The limits of RMB internationalization

By John Ross
0 Comment(s)Print E-mail, June 11, 2014
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RMB internationalization is one of the most important questions for China’s economy. But it is also one where developments will go more slowly than media speculation imagines, due to the real factors affecting it.

An exaggerated picture on RMB internationalization is presented when percentage growth figures are used as these are calculated starting from very low levels. For example, the proportion of RMB payments carried out in the United States in April 2014 rose by 100 percent compared to a year earlier, which sounds spectacular – except that the rise was only to 0.04 percent of all worldwide currency transactions. In April 2014 the RMB accounted for only 1.4 percent of international payments.

Taking China’s strongest area internationally, by the end of 2013, 8.7 percent of world trade was RMB denominated, but around 80 percent of this was with Hong Kong. The dollar’s global share was 81 percent. The European Central Bank states that by the second quarter of 2013 only 0.3 percent of international bonds were in RMB. By the beginning of 2014, 60 percent of foreign exchange reserves were in dollars, 25 percent in Euros and only 0.01 percent in RMB.

These numbers are so low that there is room for huge percentage increases, yielding profitable business for individual financial institutions, without the RMB’s peripheral position in global finance altering.

Beyond these extremely low numbers, there are fundamental structural reasons why the RMB will not play a central role in global finance in any near time frame, and the dollar will remain dominant for a prolonged period.

Only two global currency systems have existed in the last 300 years. In 1717 the pound was linked to gold, establishing the international gold standard. This system lasted for 200 years – its collapse can be taken as either 1914, when it was temporarily suspended, or 1931 when the pound formally broke its previous parity with gold. The second global system, a de facto dollar standard, has lasted for almost seven decades since 1945. The interregnum between the two, 1931-45, accompanied the most catastrophic crisis in world economic history.

There is therefore a prolonged lag between the economic rise and fall of states and changes in international monetary systems. The UK fell behind the United States as the world’s largest market economy in the 1870s, but Britain maintained global monetary dominance for half a century. There was a seventy year lag between the United States, becoming the world’s largest economy and the dollar becoming the dominant international currency.

This extreme “rigidity” in international payments structures flows from the fundamental character of a market system. An efficient market can only operate if there is a single measure of prices – if there were different prices in different parts of the market uncontrollable arbitrage and/or fragmentation would destroy it. Gold provided a single measure for international markets, then the dollar did. The only period in which there was no single price measure, 1931-45, could only exist because the world economy was disastrously fragmented – and the accompanying results, the Great Depression and World War II, were catastrophic.

A necessary consequence of the existence of only a single price standard is that, to allow its functioning, substantial international holdings of whatever is the price unit must exist – large gold holdings under the gold standard, and large dollar holdings under the dollar standard. The scale of these reserves then becomes a powerful factor maintaining the dominance of that monetary unit.

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