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Once again we are seeing articles
and research papers stating the Chinese renminbi (yuan) is about to replace
the dollar as the global reserve currency.
Here is a working paper by Arvind Subramanian and Martin Kessler at the Peterson
Institute of International Economics stating The
Renminbi Bloc is Here: Asia Down, Rest of the World to Go?.
A country’s rise to economic dominance tends to be
accompanied by its currency becoming a reference point, with other currencies
tracking it implicitly or xplicitly. For a sample comprising emerging market
economies, we show that in the last two years, the renminbi (RMB) has
increasingly become a reference currency which we define as one which
exhibits a high degree of co-movement (CMC) with other currencies. In East
Asia, there is already a RMB bloc, because the RMB has become the dominant
reference currency, eclipsing the dollar, which is a historic development.
The same authors present a case
in the Financial Times article China’s currency rises in the US backyard.
East Asia is now a renminbi bloc because the currencies of seven
out of 10 countries in the region – including South Korea, Indonesia,
Taiwan, Malaysia, Singapore and Thailand – track the renminbi more
closely than the US dollar. For example, since the middle of 2010, the Korean
won and the renminbi have appreciated by similar amounts against the dollar.
Only three economies in the group – Hong Kong, Vietnam and Mongolia
– still have currencies following the dollar more closely than the
renminbi.
This shift stems from China’s rise as a trader; its share of east Asian
countries’ manufacturing trade has risen from 2 per cent in 1991 to
about 22 per cent today. Countries that sell to the growing Chinese market or
are locked in supply chains centred on China see the advantages of
maintaining a stable exchange rate against the renminbi.
This development has two implications. First, it is one more important marker
in the shift of economic dominance away from the US and towards China. Not
only is China, by some measures, the world’s largest economy in
purchasing power parity terms, the world’s largest exporter and the
world’s largest net creditor (for more than a decade), but the renminbi
bloc has now displaced the dollar bloc in Asia. The symbolism and its
historic significance cannot be understated because east Asia, despite
physical distance, has always been part of the dollar backyard.
Déjà Vu Rehash
The analysis by Subramanian and Martin Kessler is nothing but a Déjà Vu rehash of easily rebutted
arguments that crop up time and time again.
Three Essential Facts
1.
China's bond markets are not big
enough or deep enough for the Yuan to displace the US dollar.
2.
Contrary to what most think,
having the reserve currency is a a curse more than a
blessing.
3.
Neither China nor the US wants to
be the global reserve currency.
The first point alone seals the fate in my opinion but let's take a closer
look at the "curse of the reserve currency".
Via email, Michael Pettis at China
Financial Markets responds to points two and three. ...
I think there is a lot less to all this than meets the eye. I
have many times expressed my deepest skepticism about much of what is said
about reserve currency status, and especially about most of the arguments
based on the claim that “history proves…” History almost
never proves the many statements made about reserve currency status,
especially when the history of shifts from one dominant reserve currency to
another consists of a single case, the shift in the 1920s to 1940s from pound
sterling to the US dollar.
But history aside, there is a much more important
objection to the idea that the RMB is likely to become a dominant reserve
currency. Reserve currency status involves substantial costs to the issuing
country. In fact – and I will discuss this extensively in my upcoming
book due February next year (Princeton University Press) – I do not
think that the role of the dollar provides for the US any “exorbitant
privilege”, contrary to what many suppose. Rather, I have argued, it creates
an exorbitant burden for the US economy, one that forces the US to choose
between higher debt and higher unemployment whenever a country takes steps to
force up its savings rate or, which is pretty much the same thing, to force
up its current account surplus
It is for this reason that I have never thought that the RMB would become an
important reserve currency – precisely because Beijing has made it very
clear that it will not accept any of the important costs that reserve
currency status bring. Besides the fact that major reserve currency status
would require complete liberalization of the capital account and a flexible
financial system largely independent of government control, with clear and
enforceable rules, it would put China’s economy at the mercy of countries
that want to turbo-charge growth by running large trade surpluses. Beijing
isn’t eager to accept any of these things.
But what about the advantages of reserve currency status – don’t
they more than compensate the costs? The two most widely cited advantages in
China of reserve currency status are first, that reserve currency status
allows a country to borrow in its own currency and
second, that it protects a country from accumulating too-large foreign
currency reserves.
It turns out that the first “advantage”, however, has absolutely
nothing to do with reserve currency status. Lots of countries, including
China, borrow in their own currency. What matters is the quality of the
balance sheet.
In fact in the case of China if the preconditions for reserve currency status
were imposed there is a good chance that it would be harder, not easier, for
China to borrow in its own currency. Why? Because at least part of the reason
the Chinese government can borrow so easily in RMB has to do with
restrictions on capital outflows and control of the domestic savings through
the banking system. Relax both constraints, which are necessary if the RMB is
ever going to become an important reserve currency, and domestic financing
may very well be much more difficult.
The second “advantage” is mostly confused nonsense. Aside from
the fact that no country can accumulate its own currency in its foreign
currency reserves, the size of foreign currency reserves has nothing to do
with whether or not others accept your currency as a reserve currency.
Reserve accumulation is fully explained by the sum of the current account and
the capital account.
Any country that runs a surplus on both accounts must accumulate foreign
currency reserves, and the reason Germany has a large current account surplus
and no foreign currency reserves is simply because it runs a large capital
account deficit. Instead of recycling its current account surplus by having
the central bank lend to foreign governments, as the PBoC does, it recycles
its current account surplus by having German banks lend to other European
countries.
Math is Math
But let’s leave all of this aside. The paper by Arvind Subramanian and
Martin Kessler argues that, regardless of what people like me believe ought
to happen, in fact the RMB is actually displacing the dollar, whether or not
we think it can or should. The proof?
In East Asia, there is already a renminbi bloc, because the renminbi has
become the dominant reference currency, eclipsing the dollar, which is a
historic development. In this region, 7 currencies out of 10 co-move more
closely with the renminbi than with the dollar, with the average value of the
CMC relative to the renminbi being 40 percent greater than that for the
dollar.
You can’t argue with the math, can you? As The Economist put it in
their review of the article, “Seven currencies in the region now follow
the yuan, or redback, more closely than the green.” Since this only
leaves three recalcitrant currencies, sheer arithmetic shows that the dollar
is being displaced by the RMB.
Well actually you can argue with the math, or at least you can argue with the
interpretation of the math. There are alternative – and much simpler, I
think – explanations for the increased “co-movement”, and
these do a much better job, I think, of explaining what is happening than
reserve currency displacement.
Assume for a moment a global scenario in which the largest exporter of
manufactured goods in the world has a significantly undervalued currency.
Assume further that many of its competitors also have undervalued currencies,
and would like to revalue in order better to manage their domestic monetary
policies. Assume finally that the world is in crisis, and exporting nations
are having trouble maintaining the necessary growth rate of their exports, so
they cannot allow their currencies to rise faster than that of their main
export competitors.
In this scenario which currency would the currencies of the smaller exporting
countries track, the US dollar, or the undervalued currency of the largest
and most competitive exporter of manufactured goods in the world? Almost
certainly the latter, right? The smaller exporters
would want their currencies to rise, but the rise in their currencies would
be limited by the rise in the currency of their largest competitor. This
would happen not because they are tracking a new
reserve currency but only because they are in export competition with that
currency.
Is my scenario a plausible description of the world today? I think it very
clearly is. The world certainly is growing slowly, exporters are having real
trouble, countries are engaged in currency war, and one can very easily argue
that the RMB is seriously undervalued and acting as a constraint on other
Asian currencies. In fact over the past several years many Asian finance
ministers have said exactly that – they cannot appreciate their
currencies as much as they would wish until the RMB appreciates more. The
conclusion, then, might be not that there is a RMB bloc, but rather that the
appreciation of the RMB against the dollar is a kind
of cap against which other currencies are constrained.
Or let’s take another scenario. Assume the world is in crisis and the
US dollar is seen widely as the “safe” asset. In this world,
perhaps when risk perceptions rise, investors and traders move generally out
of riskier currencies into the dollar, and when risk perceptions decline,
traders move out of the dollar into riskier currencies. Perhaps we could even
call these trades “risk-on” and “risk-off” trades.
In this case it would be natural to see an increase in the correlation among
riskier currencies. Would this be a sign of an emergent currency bloc? No. It
would just be a sign that the dollar is the dominant reserve currency and
that everyone is treating it as such, buying and selling it is response to
changes in risk perception. Is my second scenario a plausible description of
the world? Again, it almost certainly is.
I am not saying that Subramanian and Kessler are necessarily wrong. I am just
suggesting that there are alternative, and in my opinion far more plausible,
explanations for the greater correlation between the RMB and these other
currencies than the RMB bloc hypothesis. Of course if the RMB were a freely floating currency and there was no longer PBoC
currency intervention, and the correlations that the authors find still hold,
then perhaps this could be a more powerful argument about the rise of the
RMB. Until then, it is almost wholly irrelevant.
Who is Top Dog?
But where I have a real difference of opinion is the claim that
“American optimists” somehow don’t want the RMB to become
the dominant reserve currency and want the US dollar to retain the title.
This suggest to me that the argument here is really not about the whether or
not the RMB is likely to become a reserve currency but rather about whether
or not you expect this to be the “China Century”, and if the RMB
becomes the reserve currency Chinese dominance will inevitably follow.
In fact I have also argued many times that if the US does not take steps to
prevent foreign countries from acquiring unlimited amounts of US dollar
reserves, for example by forcing, as Keynes wanted, reserve accumulation to
be more evenly divided amount all the major currencies, it will force the US
into a very difficult position and can actually hasten the coming of the
China Century. As I see it, “American optimists” or at least
those who want the US to remain the only “indispensable country”,
should actively encourage a greater role for the RMB and a lesser role for
the dollar.
Unfortunately what should be a technical discussion about the merits for and
preconditions of reserve currency status has been completely subsumed into
the idiotic argument about whether you are “for” China or
“against” China. But anyone who conflates his opinion about which
country should be top dog with his analysis of the rise of the RMB as the
dominant reserve currency is, I think, engaged in bad economics.
There are of course plenty of generals, journalists, and policymakers in
China who believe that dominant reserve currency status is desirable and
inevitable, but very few Chinese monetary economists, even among those
blessed few that do not believe China is going to have a very difficult
adjustment, think reserve currency status is likely to happen soon. Among
economists, it seems that only foreigners, and based mainly abroad, seem to
believe that this process is happening.
Discussion Simplified
Portions of the above discussion may be a bit complicated for some to
understand. Let's see if this simplification helps:
·
The US treasury department,
President Obama, Mitt Romney, and especially Ben Bernanke all want the Yuan
to rise.
·
China does not want the yuan to
rise because of export issues.
·
No country is acting as if it
wants ownership of the reserve currency, precisely because no country does
want ownership of the reserve currency. Currency wars are proof enough.
I consider Michael Pettis to be the foremost expert on international trade. I
am very pleased to have him as a speaker along with John Hussman, James
Chanos, John Mauldin, and Chris Martensen on April 5 at the Wine Country
Conference.
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