International | Mar 12 2013
By Andrew Nelson
The Chinese started the shift from central planning to market-based economic reforms back in 1978 and since that time China’s economy has grown 28 times larger. This thirty five years of growth has made China the second largest economy in the world after the US and the largest trading nation in the world, just pipping the US last year.
Yet while this shift has been massive in terms of trade, China’s currency, the renminbi (RMB), plays no part. Analysts from South East Asia’s largest bank, Singapore’s DBS, note that in mid-2011, less than 1% of the world’s trade was conducted in RMB versus some 46% of the world’s trade being conducted in US dollars. The next 35% was conducted in euros, yen, pounds and Aussie dollars.
China is now looking at addressing this issue, the nation embarking on a path over the past few years to make the RMB an internationalised global currency. With the currency on a par with the country’s trading position, it would allow China to denominate and settle international trade, whether conducted with China or between countries external to China. The country could also borrow and lend in off-shore markets and could be used as a foreign reserve currency held by central banks outside of China.
While it may sound a simple enough plan, DBS points out it would mean massive changes for China’s economy and the way the nation does business. First, China’s markets would have to open to foreigners such as those in America and Europe. Interest rates would have to go up and down because of markets, not Beijing, and rules and institutions would need to be created to control these markets if investors plan to hold the RMB the same way they do the USD, EUR and AUD.
DBS sees a long list of reasons why China may not want to ultimately make this move, but at least to the bank, these reasons are nowhere near enough. The first core cause is that a strong and independent RMB would have helped the world avoid a credit crunch like the one we saw back in September 2008. While Asia did recover much sooner than the rest of the world, the downturn was still sharp and deep and probably could have been avoided were there some alternative to the US dollar to finance Asia’s trade.
The downturn in Asia was sharp and severe, but it wasn’t caused by falling demand from the west, it was caused mainly by a credit crunch in the financial sector. If there are no US dollars to fund regional and international trade it means no credit, which in turn means no trade and thus no activity. DBS thinks China is keen to avoid this happening again, hence the push to internationalise the RMB.
The bank notes Asia’s latest bounce-back would not have been possible 10 years ago, but Asia is now no longer too small to matter. As we’ve seen, there’s enough now in Asia to allow it to drive its own growth and enough left over to help it drive global growth like never before. In 2014, DBS predicts Asia-10 GDP will be the same size as the US’s. China will be 60% the size of the US and even with growth in Asia and China slowing over the years ahead, China alone is expected to be 83% of the size of the US by 2020.
Imports are expected to grow pretty much in line with GDP, thus by 2020, DBS estimates China’s imports will grow to US$3.8 trillion dollars. This is an increase of nearly US$2 trillion dollars from 2012 levels. For the entire Asia-10, import demand is expected to grow by US$3 trillion dollars, which is seven times more than US imports will expand by. And if exports maintain the rough correlation with imports, then China’s total two-way trade would grow by some US$4 trillion dollars by 2020.
Just so we understand how much money that actually is, DBS points out that USD four trillion dollars could buy all of Germany’s GDP this year. It is also USD two trillion more than the Fed’s balance sheet expansion over the past couple of years. And while many were so afraid all that quantitative easing would ignite an inflation explosion, it only represents half the growth in China’s trade over the next seven years. Another way to look at it is: that this increase is just a bit smaller than the size of the US$4.5 trillion offshore dollar market in mid-2010. And the euro market is not even close to being able to cover just the growth in China’s trade between now and 2020.
With the control of these sorts of sums at stake, it’s no wonder China needs to internationalize the RMB. The bank finds it unimaginable were China to still be denominating its trade in US dollars in 2020, noting that if China wishes to be the main player in Asia and eventually the world, DBS says a globalized currency is necessary both economic and political reasons.
All of the above aside, this push to internationalise is much easier talked about than accomplished. Firstly, DBS notes an internationalised RMB means China’s capital account has to be opened up to not only allow returns to be paid on holding the currency, but also to allow foreigners to buy and sell domestic assets. DBS does point out that capital flows can be volatile and difficult to control, and in a truly open capital market, there are no direct controls on flows, making macroeconomic management quite difficult.
This may be something Beijing is very reluctant to give up. But DBS points out a problem that was identified by Nobel Prize winner Robert Mundell in the early-1960s: you can’t have an open capital account, control over interest rates and control over the currency all at the same time. Maybe two of these at one time, but never all three. Thus, Beijing is going to have to give up control of either interest rates or the currency and that’s the part of all of this that will be really difficult.
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