China has been making moves to replace its trade in dollars with trade in the renminbi.
The Chinese trade in renminbi is going to be worth nearly 30% of their international trade by 2020, according to a research note by Standard Chartered’s Becky Liu and her team. This is projected to be worth $US3 trillion.
That’s $US3 trillion that could otherwise be denominated in dollars. And this has implications for the U.S. monetary system, which boasts the dollar as the global reserve currency.
Being the reserve currency has huge advantages.
Since international trade is currently denominated in dollars, there is a constant, ensured demand for dollars. This is one of the reasons the Fed is able to issue large amounts of debt and carry out programs like quantitative easing — buying government issued bonds to lower long-term rates when short-term rates are zero.
This demand for the dollar has also helped keep interest rates and inflation in the U.S. economy low, which makes it an attractive destination for international borrowers.
The push to replace the dollar trade has come, in part, as a result of volatility in the dollar. Political instability in the form of the debt limit and the potential for U.S. debt default, as well as the uncertainty coming from the Fed’s taper talks has driven volatility in the greenback.
In order to side-step this volatility, countries have been taking steps to make themselves less dependent on the dollar. Last month, Europe and China signed a €45 billion currency swap deal that allowed them to settle trades in local currencies in order to sidestep the dollar. India has also made an agreement with Iran to settle trades in rupees.
Currently, the trade in China’s renminbi is extremely restricted. Its value trades within a narrow band of the dollar and converting money to and from renminbi isn’t easy. This is because the Chinese government is worried about speculative attacks on the currency.
“We expect China’s capital account to be basically open by 2020,” writes Liu. “Direct investment will flow much more easily than today, with only large deals subject to approval requirements.”
“We think the Renminbi will be a basically freely floating currency, the capital account will be more or less open, and SHIBOR (or a similar rate) will operate as China’s equivalent of the federal funds target rate.”
As the onshore renminbi market expands (CNY), the offshore Renminbi (CNH) debt market is expected to grow at 30% a year, and to be worth $US500 billion by 2020.
One particularly blistering editorial in Xinhua, China’s official news agency, reflects how the Chinese feel about the U.S. dollar:
“Most recently, the cyclical stagnation in Washington for a viable bipartisan solution over a federal budget and an approval for raising debt ceiling has again left many nations’ tremendous dollar assets in jeopardy and the international community highly agonized.
…The developing and emerging market economies need to have more say in major international financial institutions including the World Bank and the International Monetary Fund, so that they could better reflect the transformations of the global economic and political landscape.
What may also be included as a key part of an effective reform is the introduction of a new international reserve currency that is to be created to replace the dominant U.S. dollar, so that the international community could permanently stay away from the spillover of the intensifying domestic political turmoil in the United States.”
But China still has some way to go before it can become a truly international currency.