Yuan's rise will create more stability

Global economy would benefit from monetary responsibility being shared more equally

The rise of the Chinese currency to challenge the dollar's dominance has global geopolitical implications, says Alan Wheatley, editor of the 2013 book The Power of Currencies and Currencies of Power.

As an increasing number of countries boost their trade and investment ties with China using the yuan, they will take an increasing interest in the growth of the Chinese economy, he adds.

For example, earlier this year Reserve Bank of Australia Deputy Governor Philip Lowe said the country's central bank plans to invest about 5 percent of its foreign currency reserves in yuan.

"This means that Australia has an increasing interest in China and wants it to do well, because Australia would have some interest in the strength of the Chinese currency," Wheatley says. "Nobody wants to own an asset that cannot be used anywhere."

In practical terms, China would then have more clout when asking Australia to open its market, approve plans for a mining company in Australia, or take other actions to benefit China.

Wheatley, a former Reuters journalist who covered economics, took an interest in currency as a result of writing about money watershed moments in the currency world including the Plaza Accord agreement to devalue the dollar in 1985 and the introduction of the euro in 1999.

These historical events made Wheatley curious about the power of currency and prompted him into thinking deeper about the connection between the financial power of currency and the political power of the country behind a currency.

One big focus of his book is how the United States historically has leveraged its power to achieve its political agenda.

For example, the US invasions of Iraq and Afghanistan were financed by the dollar money supply. This is because countries like Iraq and Afghanistan receive dollars as payment for their exports, so they exchange goods for dollars, the commonly accepted global reserve currency, and effectively, at least in part, funded their own invasion, Wheatley says.

"In order to obtain dollars then, Iraq has to export something physical, something real and something important," says Wheatley.

The dollar's status as a dominant currency was built up over more than two centuries of credit record, dating back to the insistence of the first US secretary of the treasury, Alexander Hamilton, that the US government had to honor debts owed to private citizens of countries with which it was at war.

The dollar continued to grow in importance and largely became the dominant world reserve currency after the World War I. After World War II this was further cemented because the dollar became convertible into gold through the Bretton Woods negotiations in 1944.

Today, because the demand for the dollar is so strong, the US has been able to finance big deficits on its current accounts, whereas any other country deeply in debt might be forced by financial market pressure to cut spending and raise taxes, Wheatley says.

The advantage for the US of the strong demand for the dollar from countries that carry a surplus is that interest rates for dollar securities become low, and it becomes increasingly cheap for the US to finance its debt.

"This means US companies can borrow more cheaply than they otherwise could around the world and spread their influence. That's the main economic and financial advantage of the reserve currency," Wheatley says.

He says a more dramatic example of the United States' exercise of its currency power is the financial sanctions it has placed on countries it blacklists from a political perspective.

It has sanctions, for example, against using US dollars to finance trade with Sudan, Iran and Cuba. In early July, the US government fined the French bank PNB Paribas $9 billion (6.63 billion euros) for breaking this sanction via money laundering from 2004 to 2012, and as additional punishment has prevented the bank from clearing certain transactions in US dollars for one year from the start of 2015.

And in 2012, London-based Standard Chartered bank paid a total of $674 million to US regulators and authorities for illegally hiding transactions with Iran and other countries under US sanctions. In 2012, British banking giant HSBC also was fined $1.9 billion by US regulators for sanctions violations.

"Because the business trading with these countries which BNP Paribas is helping to finance is denominated in dollars, it had to circulate through the Fed, and is subject to US rules. If it had been based on renminbi or even euros, then BNP Paribas and other banks would not have been caught," says Wheatley.

He adds the US government has been assuming the responsibilities of a country with the dominant global reserve currency in some respects but not all. According to Wheatley, in areas it has been using its financial power irresponsibly, it risks political backlash, as is evident in the recent criticism from French Finance Minister Michel Sapin. He was critical of the size of the penalties imposed after BNP Paribas pleaded guilty to criminal conspiracy charges as part of a plea agreement.

Sapin urged eurozone countries to trade more in euros in order to break the monopoly the dollar has on international transactions.

"We (Europeans) are selling to ourselves in dollars, for instance when we sell planes. Is that necessary? I don't think so. I think a rebalancing is possible and necessary, not just regarding the euro, but also for the big currencies of the emerging countries, which account for more and more global trade," Sapin told the Financial Times.

China's push to internationalize its currency started in 2008, when the global financial crisis demonstrated the danger of too much reliance on the dollar. During the G20 summit in November 2008, former Chinese president Hu Jintao called for "a new international financial order that is fair, just, inclusive and orderly".

Beijing soon began to encourage the use of its currency in international trade, swap arrangements among central banks, and bank deposits and bond issuances in Hong Kong.

Trade in offshore renminbi has since boomed. Increasing Chinese exports also led to a surge in demand for renminbi outside China as Chinese exporters increasingly expect to be paid in their own currency to eliminate exchange risks.

Wheatley says it definitely makes more sense for some emerging economies to trade with China in yuan, and China is already moving in this direction, as can be seen by China's support of emerging market financial institutions like the BRICS Development Bank and Asian Infrastructure Bank.

"China is saying that it wants to forge regional relationships. It's logical that as Chinese trade continues to grow, the yuan would occupy a larger regional role," Wheatley says.

However, the road to making the yuan a popular investment currency and a global reserve currency is still long, particularly because China has yet to liberalize much of the capital account controls on the yuan, Wheatley says.

China already is taking some steps to achieve current controls liberalization. It is allowing offshore yuan to be reinvested into its onshore financial markets through the RQFII (Renminbi Qualified Financial Institutional Investors) scheme.

At the same time, China also has appointed official clearing banks in offshore yuan centers, and established yuan swaps with many international central banks, which can provide liquidity for private sector financial transactions if needed.

Wheatley says China also needs to build up a strong yuan bond market, so that other central banks are happy to hold yuan bonds in their reserves, much like many central banks hold US dollar bonds in their reserves.

Wheatley says it may take a long time for the yuan to establish itself as a global reserve currency, first because of inertia stemming from the dollar's dominance and second because any country takes decades to establish the trust, confidence and credibility that underpin a reserve currency.

"After the US overtook the UK as the largest economy, it took the dollar 40 to 50 years to displace sterling as the main reserve currency, and that was only because of World War I and because the US had spent a century establishing its creditworthiness and credibility beyond a doubt," he says.

Wheatley says the rise in the yuan brings stability to the global monetary system, because the reduced dominance of the dollar means the global monetary system will experience less shock in future financial crises like the one in 2008.

"I think the global economy would be much more stable if we had an international monetary system where the responsibilities are shared more equally, between Europe, America and Asia," Wheatley says.

"If you have three blocs sharing responsibility, every time there is a crisis, there wouldn't be a rush for a safe haven, so some people would be happy to keep their money in euros or renminbi."

cecily.liu@chinadaily.com.cn

(China Daily Africa Weekly 07/25/2014 page32)