Daniel Suchenski
March 14, 2016
Introduction
For international
financial managers in China November 30, 2015 will be remembered as a
significant moment for the Renminbi (Yuan). The International Monetary Fund
(IMF) indicated as part of its regular five-yearly review of the global
currencies that make up the coveted Special Drawing Right (SDR) announced that
the Chinese currency, the Renminbi would be included in this group starting
October 1st, 2016. Ms. Christine Lagarde, the current managing
director of the IMF stated:
“The
Executive Board's decision to include the RMB in the SDR basket is an
important milestone in the integration of the Chinese economy into the global
financial system. It is also a recognition of the progress that the Chinese
authorities have made in the past years in reforming China’s monetary and
financial systems. The continuation and deepening of these efforts will bring
about a more robust international monetary and financial system, which in turn
will support the growth and stability of China and the global economy.”[2]
The big question that
many in the financial world are asking since this announcement and will likely
continue to ask throughout much of 2016 is what does this mean for the
international financial markets and specifically does this mean that the RMB
may one day overtake the predominant currencies in the SDR as the leading
reserve currency?
Background
The Special Drawing
Reserve or SDR is a global reserve asset that the IMF created in 1969 as a
means of supplementing the existing official reserves. The IMF goes into
greater detail about the SDR defining it as,
“A potential claim on the freely usable currencies
of IMF members. Holders of SDRs can obtain these currencies in exchange for
their SDRs in two ways: first, through the arrangement of voluntary exchanges
between members; and second, by the IMF designating members with strong
external positions to purchase SDRs from members with weak external positions.
In addition to its role as a supplementary reserve asset, the SDR serves as the
unit of account of the IMF and some other international organizations.”[3]
Why does the SDR designation matter? An article
from August 5th 2015 published by The Economist sheds light on the
role and importance of the SDR. SDR
constitutes “an international reserve asset that helps maintain balance between
countries with big external liabilities and those flush with cash.”[4]
RMB overtaking the USD
From instituting new
regulations on financial institutions, to seeking new ways to hedge
investments, many around the world have sought ways to ensure a repeat of the
recession that started in 2008 is less and less likely. For some, the recession
was a wakeup call that having an overreliance on developed countries currencies
might be leaving some exposed. As Dr William H
Overholt, co-author of Renminbi Rising: A
New Global Monetary System Emerges states, the decline of the US dollar during
the recession exposed China’s “reserves of about $4trn to huge book losses.
They reasoned, as did leaders of some other countries, that if more of their
transactions and more of their holdings were denominated in other currencies,
or better in their own currency, they would be far less exposed to such risks.”[5]
Indeed, many in China think the overtaking of the
USD is a foregone conclusion. “Chen Yulu, a leading economist, says it will
take 15 years. Wei Jianguo, deputy head of a major think-tank, puts it at 20.”
Still others think that the RMB is “already on the verge of displacing the
USD.”[6]
As the RMB continues to grow in use and function as it takes advantage of its
new designation with the IMF, being added to the SDR only strengthens a growing
trend in recent years as China and its currency were essential in maintaining
global trade during the great recession. This new designation by the IMF, has
some concluding that this will likely lead to cheaper and more efficient
transactions for many. Dr. Overholt explains that “companies trading with China can often structure deals much more efficiently
when they have the option of denominating the deal in RMB.”[7]
While acknowledging the great potential of the RMB and its likely rise as a
currency of significant prowess for reserves, and transactions globally, Dr.
Overholt does note that there are a number of real changes that the country
needs to make to help facilitate the rise of the RMB. Principally he lists
three things. One, that there will continue to be a period of strong economic
growth in the long-term. Two, the dismantling of China’s current capital
controls. And three, “They need to grow their domestic bond market, which is
now about 10 percent of the size of the US counterpart, and unify it so that it
is a single, highly liquid market, rather than the fragmented market under four
different regulators that prevails today.”[8]
While this is a closely watched progression and even Dr. Overholt thinks that
it will take years if not decades for this transition to take place, there are
many dissenting voices around the world when it comes to the ‘likely’ prospects
of the RMB overtaking the USD. Some believing that not only is it not likely
but that it’s highly improbable.
Skepticism for the rise of the RMB
For some
engaging in this debate, not only is the conversation somewhat surprising, the
weight given to the evidence that builds the argument is simply staggering. The
same Economist article that discussed the use of the SDR as a balance between
countries with “big external liabilities and those flush with case,” will point
out that the prior to the November 30th announcement, “rarely” in
the nearly 50 year history of the SDR has the international reserve garnered so
much attention. That’s because, according to the article, the SDR plays a
mostly “arcane role in the global financial
system.”[9] While the currency was
designed with providing greater balance in the international monetary system,
the application of the SDR is perhaps only a small part of the larger whole “as
countries largely rely on capital markets and hard currencies to cover their
obligations.”[10]
Gwynn Guilford in an article published in Quartz takes a closer look at the
reach and usage of the
currency in the real-world. According to her further examination of the usage
of the RMB, “the yuan hasn’t truly become much more
widely used than the Norwegian kronor”[11]
when it comes to international exchanges. Ms. Guilford attributes the relative
‘popularity’ of the RMB recently to short-term factors including speculators’
“one-way bet on the yuan’s appreciation against the dollar—an appeal that is
now dimming fast.”[12]
While the RMB is now the fifth-most used currency in international payments
according to data from ATLAS. A closer examination, according to Guilford,
reveals that “seven-tenths of those supposedly international yuan transactions
are done in Hong Kong, says Ho-Fung Hung, professor at Johns Hopkins University
and author of The China Boom: Why China Will Not Rule the World.”[13] Hung goes on to say that if you were to “strip away
Hong Kong’s influence, and the yuan claims only about 0.8% of international
transactions—less than the Thai baht”[14]
Zhang Jun, writing for the Taipei Times, echoes the sentiments of Hung
insisting that “despite
China’s massive GDP and trade volume, the yuan’s share in the global
foreign-exchange market remains negligible. And the process of
internationalizing the yuan is far from complete.”[15] An
article written for Business Insider takes the likelihood of the RMB becoming a
significant reserve currency further stating that “Bitcoin 2.0 has a better
chance of becoming the world’s reserve currency than China’s yuan.”[16] The
author, John Mauldin, goes on to two factors that will keep the RMB from making
any significant runs on the other major reserve currencies in the next couple
decades. One. ‘China has a massive trade surplus’.
“For a country to deliver the
currency in which most global trade is done, it must supply that currency “in
size” to enable the trading. The United States runs a massive trade deficit,
pushing dollars all over the world to circulate among the economies of other
countries. China, by contrast, has a trade surplus. It is taking in dollars and
many other currencies although it does run trade deficits with some countries.”[17]
Two, ‘no one
will ever trade in an SDR’. For Mauldin, not only does the reserve not allow
for the degree of flexibility that is needed in global finance, for example, “in the case of the United States, we could
create only the equivalent of about two to three months of our trade deficit in
SDRs”[18] which routinely runs in
the tens of billions of dollars each month. The current reserves of SDR,
according to the IMF is just a little more than 200 billion.[19] “There simply aren’t
enough SDRs to actually conduct trade in.”[20]
Conclusion
While it’s hard to see there much likelihood of either bitcoins
or the Renminbi taking on significant prevalence in the international markets
in the foreseeable future, especially without some necessary reforms in the
financial institutions within China, the possibility is still present. If this
is indeed an aim of the financial managers in China, the road will be long and
require a willingness to be more transparent and liberalized, a sign that the
country has thus far not shown signs of taking on. Many of the skeptics on the
reserve importance of the RMB may have been singing a different tune a year or
two ago when markets were predicting the value of the yuan to continue rising
which highlights the difficulty in assessing the reality of these topics when
predictions reach out decades in the future. At least for now, the prospects
remain dim but tomorrow is a new day and only time will tell which pundit and
which analyst is proven right and which wrong.
[1]
https://upload.wikimedia.org/wikipedia/en/8/88/Yuan_collection.jpg
[2] International Monetary Fund Press Release. “IMF’s
Executive Board Completes Review of SDR Basket, Includes Chinese Renminbi.”
Retrieved on March 10th 2016 from:
https://www.imf.org/external/np/sec/pr/2015/pr15540.htm
[3] International Monetary Fund. “Special Drawing Rights.” Retrieved on March 10th 2016 from:
http://www.imf.org/external/about/sdr.htm
[4] The Economist. “China knocks on
the reserve-currency door.” Retrieved march 10th, 2016 from
http://www.economist.com/blogs/freeexchange/2015/08/yuan-and-sdr
[5] Matsangou, Elizabeth. “The RMB
could lead global currencies over the USD.” World Finance. Retrieved on March
10th 2016 from:
http://www.worldfinance.com/markets/the-rmb-could-lead-global-currencies-over-the-usd
[6] The Economist. “The yuan’s rise
will challenge America, but not before China changes.” Retrieved on March 10th
2016 from: http://worldif.economist.com/article/6/what-if-the-yuan-competes-with-the-dollar-clash-of-the-currencies
[7] Matsangou, Elizabeth. “The RMB
could lead global currencies over the USD.” World Finance. Retrieved on March
10th 2016 from:
http://www.worldfinance.com/markets/the-rmb-could-lead-global-currencies-over-the-usd
[8] Ibid.
[9] The Economist. “China knocks on
the reserve-currency door.” Retrieved march 10th, 2016 from
http://www.economist.com/blogs/freeexchange/2015/08/yuan-and-sdr
[10] Ibid.
[11] Gwynn Guilford. “The
Chinese yuan won’t become a global reserve currency any time soon.” Quartz.
Retrieved on March 10th, 2016 from:
http://qz.com/561635/the-chinese-yuan-wont-become-a-global-reserve-currency-any-time-soon/
[12] Ibid.
[13] Ibid.
[14] Ibid.
[15] Zhang Jun. “Inclusion of the yuan
in SDR matters.” Taipei Times. Retrieved on March 10th, 2016 from:
http://www.taipeitimes.com/News/editorials/archives/2015/12/19/2003635128
[16] John Mauldin. “MAULDIN:
Bitcoin 2.0 has a better chance of becoming the world's reserve currency than
China's yuan.” Business Insider. Retrieved on
March 10th, 2016 from:
http://www.businessinsider.com/china-yuan-not-close-to-reserve-currency-2015-12
[17] Ibid.
[18] Ibid.
[19]
http://www.imf.org/external/np/exr/facts/sdr.htm
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