THE launch of Asian Infrastructure Investment Bank (AIIB), the Silk Road Fund as
well as the various speeches by the People’s Bank of China on the yuan currency in
the last month or so signal that the pace of yuan internationalization seems to have
gathered momentum.
What are the real benefits and risks of yuan internationalization? Basically, there are
five major reasons why the yuan should be more internationalized.
First, China achieved a US$10 trillion gross domestic product (GDP) status last year,
becoming the second largest economy in the world after the United States, if one
were to exclude the European Union as one entity.
As one of the largest trading nations in the world, China today accounts for roughly
13% of world GDP, slightly more than 10% of global trade, but turnover in the yuan in
global foreign exchange (forex) markets remains still less than the Australian or
Canadian dollars and way behind the greenback (roughly 60% of forex turnover), the
euro (20%), the pound sterling and the yen.
It seems natural that the currency of a major economy should have roughly the same
share in global trading and exchange.
The second reason is that since China is a major importer of commodities and
exporter of consumer goods, payments and settlements in the currency of your major
supplier is good for currency risk management for both buyers and sellers.
With the growing sophistication of Chinese financial institutions in supporting trade
and the creation of a global yuan clearing and settlement system by this year,
transaction costs in trading through the yuan could be as cheap and robustly settled
as in the dollar or the euro.
Third, since China is already the largest importer of commodities, such as iron and
coal, as well as crude oil, increasingly more commodities are likely to be priced in
yuan and not necessarily in dollars.
The Chinese would like to pay in yuan and if the sellers feel comfortable investing in
yuan because of liquidity and long-term returns, there is no reason why some of the
key commodities will not be priced in yuan.
Fourth, yuan internationalization is good for China as a reform driver. Major reforms
in China have historically come from “reverse pressure”, not just from internal needs,
but because China becomes more engaged in global affairs and becomes subject to
global standards and rules.
The move to join the World Trade Organization (WTO) in 2001, which required huge
internal adjustments and concessions to comply with WTO rules, was initially
considered by many within China as a “sellout” but China was a major beneficiary
from joining WTO in terms of both trade and investments.
Hence, yuan internationalization, which will require more capital account
liberalization, internal reforms in interest rate and exchange rate liberalization, and
more liquidity and competitiveness in domestic banking, insurance and capital
markets, are seen to be good not only for China, but also for global financial markets.
Fifth, and this is not obvious to many observers, there is an imperative for the yuan to
join the international reserve currency group, such as the International Monetary
Fund (IMF)’s Special Drawing Rights’ component currencies.
Some people think that China wants this for the prestige, but in reality if China does
not join soon, the IMF and the World Bank will not have enough liquidity to deal with
the coming global financial crisis.
Global financial assets have risen to roughly US$275 trillion (not counting
derivatives), roughly 3½ world GDP, mainly because, as the McKinsey Global
Institute recently pointed out, global leverage is growing faster than GDP.
At the same time, the central banks’ balance sheets have ballooned to nearly 8% of
total financial assets, mainly because of quantitative easing by the advanced central
banks, primarily the U.S. Federal Reserve, European Central Bank and the Bank of
Japan.
Because central banks lend against collateral, a lot of the so-called risk-free bonds
are tied up in central banks. Liquidity in such sovereign debt has become more
volatile, as the large global banks are required to maintain higher capital for them
even to market-make in these assets.
As the emerging market debt begins to rise in the face of higher real interest rates,
more volatile capital flows and geopolitical risks, it would not be surprising if in the
next decade there is another round of financial market spikes, if not outright crash.
Currently, the Bretton Wood twins, the World Bank and the IMF have total balance
sheets of US$800 billion (or slightly more than 3% of global financial assets).
Since the U.S. and European members, which control the majority shares of the
multilateral institutions are unwilling to increase their capital because of fiscal
constraints, these safety nets will not have enough money to deal with impending
financial crises that require more and more funding to resolve.
China’s Silk Road and Maritime Silk Road strategies, plus the AIIB, BRICS Bank and
the Silk Road Fund are all attempts to fulfill the global need for infrastructure
spending, improving trade and global liquidity in the event of another shock to the
system.
Thus, for the United States to openly lobby against their creation and membership is
a little bit like cutting one’s nose to spite one’s face.
Getting yuan totally internationalized is likely to be a long and tortuous road. After all,
it took the US dollar 70 years to overtake the pound sterling, emerging as the
dominant currency backed by an overwhelming dominant military force after the
World War II.
One cannot but reflect that the yen challenged the dollar in the 1990s, only for the
euro to overtake it as the number two reserve currency in the last decade. Was it
pure coincidence that both economies got into crises because their internal structures
were not ready to take the stresses and strains of internationalization?
In other words, the road to yuan internationalization will not be smooth as Silk, but it
could come sooner and in more different ways than most people think.
Andrew Sheng writes on global issues from Asian perspectives.
A version of this article appeared in The Star Online, 28 March 2015
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