As the world is trying to come to terms with the transformation of China, so the reserve currency story is beginning to emerge. The use of the RMB has expanded fast to settle trade contracts in RMB, and for bonds and for currency trading. But now it begins to enter into the more refined concept of “reserve currency”, which means essentially that Governments hold part of their reserves in that currency. It gives that Government global influence and the capacity to affect its trade and investment flows. The U.S.A. dominates the world through the world’s use of the dollar as the primary currency, and enables the U.S.A. to import more cheaply than other countries as other nations accept dollars as payment for their sales to the U.S.A. The value of those dollars is essentially set by the U.S.A.
The emergence of the RMB alongside, and probably passing the Euro eventually, would have a profound effect on global finance and interest rate policies. It is significant that this is happening and that the Chinese aim seems limited to establishing it as a basis for an Asian currency with global availability. It will not lead to the replacement of the dollar in the first half of this century, and because the Chinese have analysed and rejected traditional reserve currency characteristics, it probably never will replace the dollar globally, but could, eventually, over decades, become the main currency in Asia.
It’s emergence as a major global currency is part of the changing global landscape especially in Asia.
While this piece might seem a trifle dry it is essential to understanding the plays around the rise of China.
It is worth our understanding this as it is a key part of the emerging story of global change. Change can set off positives and negatives.
Change is inevitable but we need to see it and ensure it is part of our policy development.
The emergence of a New Asia with its own strong currency could make us feel challenged. But we have so many other powers in the West , not least is the leading technology position of the West in key areas of global finance and advanced technologies across the board. So it is a question of how to accept the huge opportunities and work with the changing architecture of Asia.
We have seen change in the share of world gdp, but that of the West is not so far greatly affected yet, as the global pie has grown as well. That is the key – this is not about sharing the same pie between more nations with some losing share. This time it is about the pie increasing with ample room for all to move forward. But the structures of the present need to change to enable development. The old clothes will not suffice any longer.
The failure to adapt global institutions, such as the IMF, have led to changes around such institutions. The Asian Infrastructure Investment Bank(AIIB) is just one leading example. The West can keep a small G7 Club for American and Western interests. That is controllable. But then other global and regional structures will be developed outside the control of G7. That may not matter if the main players realise each other’s areas are that and respect them.
It is inevitable that as the Chinese economy grows its currency will move towards a 10pc share of global currency markets, and beyond, from its current share of about 2-3pc. The great plans for its economy and the Silk Roads to transform Eurasia mean that it will need to have more influence over interest rates and flows than if it used a currency – the dollar – whose decisions are made in Washington for other priorities.
At the moment the Dollar is the major world currency, followed by the Euro, and then a big gap to Sterling and the Yen. The RMB is said to be around 2pc but some expect this to rise to 10pc quite quickly- the level of Sterling and the Yen – , and probably beyond that towards 20pc. It means Western nations will hold around that share of their reserves in the RMB and their fortunes will be affected by changes in the RMB value and its interest rates.
The focus is now on the IMF making a decision to place the RMB in the SDR basket. For us interested in China, it would represent an acceptance of the RMB as having arrived as a minor, but significant global currency.
SDR – Special Drawing Rights – is a rather exotic financial term which essentially determines which currencies in what proportion make up the global basket for IMF lending. The effect of this is to determine what shares the different currencies have in central banks’ reserves, and this then affects the global share of each currency and its role in global finance. So remote from our lives but an important feature in global architecture.
We have shown a great interest in the rise of the RMB, wanting it to be based in the London market reinforcing London’s key role in the British economy and global finance. We can only imagine what might happen if China shifted its European financial focus to the Continent.
The IMF is making positive remarks about the RMB, and it appears promising that they will announce the inclusion of the RMB in the S.D.R.
But the RMB would only become a major currency, rising to 20pc or more, if China decided to place very large amounts into the global markets. This has risks for China which they would have weighed up very carefully, but it is hard to see that China’s Silk Roads project can happen without the RMB rising to global significance as the second Asian currency behind the dollar.
The U.S.A. created the dollar as the global reserve currency by exporting the dollar through large scale deficits in trade. It also reinforced this through big bond issues in the Dollar. It is hard to see China becoming a nation who would feel comfortable with trade deficits, and uncontrolled bond issues might also worry their views on stability. But the Silk Roads do open a road to huge exports of capital. $100 billion of infrastructure investment along the Silk Roads translates into 10 times that of commercial contracts back to raw materials and forward to tolls and other commercial developments that flow along the Roads.
So the Silk Roads initiative is another key aspect of the RMB becoming a major global currency.
This is not about the replacement of the Dollar and the West by Asia, China and the RMB. It is, however , a sign that an Asian system is emerging distinct from the American led system that has controlled the world for the last 70 years. We have the Euro struggling to stabilise itself as the European currency, and for the near term we have the RMB becoming the largest Asian currency.
This move is saying something very significant to Western business –Asia is developing its own systems and characteristics. The decision of HSBC to consider moving back to Hong Kong is a recognition that if your main future is in Asia then you are going to have to be part of Asia. This is going to establish challenges for Western businesses. But the U.S.A. has managed to adjust to Europe and being in Europe, so the West can do the same in Asia.
Asia is going to have its own way of doing things. The power centre is not yet resolved, but China with its huge reserves and clarity of thinking, is setting the pace. The Chiang Mai Accords were an early signal – around 1999 – that Asia was moving to self-reliance in currency and the emergence of the RMB is a further signal of change.
The good news is that China created the AIIB and immediately offered participation to the West. China sees the West as having a significant role. It also sees that the huge contracts and benefits of the Silk Road development project must be shared with the nations along the Road. So China is not the Japan and Germany of the first half of the 20th Century. They respect the West and want to work with the West.
So how do the West come to terms with the new structures in Asia and become Asian? China has thought long and hard about how to develop Asia and involve the West to share the benefits.
I doubt that many Western Governments and companies have taken the scale of this issue on board, and the proposed new Western Free Trade Areas were taken by some as a signal of an inner Western world, where the majority of the world’s GDP would be based, and the rest which would be relatively lawless and less attractive.
But Asian growth , AIIB, the Silk Roads and the emergence of the RMB, are making that appear less well grounded.
The Chinese bigger strategic guiding plan is Common Prosperity, which is the guiding hand in all this. This concept of sharing is counter-intuitive to western capitalism. But it is the Chinese way forward. Common Prosperity is based in the belief that sharing prosperity nationally and internationally is the right way to build sustainable inter-dependant development and inhibit jealousy – China’s antidote to World Wars.
But for now the story is the Silk Roads and the emergence of the RMB as a Reserve Currency, and we know China well enough to know this is part of long term thinking which is based on sharing the benefits.
Stephen
China Global Impact for the 48 Group
Ps As a postscript, we might want to keep an eye on gold where China is building its inventories. It is always possible that these 50 years of currencies not being valued to the price of gold, may have some question marks.
It is also worth noting that U.S.A. stock markets account for 36pc of global stock markets value – China about 4pc. With the economies a similar size are we to expect Chinese stock markets to grow to a similar size as the U.S.A.?