RMB will become almost as familiar as the Dollar

Familiar to you, yet?

According to the Financial Times (15 Oct. 2013) there are four key questions on the internationalisation of the renminbi.

George Osborne, Britain’s chancellor of the exchequer, thinks the renminbi will “become almost as familiar as the dollar” within his lifetime, which explains his efforts to promote London as a hub for offshore trading in the Chinese currency.

1. Is the chancellor correct?
Maybe. Throughout the history of the global financial system, the monies of countries that play major roles in global trade have tended to become reserve currencies. In the 19th century and the first half of the last century the major reserve currency was the pound, with the dollar only really taking its place after the second world war. It follows that in the coming decades, the renminbi will claim this mantle. According to the most recent World Trade Organization figures, China accounts for 10.4 per cent of all merchandise exports and 9.4 per cent of all imports. That compares with 8 per cent of exports and 12.3 per cent of imports for the US. But there is a long way to go before the dollar’s status – and the US presumption that it can spend as much as it likes and expect the rest of the world to pay for it – is challenged.

2. Where are we now?
Central banks as far apart as Malaysia, Nigeria and Chile hold part of their foreign exchange reserves in renminbi. The People’s Bank of China (PBoC) has set up 24 arrangements with its counterparts around the world, which allows it to swap renminbi in exchange for their own currencies. Some monetary authorities have been granted limited access to onshore capital markets and this week Beijing offered British private investors some skin in the game. But the renminbi is no reserve currency. Those central banks that hold renminbi reserves, do so in small quantities. According to the most recent International Monetary Fund figures, 62 per cent of the official sector’s allocated reserves are denominated in dollars. Under 3 per cent is denominated in the “other currencies” basket, which includes the renminbi. The PBoC’s swap lines are largely symbolic and, unlike those introduced by the US Federal Reserve during the crisis, have barely been used. And despite China’s dominance in global trade, only around a tenth of its companies’ dealings with businesses abroad are settled in renminbi. In large part, this is because Beijing has long placed major restrictions on the use of the renminbi internationally. While China has stepped up the pace of relaxing those restrictions in recent years, they are still baby steps. British financial institutions might now be able to invest up to Rmb80bn (£8.2bn) in Chinese securities but this is barely a sliver of the Rmb158tn market capitalisation of the Shanghai Stock Exchange.

3. What would need to happen before the renminbi becomes truly global?
The big step it needs to take is capital account liberalisation, which would allow Chinese to invest overseas whenever they like. If more trade is settled in Chinese currency, then central banks will want to hold renminbi-denominated assets to protect against sudden movements in the exchange rate. However, central banks need their reserve assets to be liquid – they have to be able to sell them fast, for a fair price, during a panic. China would have to run substantial current account deficits to create a market as deep and liquid as that for US Treasuries. Over the past 15 years, China’s current account has only ever recorded a deficit once – in the second quarter of 2001.

4. How long will it take?
The share of Chinese trade settled in renminbi could easily double over the next decade given that it is starting from a low base. However, the switch to a significant reserve currency status will take much longer. And it might not even happen at all. Japan became a big player in global trade without the yen ever becoming a reserve currency of any great magnitude. “If it happens, it’s a generation away,” said George Magnus, senior economic adviser at UBS. “The Chinese authorities will tread very carefully. Their model is based on a closed economy and, though they’ve been talking about this for 20 years, the restraints don’t look that dissimilar to what they were then.” A big barrier to challenging the dollar’s dominance is China itself. The PBoC holds $1.3tn in US Treasuries, making it the second-biggest holder in the world after the Fed. Reducing this stockpile without destabilising the market will be difficult and will work against the inherent conservatism of reserve managers in monetary authorities in China and elsewhere. Chinese officials’ bleats on the US shutdown highlight Beijing’s displeasure with the dollar’s dominance. If the political instability in Washington does not change, eventually the PBoC’s reserve managers will have to find a way to work around their reliance on the greenback.