The Renminbi as game changer
- By Ann Lee
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A staff member of the Nanchong Branch of Bank of China in southwest China's Sichuan Province counts yuan banknotes. By the end of 2013, the renminbi had appreciated 35.7 percent since China's 2005 exchange rate reform [Photo:Xinhua] |
![A staff member of the Nanchong Branch of Bank of China in southwest China's Sichuan Province counts yuan banknotes. By the end of 2013, the renminbi had appreciated 35.7 percent since China's 2005 exchange rate reform [Photo:Xinhua]](http://images.china.cn/attachement/jpg/site1007/20140210/001ec949c22b1462a77b13.jpg "A staff member of the Nanchong Branch of Bank of China in southwest China's Sichuan Province counts yuan banknotes. By the end of 2013, the renminbi had appreciated 35.7 percent since China's 2005 exchange rate reform [Photo:Xinhua]")
The announcement of the Shanghai Free Trade Zone, which heralds China's plans to liberalize the financial economy, has been seen as a welcome indication by most Western financial firms who have been pressuring China for years to allow unrestricted convertibility of its currency, the renminbi. This announcement follows a historical pattern of U.S. policy pressure on other countries' monetary management such as when the United States pressured Japan to float its currency in 1973 after the U.S. unilaterally abandoned the gold standard in 1971.
A free floating currency, especially from an economy as large as China's, is conventionally seen by financial mavens as the last great frontier for rapid profits from foreign exchange trading. Wall Street is salivating and cannot wait for this market to reach takeoff. But while the financial benefits that will accrue to Western financial firms in the short term will be unmistakable, China's move to internationalize the renminbi could actually rival the U.S. dollar in our lifetime.
Since the end of World War II, the U.S. dollar has enjoyed the primacy of being a world reserve currency and continues to do so. About two thirds of all international transactions are conducted in U.S. dollars and a large number of nations rely on financing from U.S. credit. Thus, many countries shudder at the thought of the U.S. Federal Reserve's tightening since the easy credit that flows to their shores can suddenly dry up and cause a credit crunch that in the past has resulted in the Asian crisis, the Russian crisis, and more recently the 2008 global financial crisis.
However, reliance on the U.S. dollar is slowly being eroded as countries seek to avoid being vulnerable to such credit shocks. The growing use of the renminbi in many parts of the world for trade settlement and even loan growth will slowly marginalize the U.S. dollar. Thus, when the Fed finally implements the tapering off of its extraordinarily loose monetary policies, instead of creating another Asian crisis as it did in 1997 or other similar panics, these nations will likely find alternative sources of credit in the form of China's renminbi to keep their economies running smoothly.
While the other alternative reserve currency, the euro, can also function as an alternative source of credit, the European Union will face considerably more challenges in getting consensus on European-wide bank regulation given the highly variable political challenges across the member states. China, on the other hand, can act more quickly and decisively as one nation in the credit markets should another international financial crisis befall the world, and this ability could quickly challenge the supremacy of the U.S. dollar in international transactions.
Many argue that the U.S. dollar's status as the world reserve currency is guaranteed for the foreseeable future given the strong fundamentals of the U.S. economy and its military that is second to none. Though no one denies U.S. military superiority, the fundamentals of the U.S. economy are far more questionable if one examines its long term prospects.
First, the political will needed to reign in deficit spending is nonexistent. With annual tax revenues of $2.2 trillion, but transfer payments for such entitlement outlays as pension and unemployment amounting to $2.4 trillion every year, the United States is already $200 billion in the hole without spending a single dime on any of the other government services. Once the other government spending such as military is added to the annual budget, the United States will face deficit spending north of $1.3 trillion every year.
With U.S. total debt exceeding $60 trillion, no one actually believes that the United States will ever pay its debt obligations. The avoidance of much needed infrastructure spending such as a high-speed train between Boston and Washington D.C. that can improve American productivity compounds American slippage in competitiveness.
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