November 15, 2013, by Editor

What next for the Dollar and RMB? Seeking Clues in the US and China’s Past

Written by Niv Horesh.

London’s grooming as the launch-pad of the RMB, China’s currency, into becoming the next global reserve currency may merely be on the drawing board. Yet, coupled with the recent fiscal shutdown in the US, some insecurity about the long-term future of the US$ could perhaps be felt for the first time among market pundits. That insecurity was not just a result of the upbeat rhetoric that London Mayor Boris Johnson sounded during his recent trade mission to Beijing, or talk of the UK nuclear-power industry being taken over  by cashed-up Chinese state-owned enterprises. Rather, it has to do with the streak of news for China this quarter: its economy still seems to be growing much faster than other economies. A few new important studies further suggest that the Chinese economy is transitioning much faster than previously thought toward a greater share for household consumption as compared with infrastructural and industrial investment. In other words, Beijing’s measures to curb the investment glut and manufacturing over-capacity that are associated with its post-GFC stimulus package may be working at least in part.

So the centre of gravity of the global economy is continuing to steadily shift eastwards, and China’s economy may have begun slowly de-coupling from America’s after decades of dependence on exports to that part of the world. The RMB has, however, not been floated globally, although its share of cross-border transactions worldwide is steadily growing, and although Chinese agencies have symbolically downgraded America’s credit rating. China’s insular financial market is the argument RMB-skeptics and China “bears” often invoke by way of explaining why the RMB is not likely to assume reserve-currency qualities before 2025. After all, China still readily buys into US$-denominated assets so as to help America tide over its trade surplus with China.

Memories of the initial euphoria surrounding the Euro may also play a role here. A decade ago, economists predicting that the euro would one day supplant the U.S. dollar as the preferred global reserve currency were not uncommon. In fact, today’s talk of RMB internationalization owes much to Eurozone disillusionment and downbeat predictions concerning the prospects for Japanese economic recovery. But is today’s talk of the RMB becoming one of the next few global reserve currencies not premature and misguided to the same degree ? The answer is a clear ‘no’ to my mind. One reason why doubts linger may have to do with the fact that most analysts consider the prospect of RMB internationalisation merely based on the US$ trajectory over the course of the 20th century. This is precisely where economic historians can make a contribution to the conversation.

Awareness of the competent manner in which the RMB was propagated and stabilized in a country as vast and diverse as China during the 1950s might perhaps make one a fraction less sceptical of that currency’s potential to play a greater role. Ironically, with the RMB managed by a party-state credited with three decades of breakneck economic growth rather than by a monetary union of fractious, developed nation-states might also be more reassuring to financiers, as might China’s responsible monetary conduct during the Asian Financial Crisis in 1997. But quite apart from all of these factors, one would have to recall that the Nixon Shock of 1971, when the US unpegged the US$ from solid gold, could only be effectively countenanced in a world divided by the Cold War. This is not the case today, as China is no longer a Cold War enemy, and its huge economy is closely intertwined with the West. In other words, inflationary measures in the US will likely prod China to let its currency gradually float on world markets.

Libertarians are nowadays so alarmed at the rising debt level of the U.S. government that a return to an international gold standard may not sound so far-fetched in their ears. There is in that sense uncanny similarity between the position of Zhou Xiaochuan, governor of China’s central bank, and the position advanced by GOP figures like Ron Paul or Robert Zoellick for gold to be given greater weight in settling international accounts . Influential columnists like The Economist’s Philip Coggan have, moreover, diagnosed the Nixon Shock, namely the abandonment of the postwar gold-exchange standard, as the original sin that led to the 2008 global financial crisis.

If early-modern history is anything to go by, then a lapse back to commodity money may be somewhat less implausible than it currently sounds. However, a more likely scenario still would be for the RMB to assume more global-reserve properties over the next few decades, including freer capital flows from and into China.  This does not necessarily mean the US$ will lose its leading position, but its share in cross-border transactions not involving the US itself will likely diminish in the future. If and when this transpires, the RMB will have been the first global reserve currency issued by a nation-state to have never been historically linked with any precious metal.

Niv Horesh is Senior Fellow at the University of Nottingham’s China Policy Institute. His latest book is Chinese Money in Global Context, published this year by Stanford University Press. The original version of this post was published in the South China Morning Post on 12 November 2013.

Posted in Business and ManagementEconomics