Cost-effective opportunity

China's capital account should be opened to boost the international status of the renminbi

The global value chains increasingly feature three pillars: Asia with the Chinese market at the core, Europe with the German market at the center, and North America with the US market as its cornerstone. There is a contradiction between the tripartite economic structure and the dollar-dominated international monetary system. Among them, the international position of the US dollar is higher than the economic strength of the United States, while that of the renminbi is lower than China's economic strength. China's GDP accounts for about 18 percent of the world total, and the trading share of the renminbi in the global foreign exchange market is around 3.5 percent; The US GDP accounts for 24.65 percent of the global GDP, and the US dollar accounts for approximately 44 percent of global foreign exchange transactions. Judging from the share of GDP in the world economy, the dollar's share in global foreign exchange transactions is about 19 percentage points higher than the US' GDP share, while the renminbi share is about 14 percentage points lower than China's share of the global GDP. There is a mismatch and imbalance between the international status of the renminbi and China's economic status.

The dollar's dominant status as the international reserve currency is the principal competitiveness of the US, and it has to use the dollar to protect its economy and boost its economic growth. For example, the country's reindustrialization, hightech war against China, and the distribution of cash to low-income families during the COVID-19 pandemic could all be achieved through the issuance of currency. From a historical perspective, if the dollar exchange rate faces significant depreciation pressure after printing money, the US may even launch military action. Because the dollar is the dominant international currency, after the US creates turbulence and risks, global capital will flow to the US to lower the exposure to risks, which further consolidates the dollar's status as an international currency.

The dollar has two main advantages for the US. One is to collect seigniorage from around the world, as it is the most widely used currency in the world. The second is to impose financial sanctions on other countries. After the outbreak of the Russia-Ukraine conflict, on the one hand, the US announced that it would not send any military personnel to the battlefield, and on the other hand, it imposed severe financial sanctions by cutting off the access to and use of dollars on countries being sanctioned. Given the above importance of the dollar's status, the US is committed to safeguarding the dollar's international status.

In fact, the establishment of a new international monetary system is conducive to world peace, and will be beneficial to both China and the US. Currently, due to the superiority of the dollar, the US economy is excessively virtualized and financialized, which has brought about serious inequality between the rich and the poor in the US society. The reform of the international monetary system conforms to the development of the global economic pattern, and it is conducive to overcoming the persistent disease of excessive financialization in the US and it would help improve the wellbeing of the US people.

China is in the process of gradually opening up its capital account as the sudden opening of its capital account might lead to capital flight and increase the risk of a financial crisis. Thus, the key is to seek policy designs that help open the capital account while effectively preventing financial risks.

In some cases, the opportunity cost of abandoning the existing system is lower when competing in new arena, so it has a latecomer advantage. In the face of mutant technological innovation, the pacemakers are put in a tight spot instead. If the "race track" is switched or there is mutant technological innovation, the renminbi may not necessarily lag behind but may surpass the dollar in their competition.

Currently, the international monetary system is facing reform, and the renminbi can achieve a breakthrough in its status as an international currency through monetary policy innovation and monetary technology innovation.

First, through monetary policy innovation, China can effectively prevent international financial risks while opening the capital account. For example, through the policy design of the progressive tax on cross-border capital flows, a "firewall" can be set up for cross-border capital flows before opening the capital account. When China's capital account is opened and the free convertibility of the renminbi is achieved, the dilemma mentioned above will be addressed. Why doesn't the US adopt a progressive taxation on cross-border capital flows? The answer is the logic of "switching the track". The US has an absolute advantage in the existing international monetary system with free capital flow and does not want to change the status quo. China is not in the same situation. Although it does not have an advantage in the existing international monetary system, installing a "firewall" provides it with "armor "against risks.

The second is to achieve the renminbi's transcendence through monetary technology innovation. Global monetary technology has changed from gold and silver to fiat currencies. The emergence of digital technology has enabled the international monetary system to develop toward the use of digital currencies. In this context, the more advanced the countries in the existing international monetary system are, the more difficult it will become for them to give up their advantages in the current system. This means that the renminbi may not necessarily fall behind the dollar in their competition. If China can seize the current opportunity to innovate the entire system through introducing and popularizing its digital currency and establish a digital international monetary system, it still has the opportunity to be a leap frog in the current international monetary system.

It is a key issue that China needs to ponder: How to achieve transcendence through abrupt policy and technological innovation in the international monetary system, establish latecomer advantages, make bold breakthroughs, and seize the initiative in the international monetary competition.

The author is unigroup chair professor of finance at PBC School of Finance at Tsinghua University and the director of the Center for International Finance and Economic Research at Tsinghua University. The author contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn.