The Internationalisation of the Yuan (II)

The Internationalisation of the Yuan (II)

Part I 

According to International Monetary Fund standards, the world reserve issuing country has to possess 1) large GDP, 2) stable currency, 3) capacious and liquid markets.

China faces problems with the third yardstick. Financial experts believe that only the countries with fully convertible currencies can have capacious and liquid markets among other things. 

China cannot simultaneously continue the global commercial expansion and make the yuan become a reserve currency. The yuan’s rate needs to be low to facilitate the expansion but becoming a reserve currency requires the rate to be high. The leading world reserve currencies have rates much higher than the issuing countries’ purchasing power parity. All issuing countries are rich. They get profits not at the expense of production and export of commodities but rather international movement of capital. The «gold bullion» countries use to their advantage the privileges of being issuers of world reserve currencies. They attract goods and services from the entire world paying in bank notes – the types of promissory notes to be accumulated forever and never be paid off. 

To become a world reserve issuing country China will have to lose its markets. 

The reserve currency issuing countries have balance of payments deficits. It means that a reserve currency is a trap. Back in the early 1960s Belgian-American economist Robert Triffin said there is a fundamental incompatibility between the attainment of US global economic stability and having a single national currency perform the role of the world’s reserve currency. He also noted another fundamental thing - the currency issuing country has to run a deficit of payments balance. In its turn the deficit undermines the reserve currency. Developing the Triffin’s ideas, some economic experts have come to the conclusion that a national currency cannot be a world reserve currency. Others say it can if it has the support of military. One day the contradictions related to the use of national currency as a world reserve one may lead to a large-scale war to null the issuer’s financial liabilities. 

The dollar started to function as a real reserve currency only when the United States foreign trade deficit became stable. 

In the 1960s America started to lose the status of world manufacturer offering the world its greenback and IOUs in treasury bonds. Uncle Sam has been maintaining the demand for the production of the Federal Reserve System with the help of aircraft carriers and bombers. The yuan used as a reserve currency is a real trap for China – afterwards it will have either to «step back» and free itself from the woven web (but it won’t get back the external markets) or promote the yuan’s international standing with the help of military might. The latter does not correspond to the Beijing’s plans. 

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Some countries have experience of being subject to the temptation of converting the national currencies into the world reserve ones to substitute the US dollar. They have paid a heavy price. Take Germany and Japan. In the early 1970s of the XX century the United States stopped the gold for dollar exchanges and devaluated its currency to cause disappointment on the part of European partners. «The dollar is our currency, but your problem» is a phrase that John Connolly, US Treasury Secretary under President Nixon, used to a delegation of European visitors in 1971 to cause wide discontent in the old continent. The statement still has a ring to it. Europe decided to respond by strengthening the national currencies and gradually squeezing the greenback out of the European trade turnover. What happened next? In the early 1970s, the European trade mainly used the US dollar for payments. In the early 1990s, over 50% of commercial transactions were done in German marks (Deutsche Marks). Its share in world gold reserves went up to the highest 20%. 

There was a feeling that Europe starts to get rid of US dominance, including the American banking system. 

The unification of national currencies to establish the euro was the time of European heyday. Some savvies predicted the euro will take the place of US dollar as a leading reserve currency. Then, the euro share in world reserves started to dwindle like a bolt from the blue while the dollar showed the trend to restoring the previously lost positions. A bit later Europe was hit by crisis, especially the group of PIIGS (the economies of Portugal, Italy, Greece and Spain). At first, the German mark, then the euro abruptly sparked like shining stars to fade away soon. 

By and large the same thing happened with the Japanese yen. At first the «Japanese miracle» took place in the 1960-70s leading to sudden increase of the yen’s share in world currency system. By the end of the 1970-80s some analysts started to say that the yen may become a real competitor for the dollar as a reserve currency. Those days it seemed that the Japanese government deliberately slowed down the process trying to contain the rate. Washington exerted great pressure, including the threat of economic sanctions, to make Tokyo sign an agreement with the United States on lifting restrictions on cross-border capital flows facilitating the access of American financial firms to the Japanese markets. The yen/dollar agreement, liberalizing Japanese capital markets, was signed in 1984. In a year’s time, the well-known Plaza Accord (or Plaza Agreement) was signed between the governments of France, West Germany, Japan, and the United Kingdom to depreciate the US dollar in relation to the Japanese yen and German mark by intervening in currency markets. The five governments signed the accord on September 22, 1985 at the Plaza Hotel in New York. As a result the yen rose over 50% in relation to the dollar. The rise of the yen led to the emergence of huge financial bubble in Japan. It was done away with only by suffering serious losses and applying great efforts. Japan could not recover afterwards and has been facing permanent economic stagnation ever since. The yen world share reached its peak at about 10% to go down afterwards and descend to less than 4% today. 

There was only one time in the XX century when one currency substituted another to fully function as world reserve money (including a world reserve currency). The currency in question was the dollar of the US Federal Reserve System taking place of the British pound sterling. The change was taking place against the background of two world wars. The transitory period lasted for 30 years since August 1914 to in July 1944. 

It took millions of human lives to squeeze out the pound so that the US dollar could take its place. 

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There is little possibility the yuan will replace the US dollar as a world currency. The development of events in the world of international finances may unfold according to other, quite different, scenarios. 

For instance, the yuan could become a regional currency. 

For instance, it could become the currency of ASEAN (the Association of Southeast Asian Nations). It could also become the reserve currency of economically backward countries which find it rather hard to accumulate dollars, euro and other reserve currencies. The process of opening their markets to China as the main trade partner is already obvious. For instance, three and a half years ago Nigeria was the first African country which announced the decision to consider adding the yuan (the Renminbi) to the basket of reserves. It has been joined by some a number of other African states. China has special relationship with many states of Latin America. The National Bank of the Republic of Belarus stands out among others officially announcing the intention to use the Chinese yuan as a world reserve currency. As far back as the September of 2013 the Bank informed that it added the yuan to its gold and foreign currency reserves. According to various sources, the central banks of Malaysia, South Korea, Cambodia, the Philippines and Russia. 

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Thus, de-facto the yuan has to some extent has become a reserve currency for some states while de-jure it still has a long way to go for becoming an alternative to the dollar. 

The International Monetary Fund has the last word to determine the status of a currency. According to it, there are four key international currencies today: the US dollar, the euro, the British pound sterling and the Japanese yen. The special drawing rights (SDR - supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund) for international payments are calculated daily from this basket. The basket of currencies that values the SDR is re-considered by the IMF every five years. In 2009 China made a proposal to add the yuan and other foreign currencies to the SDR basket to decrease the share of the dollar. The current structure of SDR is as follows: the dollar - 41, 9%, the euro - 37, 4%, the pound - 11, 3% and the yen - 9, 4%.The basket is to be valued again in 2015. One can be sure that once again China will raise the issue of adding the yuan to the SDR basket and the United States will oppose the measure. The issue of yuan status adds to the disagreements tearing the International Monetary Fund apart. These very contradictions are getting exacerbated inside the IMF. It pushes China and other countries that belong to the periphery of world capitalist economy to creating alternative financial structures. This summer the BRICS summit was hosted by Brazil. The parties signed an agreement on creating a Pool of Conditional Currency Reserves. The agreement involves provision of mutual financial support by the member countries of the BRICS. This support can be provided via immediate provision of liquidity to a country in need by other members of the Pool. The initial volume will make $100 billion (the share of China is 41%). The Pool is ‘conditional’ - this means that reserve assets of the participating countries will not be used until a decision on granting an application will be made by the Standing Committee of the Pool, which will include representatives of all five countries. At first it is envisaged to provide credits inside BRICS in world reserve currencies (first of all the US dollar). But it’s not excluded that in future the Pool will be added by the yuan and other national currencies of the member – states. 

Tags: BRICS    IMF  China  US