Renmin-mumbo-jumbo: the hype about China's currency

The only thing bigger than China is the hype about China. In particular, the ceaseless chatter about the rise of Chinese currency and how it will “rule the world” has in recent times acquired high-decibel fever-pitch.

Writing in the Financial Times, Arvind Subramanian, senior fellow at the Peterson Institute for International Economics, prophesied the “potential eclipse” of the dollar as a reserve currency in just a decade - and the rise of China currency, the renminbi (or the yuan), to supplant it.

Although Subramanian caveated his thesis, which is one strand of narrative in his upcoming book, by claiming that this outcome wasn’t inevitable, his base case argument is that we’ll all soon be walking with Mao Zeodong-decorated currency notes in our wallets.

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Last week, a European official claimed that Chinese officials had told EU business executives that the yuan will achieve “full convertibility” by 2015. That report set off yet more feverish chatter, but within hours, China’s top central banker Zhu Xiaochuan stepped in to deny it. China, he said, did have a plan for full convertibility, which would mean the yuan can be exchanged for other currencies without government restriction, but it did not have a timetable.

[caption id=“attachment_83801” align=“alignleft” width=“380” caption=“Chinese officials have been pushing for greater international use of the renminbi as a way of incrementally lowering their exposure to foreign currency risk. Petar Kujundzic/Reuters”]  [/caption]

It’s true that Chinese officials have been pushing for greater international use of the renminbi as a way of incrementally lowering their exposure to foreign currency risk - principally, the US dollar ( of which they have piled up quite a hoard ). Towards that end, they are building up an offshore renminbi market and have entered into currency swap agreements with their primary trading partners. Renminbi-denominated loans are also on offer in Hong Kong, although as this report notes, the business has not really taken off.

Even the Mexican peso has a wider reach

But as with many things about China, the hyperbolic projections about the “almighty renminbi” - and the inevitability of its rise as a reserve currency - ignore some fundamental facts.

Indicatively, according to statistics put out by the Bank for International Settlements (see Table B. 4 on Page 12),in April 2010, the most recent date for which data is available, the renminbi account for 0.9 percent of the average daily turnover of global foreign exchange transactions, considerably lower than China’s share of world trade. (Since two currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200 percent, not 100 percent.)

Even the benighted Indian rupee, about which no one - not even the good folks at the RBI - speaks as a reserve currency in waiting, accounts for 0.9 percent of average daily turnover of global foreign exchange transactions - about the same as the renmimbi.

The renminbi’s share of forex transactions has inched up from 0.1 percent in 2004, and although the pace of its internationalisation is certainly accelerating, particularly after the 2008 financial crisis, the fact that it still accounts for less than 1 percent of daily forex turnover means it has aeons to go before it can gain wider acceptance as a preferred currency of trade.

For all the dollar-bashing we've seen in recent years, the share of the US dollar in the average daily turnover of global foreign exchange has declined only marginally from 86.8 percent in 1998 to 84.9 percent in 2010; the euro’s share has edged up only fractionally from 37.9 percent in 2001 to 39.1 percent in 2010.

Heck, in 2010, even the Mexican peso accounted for a larger share (1.3 percent) of average daily turnover of foreign exchange transactions than the renminbi.

Of course, given China’s increasing share of the global trade, its progressively higher contribution to global GDP growth, and the “dollar trap” that it finds itself in, there is an incentive and an opportunity for the renminbi to gradually go international. But this progress is likely to be glacial at best.

And it’s not even sure that Chinese leaders, for all the national pride that would be engendered in seeing the yuan “buy up the world”, want to see the renminbi rise to reserve currency status in the near future.

Political constraints on the yuan

Arthur Kroeber, managing director of GK Dragonomics, a Beijing-based economic consultancy; editor of the China Economic Quarterly; and a nonresident fellow of the Brookings-Tsinghua Center in Beijing, explains it thus:

[caption id=“attachment_83793” align=“alignleft” width=“380” caption=“In 2010, even the Mexican peso accounted for a larger share (1.3 percent) of average daily turnover of foreign exchange transactions than the renminbi. Alfredo Estrella/AFP”]  [/caption]

"…The prospect of the RMB becoming a reserve currency on the order of the euro – let alone replacing the dollar as the world’s dominant reserve currency – is remote. The reason is simple: To be a reserve currency, you need to have safe, liquid, low-risk assets for foreign investors to buy; these assets must trade on markets that are transparent, open to foreign investors, and free from manipulation. Central banks holding dollars and euros can easily buy lots of US Treasury securities and euro-denominated sovereign bonds; foreign investors holding RMB basically have no choice but to put their cash into bank deposits. The domestic Chinese bond market is off-limits to foreigners, and the newly created RMB bond market in Hong Kong… is tiny and consists mainly of junk-bond issuances by mainland property developers."

Of course, the Chinese government bond market could grow organically, but in Kroeber’s reckoning, it is bound to be constrained by political considerations.

“Chinese officials… do not trust markets to set the interest rate at which the government can borrow. Over the last decade Beijing has retired virtually all its foreign borrowing; more than 95 percent of Chinese government debt is issued on the domestic market, where the principal buyers are state-owned banks that are essentially forced to accept whatever interest rate the government dictates. There is absolutely no reason to believe that the Chinese government will at any point in the near future surrender the privilege of setting the interest rate on its own borrowings to foreign bond traders over whom it has no control. As a result, it is likely to be many years before there is a large enough pool of internationally available safe RMB assets to make the RMB a substantial international reserve currency.”

In effect, anyone who claims - as Subramanian and others do - that the Chinese renminbi will become a global reserve currency is effectively saying that China’s political leadership will be ready to cede control over the political economy. As anyone familiar with the power control-freak nature of the Communist Party knows, that’s not something that will happen by choice.

All this chatter about the renminbi’s rise is pure renmin-mumbo-jumbo that is best ignored.