Economist Nouriel Roubini is one of a growing chorus of pundits to predict that China’s currency, the renminbi, is bound to supplant the dollar. Asia-phile Jim Rogers says he buys the currenncy every chance he gets, though opportunities are rare given Chinese capital controls. Now BusinessWeek has joined the bandwagon.
Meanwhile, the enthusiasm over China’s currency dovetails nicely with the growing belief that the era of US political and economic dominance is finished, and that the US dollar will go down with it.
Over at FT’s Dragongbeat blog, Arthur Kroeber cries hogwash, arguing that the renminbi is nowhere near ready to supplant the dollar, let alone become a secondary reserve currency, a la the Japanese Yen.
He makes several points:
First, China has to make its currency become an international medium of exchange (like the Swiss Franc or the Singapore Dollar), something that will likely happen over time, but hasn’t happened yet. The Chinese government may facilitate this by establishing currency swap lines with other countries — so that transactions don’t have to take place in a third party currency — but while $100 billion of these agreements have been made, putting them actually into practice is a different story.
Next, China would have to get real about liberalizing its capital controls. Even Jim Rogers would admit this.
For the renminbi to become a vehicle for reserve holdings, foreigners must be able to invest freely in onshore renminbi financial assets (stocks, bonds and bank deposits), and freely repatriate both their earnings and their capital. For foreign investors to want to hold renminbi assets on a large scale, they must be convinced that China’s financial markets are trustworthy and not rigged.
For the renminbi to become even a secondary reserve currency, it must therefore fully liberalise its capital account and set up reliable financial markets that are reasonably free of government interference. Technical difficulties aside, this will require a significant retreat from the current state-dominated model of credit allocation – and this cannot happen quickly.
Finally, he notes, America’s biggest perceived weakness is actually its strength:
It boils down to this: in a fiat currency world (unlike the gold- and quasi-gold standards that prevailed until 1971), the dominant reserve currency nation must be a net debtor, not a net creditor.
This is because the principal reserve asset is the debt securities of the reserve nation. Other countries must have current-account surpluses that they can invest in those debt securities, so the reserve nation itself must run a current-account deficit. (The problem of recent years was not that the US ran a current-account deficit, but simply that the deficit grew too large – nearly 7 per cent of GDP rather than the sustainable 1 per cent of GDP or so.)
So if China wants the renminbi to become the world’s main reserve currency, one condition is clear: it must abandon mercantilism and start running a current account deficit. Until it is willing to satisfy that condition, all talk about the future dominance of the renminbi is the purest hot air.
To some extent, this paradoxical condition, by which the reserve currency belongs to the world’s biggest debtor is implied in China’s so-called “dollar trap.” Part of the reason China msut continue to recycle its money into dollars, is because no other currency or debt market is large enough for China to enter without causing significant disruption to it. The US debt market — simply by virtue of it being so large — is perfect for all kinds of players to enter without fear that their actions will cause too many waves.