SEOUL – Last
month, China
unveiled its first aircraft carrier, and is gearing up to challenge the United
States in the South China Sea.
By initiating a plan to internationalize its currency, China
is similarly seeking to challenge the dollar on the international stage.
In carving out a global role for the renminbi, Chinese policymakers are
proceeding deliberately. In the words of the venerable Chinese proverb, they
are “feeling for the stones while crossing the river.”
The authorities’ first step was to
authorize Chinese companies to use the renminbi in cross-border trade
settlements. As foreign firms exporting to China
accepted payment in renminbi, the currency piled up in their bank accounts in Hong
Kong. That led to the next step: Foreign firms wishing to invest
in China were
allowed to tap those deposits by issuing renminbi-denominated bonds, and
eligible offshore financial institutions were permitted to invest renminbi
funds in China’s
interbank bond market.
Then, last summer, China
announced plans to allow banks in Hong Kong to lend
renminbi to companies in Shenzhen, opening that city financially to the rest of
the world. The expectation is that if financial opening works in Shenzhen, it
will be implemented more widely.
Finally, as a step toward making the
renminbi a reserve currency, China
signed currency-swap agreements with the Philippines,
South Korea, Japan,
and Australia.
Meanwhile, Malaysia,
Nigeria, and Chile
have already acquired modest amounts of renminbi reserves. Other central banks
are expected to follow.
So, will China’s
plan for transforming the renminbi into an international rival to the dollar
succeed?
The answer, in my view, turns on how China
addresses four challenges. First, China
will have to build more liquid financial markets. Its bond markets remain
small, and trading volume is low, because the majority of bonds are held to
maturity by domestic investors. This is a matter of considerable importance to
central banks, which value liquidity when deciding which currencies to hold as
reserve. After all, it is the liquidity of US Treasury bonds that makes them
the world’s leading reserve asset.
Second, much will depend on how China
navigates the transition to a more open capital account. History is littered
with financial crises occurring in the wake of precipitous capital-account
liberalization. Falling prey to a crisis would not exactly encourage
international use of China’s
currency.
Third, the renminbi’s international
and reserve-currency prospects will be shaped by how China
handles its growth slowdown. The key will be whether it manages a smooth
deceleration, in which case renminbi internationalization will proceed, or
suffers a hard landing, in which case social unrest will intensify and all bets
are off.
The last challenge can be stated as a
question that is rarely posed: Is China’s political system an obstacle to
renminbi internationalization?
The pound sterling and the dollar, the
principal international and reserve currencies of the nineteenth and twentieth
centuries respectively, were issued by democracies. Britain
and the US had
contested elections and political systems that limited the arbitrary exercise
of executive power – institutions that are absent in China’s
political system.
One reason why democracy might matter
for international currency status is that democratically elected governments
are best able to make the credible commitments needed to develop deep and
liquid financial markets. They can commit not to expropriate creditors, since
the latter will vote them out of office if they do. And the same respect for
creditor rights that reassures domestic investors reassures foreign investors –
both official and private – as well.
Might it be possible for China
to establish limits on arbitrary executive power and strengthen creditor rights
sufficiently without undertaking a full-fledged transition to democracy?
Until now, constraints on decision-making
by the general secretary of the Chinese Communist Party, the country’s
highest-ranking official, have been – how to put it politely? – limited. But
that is beginning to change. The general secretary is increasingly constrained
by the CCP’s other institutions. The deliberations of the National People’s
Congress, for example, are becoming less ceremonial and more substantive.
Other bureaucratic decision makers,
for their part, are increasingly constrained by requirements of transparency
and disclosure. Internet-based movements are forcing Chinese policymakers to
strengthen labor and environmental standards. Why not creditor rights?
Since the early nineteenth century,
the leading international currencies have been those of countries with
democratic political systems, where arbitrary official action is constrained
and creditors are well represented. This does not imply that China
must have a Democratic Spring before the renminbi becomes a leading
international and reserve currency. But it does suggest that it will have to
strengthen the powers of the National People’s Congress further and create a
more transparent rules-based bureaucracy in order to achieve its monetary goals.