The RMB: A Reserve Currency for the Future?

By Jing Guan, columnist

China has been blamed for America’s debt crisis while, at the same time, trying to gradually increase the value of the RMB. However, RMB appreciation alone is not the answer to America’s debt crisis. Many economists, including Noble Prize Laureate Joseph Stiglitz, argue for a new global reserve currency. The next big question is: which economy will issue this new global reserve currency?

China’s digital RMB is under public testing.

China, whose leaders are pushing to RMB onto the world stage to compete against the dollar and the Euro, is currently pursuing a “Growth with Stability” policy. Revaluing the RMB is a key to control inflation but not to the extent that currency adjustments will cause social instability.

China has proposed using special drawing rights (SDRs), calculated daily from a basket comprised of the US dollar, euro, Japanese yen and British pound, for international payments. The IMF released a report in February 2011, stating that using SDRs could help stabilize the world economy. The RMB cannot be used as a reserve currency as long as the Chinese government maintains capital controls on the conversion of its currency and lacks a developed bond market.

Some economists believe the RMB, in the long run, will eventually compete with the U.S. dollar as a reserve currency. Nonetheless, Larry Summers, Former Treasury Secretary, commented that the US dollar would be on the stage for a long time for two reasons. Firstly, like the English language, the dollar is understood, used and accepted everywhere. That is not going to change. Secondly, looking at the euro and yen, clearly there is little in the way of an immediate competitive threat. Further, the policy of China to impose currency controls and restriction of capital flows is also not disappearing anytime soon.

Western media has long reported that Chinese are pushing for the RMB to become a more global currency to rival the dollar. However, there is a fundamental difference between China’s desire to compete economically with the US and the desire to make the RMB more widely available for international trade and investment.

Since Nixon’s first visit to China in 1972, U.S.-China trade volume increased 180-fold to 440 billion U.S. dollars. Apart from trade numbers, much has changed over the last 40 years in terms of China-US relations. Given that the Obama administration is under severe public pressure to create more jobs, China’s economic development may be a hidden opportunity for the United States. China’s investment in the U.S. may provide support to the “Jobs Act” passed by the Congress. The 2012 elections clearly demonstrated the electorates’ keen interest in foreign policy with China and the effect– for better or for worse – with job creation inside America.

Stephen Orlins, former Managing Director of Carlyle Group in Asia, argued that putting the blame for America’s weak trade position squarely on China and its undervalued RMB is unfair and over simplistic. China is faced with a difficult conundrum. It is committed to price stability and unlikely to impose any dramatic appreciation of its exchange rate. However, raising the value of the RMB is one of the most important measures to rebalance the Chinese economy and, Orlins adds, one of the most effective means to control China’s current inflation.

According to Stiglitz, at the time of the 1998 Asian financial crisis, there were proposals for the creation of an Asian Monetary Fund which might have enabled the region to recover much more quickly. The United States strongly opposed this initiative fearing, perhaps, that such an institution would undermine the effectiveness of the IMF as well as diminish American influence in the region. In opposing an Asian IMF, did the US put its own interests above the well being of those in the region?

“A new global reserve system may benefit a lot of countries, especially emerging economies such as China, but offset developed countries such as the U.S.”, says Kevin Chen, Director of Asset Management at TIAA-CREF says, “There is huge benefit for RMB to play a globalized role, or even become a designed EM (Emerging Markets)-currency for trading purposes – but not necessarily for reserve purposes.”