The limits of RMB internationalization

By John Ross
0 Comment(s)Print E-mail, June 11, 2014
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This is why periodic predictions, ignoring economic fundamentals, that the dollar is about to be replaced or challenged by some other unit invariably turn out to be false. For example, the prediction was made that the Euro could replace the dollar. The reality, as the statistics show, is that the dollar continues to dominate international payments.

What are the consequences of these fundamental economic realities for RMB internationalization? The RMB can certainly become a minor international currency, but it cannot challenge the dollar’s dominance. That could only occur if the “dollar system,” as a global price unit, were replaced by an “RMB system” – which would require a revolution in the global economy, and is unrealistic in the coming period.

This, in turn, has major consequences for any liberalization of China’s capital account. As it is impossible, for a prolonged period, to replace the dollar as the dominant international currency, and therefore the dollar remains the dominant unit people wish to hold, the inevitable result of global capital account liberalization since the 1970s was not a multilateral flow between currencies but merely a net inflow into dollars. This strengthened the dollar’s international position, allowing the U.S. to finance its huge balance of payments deficits.

Countries which ignored these economic fundamentals, and mistakenly believed international capital account liberalization was a multilateral system, rather than one to allow funds to flow into dollars, were hit by economic crisis. For example, South East Asian countries, which had mistakenly imagined that they could benefit from capital account liberalization, were taught a devastating lesson in the crisis of 1997 that the only large scale net flows which the global payments system permits are into the dollar.

This current international monetary system is certainly unjust. Gold was produced internationally, therefore could not be controlled by a single country, and was a multilateral unit against which all currencies were measured. In contrast the “dollar standard” means one country’s currency is the unit in which all others are measured, giving the United States a type of “monetary monopoly” – with many consequent advantages in the international monetary system. But there is nothing that can be done about this until another unit can replace the dollar as setting international prices. Until then international crises, even those originating in the United States, as in 2008, do not weaken the dollar’s position. As Eswar Prasad comprehensively documented in The Dollar Trap: “Global financial crisis has strengthened the dollar’s prominence in global finance.”

Because the inevitable factual content of the international monetary system is to allow flows into the dollar, capital account liberalization, which would be required for full internationalization of the RMB, has become an extremely destabilizing economic force. Joseph Stilitz, Nobel Prize winner in economics, concluded, reviewing the history of financial crises:

“Capital account liberalization was the single most important factor leading to the crisis. I have come to this conclusion not just by carefully looking at what happened in the [Asian] region, but by looking at what happened in the almost one hundred other economic crises of the last quarter century… capital account liberalization represents risk without a reward.”

“Risk without reward” is a necessary consequence of the structure of the international monetary system, and capital account liberalization, as simply creating a flow into dollars. Large scale RMB “internationalization,” which would require liberalization of China’s capital account, would therefore lead to a large outflow of China’s capital into the United States and dollar assets to the detriment of investment in China. For this reason, as leading Chinese economist Yu Yongding put it:

“China has to maintain its capital controls in the foreseeable future. If China were to lose control over its cross-border capital flows it could lead to panic and so capital outflows would turn into an avalanche and eventually bring down the whole financial system.”

China therefore can, undoubtedly, develop limited RMB internationalization within a global monetary system continuing to be dominated by the dollar – particularly for trade. But any idea that the RMB can challenge the dollar’s position, or escape the dangers of liberalization of the capital account, is an illusion and at worst could seriously damage China’s economy.

The author is a columnist with For more information please visit:

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