation sound and crisis proof ? (please see country by country the current accounts trends ( JEH report as maintained by the WB (SDDS/QEDS Country Data Tables)
Can liquidities guarantees be provided beyond a given assets threshold amount?
Should these liquidities not be available what are the adverse impacts on the foreingn assets entrusted for pricing to the host country (ies)?
Should markets liquidities be in attrition,how would the hosting country (ies) be treating foreign assets pricing versus their domestic assets?
Are the regulations,regulators,supervision reliable parties with sound and ethical fiduciaries duties?
As for the 2008 sudden requirements of usd dollars,do not go further than assets currencies mismatches,duration mismatch in assets booked by foreign entities.
They were to believe that interest rates will always decrease and liquidities be plentiful.Central banks filled the gaps through currencies swaps.
As often written the privilege of being an international currency,may be offset by the burden of creating more or appreciating assets.
Deliverance for the human being is a gestation period of nine months,21 months for the elephants.
We are now in the fourth year of contemplation of the eventual mending of the structural problems of the financial world.
latest I check:
Onshore Rmb-CNO spot daily turover 13-15b USD, swap 5-6b,Fwd 1b
Offshore Rmb-NDF, USD4-5b,
offshore Rmb-CNH , USD500m-1b spot, Swap-FWD 1b
it is still very small indeed, considering China USD2.5 tr foreign trade, USD6 trillion GDP and USD3 trillion FX reserve
Menzie-
Graph 2, obscures the real potential power of the Renmimbi in international trade. From a real value perspective, the Chinese Yuan has a far higher value in terms of Purchasing Power Parity than western currencies. In 2010, China had a GDP(PPP)/cap of USD-$7518/y, rising at about 10%/year; In 2009, Switzerland had a GDP(PPP)/cap of USD-$40,000/y rising at about 4%/year. At this rate of growth, China will catch up to Switzerland (in terms of real value) on the x-axis in about 30 years.
Relative to the Y-axis, Forex-turnover/ international-trade better describes churning in the banking and securities markets via derivative contracts than it does actual trade. Higher trade reduces the Y value on this graph. I seriously doubt that the Chinese government wishes to allow the same economic predation to its economy by the finance industry as has occurred in the Western
(BIS) banking system.
I think that the Chinese will be happy to have American and European economists fixate on paper shuffling: FOREX distorted GDP and FOREX dominated security deals, rather than the value of tangible trade and real wealth accumulation.
Menzie,
A fantastic post! It is posts like this one that keep me here.
Note the following quote from the paper:
The Chinese have been buying huge amounts of gold. While I do not believe that they need such large gold reserves it seems to me that they are seriously considering a convertible currency. If such things as the gold contract dnominated in RMB is to have meaning the RMB will have to maintain its value relative to gold. This will essentially put China on a gold standard.
As Chen and Cheung write:
While most interpret that convertibility as against the dollar, if the Chinese leap-frog the dollar and move directly to gold convertibility the RMB will become the most stable currency in the world and will be in direct competition with the dollar as the world reserve currency. You have to understand that the world reserve currency will always be the most stable currency in the world. If you do not comprehend the connection between gold convertibility and stability you need to study it really quickly because at the pace the Chinese are moving it will happen more quickly than anyone will realize, virtually over night.
No worries. Paul K said Renminbi would not be a reserve currency in his life time.
Marks – is there enough gold in the world for the Rimnimbi to become a gold standard currency? I’ not sure..
James B,
You don’t need any gold for the RMB to become a gold standard currency. I can see that you do not understand the gold standard.
James B,
I feel that I left much out of my post to you so let me expand my comments.
Consider a company, perhaps on the internet, that sells t-shirts (or any other commodity). Now would you suggest that such a company maintain an inventory of enough t-shirts to satisfy all the demand that exists for t-shits? Of course not. You understand that the company only needs inventory sufficient to fill the immediate need and then can buy t-shirts to maintain this inventory. You probably also understand that many companies do not even carry inventory and just have the products they sell drop-shipped to the buyer.
A gold standard can function in a similar way. Let us say that the RMB is fixed by the Chinese government at 200 RMB to an ounce of gold. Their task will be to maintain the price of RMB at 1/200 of an ounce of gold and the price of gold at 200 RMB. This can be done completely by simply allowing full convertibility and then adjusting the supply of RMB.
If someone presents 200 RMB and requests gold the monetary authorities buy gold on the open market and supply the gold. As long as the monetary authorities allow the supply of RMB to contract, soon there will be someone presenting gold to the monetary authorities in exchange for RMB. This could be a business that wants to trade in China.
If the exchange value, RMB to gold, is held in a very narrow trading range, the monetary authority does not need to hold any gold at all. Now just as with our imaginary company above, it is prudent for the monetary authority to hold inventory sufficient to supply immediate needs but no more.
The key is the veracity of the monetary authority in maintaining a sound ratio of the RMB to gold. As with out company above if the veracity of the company comes into question the company will fail. When the ratio is maintained there will be confidence in the currency. When the ratio is maintained there are no windfall profits or losses from monetary manipulation, and no monetary frictions to hinder the functioning of an economy. Not only that your savings for retirement will be as valuable when you retire as is was the day you began to save.
It seems to me the biggest obstacle to the RMB “going global” is trust in the gangsters who run China. Our adherence to the Rule of Law is waning, but it’s a foreign concept in China.
James,
You are correct. The greatest hurdle the Chinese face is their repressive government. They will never realize the full potential of their economy as long as they stifle freedom.
But the RMB may still be able to take the role of the world’s reserve currency if traders lose faith in the soundness of the dollar.
I was hoping Dr. Chinn could comment on this paper:
Since this subject is discussed a lot here, I thought this paper might be of interest:
http://ssrn.com/abstract=1792587
Does Appreciation of the RMB Decrease Imports to the U.S. From China?
Miaojie Yu
Peking University – China Center for Economic Research (CCER)
November 23, 2010
Abstract:
In 2005, China abated its fixed exchange rate against the U.S. dollar and began to appreciate the Renminbi (RMB). In this paper, I explore the effect of the appreciation of the RMB on imports to the U.S. from China by augmenting the gravity model with the exchange rate. Using an industrial panel data set during the period 2002 to 2008 and controlling for the endogeneity of the bilateral exchange rate, this extensive empirical analysis suggests that the appreciation of the RMB against the U.S. dollar significantly reduced imports to the U.S. from China. This finding is robust to a variety of econometric methods and to coverage in different periods.
Menzie,
Thanks for your post! A very interesting and worthwhile read.
I would further argue that China’s attempts to achieve greater internationalization of its currency through parallel development, both in offshore and onshore renminbi markets would benefit both China and the rest of the world. While I agree with the paper that relative to the size of China’s economy, the current scale of RMB use is quite small, I believe Chinese success in both implementing and nurturing the growing offshore market in Hong Kong (followed now by Singapore) demonstrate the country’s clear commitment to establishing the RMB as an international reserve currency. While offshore markets generally don’t develop until a currency reaches a certain level of internationalization, it is evident that China wishes to speed up the process and reduce any potential negative impact this strain might pose to its domestic economy (and a potentially unprepared financial system!). China has also taken small steps in giving the RMB greater exposure: Chinese bank branches in Singapore and New York now allow their customers to open RMB bank accounts and multinational companies like McDonalds have issued RMB-dominated bonds in Hong Kong that can be bought by investors looking to gain from expected the appreciation of Chinese currency.
In terms of the potential impact an internationalized renminbi might pose to the rest of the world, consider this: a more globalized RMB means a more globalized China. Some might argue that internationalizing the RMB changes the global financial balances and shifts weighted reserves away from the US dollar. Greater inclusion in global financial markets, however, potentially aligns Chinese interests with the world economy and ties them more closely to other major players in the global financial system. For investors, this means the prospect of being able to invest directly in Chinese markets. At present China’s capital account is essentially closed off to foreign investors, denying them exposure to China’s rapidly growing economy.
There are many obstacles to overcome, most importantly China’s reluctance in allowing its currency to become fully convertible. Were controls over the RMB to be relaxed quickly, it would be hard for China to prevent it from quickly appreciating (something that has been long resisted in China’s export-dominated market!). Other foreseeable issues would involve greater development of offshore markets and domestic financial reform (namely interest rate deregulation). Regardless of current global noise regarding this issue, I believe we are quite a ways off from its realization. The obstacles, while not insurmountable, pose significant hurdles to its swift implementation.
Menzie,
Thanks for your post! A very interesting and worthwhile read.
I would further argue that China’s attempts to achieve greater internationalization of its currency through parallel development, both in offshore and onshore renminbi markets would benefit both China and the rest of the world. While I agree with the paper that relative to the size of China’s economy, the current scale of RMB use is quite small, I believe Chinese success in both implementing and nurturing the growing offshore market in Hong Kong (followed now by Singapore) demonstrate the country’s clear commitment to establishing the RMB as an international reserve currency. While offshore markets generally don’t develop until a currency reaches a certain level of internationalization, it is evident that China wishes to speed up the process and reduce any potential negative impact this strain might pose to its domestic economy (and a potentially unprepared financial system!). China has also taken small steps in giving the RMB greater exposure: Chinese bank branches in Singapore and New York now allow their customers to open RMB bank accounts and multinational companies like McDonalds have issued RMB-dominated bonds in Hong Kong that can be bought by investors looking to gain from expected the appreciation of Chinese currency.
In terms of the potential impact an internationalized renminbi might pose to the rest of the world, consider this: a more globalized RMB means a more globalized China. Some might argue that internationalizing the RMB changes the global financial balances and shifts weighted reserves away from the US dollar. Greater inclusion in global financial markets, however, potentially aligns Chinese interests with the world economy and ties them more closely to other major players in the global financial system. For investors, this means the prospect of being able to invest directly in Chinese markets. At present China’s capital account is essentially closed off to foreign investors, denying them exposure to China’s rapidly growing economy.
There are many obstacles to overcome, most importantly China’s reluctance in allowing its currency to become fully convertible. Were controls over the RMB to be relaxed quickly, it would be hard for China to prevent it from quickly appreciating (something that has been long resisted in China’s export-dominated market!). Other foreseeable issues would involve greater development of offshore markets and domestic financial reform (namely interest rate deregulation). Regardless of current global noise regarding this issue, I believe we are quite a ways off from its realization. The obstacles, while not insurmountable, pose significant hurdles to its swift implementation.