Part three: Establishment of New “Three Pillars” for International Monetary System

At present, the USD-dominated international monetary system is extremely unreasonable and unstable. It is urgent to establish the “three pillars” for new international monetary system. Based on historical and present experiences, a unified currency system in East Asia which is known as the “Asian Dollar” lacks the reality basis. It is a general trend that RMB is becoming the international currency and one of the three pillars.

I Chinese feasible countermeasures to the decline of US dollar

The 2008 global financial crisis is definitely not only a simple periodic and localized financial crisis, but a crisis of “Anglo-Saxon model” of the capitalist mode of production, a crisis of the “Washington consensus” and especially a crisis of the USD-dominated international monetary system. During the 1998 Asian financial crisis, western countries ascribed it to “crony capitalism”, the over-sized banking sector in the financial system, the weak role of capital market in allocating financial resources and inadequate financial supervision.

Meantime, tthey have acted as teachers to propagandize the “Anglo-Saxon” financial model all over the world. Compared with Japanese model, German model and East Asian model, “Anglo-Saxon model” had been considered the most perfect financial model with universal value. Developing countries have to humbly reconstruct their financial systems based on this model. Ironically, teachers themselves suddenly made serious mistakes before students finished their papers.

China, on behalf of the East Asian countries, needs to take warning and adjust strategic and economic structure as soon as possible. Otherwise, such kind of the global financial crisis can be expressed by the Chinese proverb that “a fire on city wall brings disaster to the fish in the moat” and will be repeated periodically. China is supposed to redesign its national financial structure from a strategic perspective.

First of all, dependent status of the RMB on the US dollars should be changed. With RMB closely linking to US dollar, Chinese economy tends to lose international competitiveness. This could be learned from commonwealth countries that suffered from the decline of British pound. Now, RMB has been no longer pegged to the US dollar. Instead, it has been pegged to a basket of currencies, switching from fixed exchange regime to manageable floating exchange rate regime. China would accelerate the RMB internationalization by experiencing RMB appreciation on a gradual basis.

Secondly, China needs to gradually get rid of the dependency on US economy, by shifting economic development strategy from export-led to domestic demand-led. Based on the manufacturing industry, Chinese policies include: to develop the emerging industries and modern services, to optimize the industrial structure, to promote the geographical diversification of trade and to develop the intra-regional trade and investment in East Asian countries to build the mechanism of endogenous growth. At present, the Free Trade Area (FTA) between China and ASEAN has already been established, and Japan and South Korea are expected to participate in the near future.

Thirdly, the allocation of Chinese foreign assets needs to be optimized. China should ease capital controls on residents and business so that the private sector can play a main role in overseas investment, which supports the strategy of “going abroad” for Chinese enterprises to implement overseas mergers and acquisitions. This is conducive to the establishment of overseas energy and resource bases, expansion and optimization of overseas assets, and appropriate increase of the euro, Japanese yen holdings and positions in commodity in order to achieve diversification of reserve assets and to avoid risks of the US dollar depreciation.

Fourthly, China needs to strengthen international financial cooperation. China could act as a leader in Asian countries. A unified voice is expected to be delivered by East Asian countries to the world. It has been and will be a right path for East Asian countries to strengthen cooperation in the fields of reforming international monetary system, supervising sovereign wealth funds so that they will obtain complete information, discourse power and independency of decision-making. Moreover, they could together claim that US should take responsibilities and prevent unfettered currency deprecation.

II Enhance RMB internationalization

Currency internationalization is the result of market selection, and the economic power determines the strength of currency. With the rise of Chinese economy, it is the right time for RMB internationalization.

First of all, RMB has to get rid of the tight relationship with US dollar. China used to adopt fixed exchange rate regime pegging to US dollar to maintain the stability of RMB exchange rate. This was helpful at the first stage of RMB internationalization. But in the long run, this will limit such process since it lacks independence. Now, the RMB exchange rate regime has been reformed, and China will keep pegging to a basket of currencies, and gradually get rid of the impact of US dollar.

Secondly, the “three-step” strategy needs to be put forward. At the first step, RMB is circulated and used in the surrounding regions of China. At the second step, RMB engages in large-scale trade and financial settlement, which has been known as RMB regionalization. At the last step, RMB becomes an international reserve currency. Actually, in the “three-step” process, RMB gradually serves as a currency of international settlement, international investment and international reserve, which are the three major functions of international currency.

Thirdly, RMB needs to pursue the right path from the regional currency to the international currency based in Asia. By relying on cooperative mechanism of East Asian “10+3”, RMB internationalization requires RMB to improve influence in Asia-Pacific, to actively participate in the Asian monetary cooperation, to increase the share of RMB used in the regional trade, and to gradually penetrate into financial and investment market. Moreover, building more channels and generating relevant mechanisms are required as well to satisfy conditions of RMB to be reserve assets.

Fourthly, the international monetary functions of RMB should be actively cultivated. China could encourage bilateral trade and investment with RMB. Meanwhile, commitments that the overseas holders of RMB are able to freely convert RMB into US dollar needs to be provided. The ideal result is that more countries are willing to accept RMB. By now, the approximate amount of China's foreign exchange reserves is 2.45 trillion US dollars, so China has the ability to fulfill her commitments.

Fifthly, unnecessary foreign exchange controls need to be eliminated gradually. Relaxation of capital controls is the inner need of economic development, and strict exchange controls have impeded the process RMB internationalization. China’s economic rise and improvement of macro-control capacity have increased the risk resistibility of capital account. RMB convertibility should be gradually put into practice.

Sixthly, Shanghai and Hong Kong should perform functions of international financial centers. The serious problem in RMB international settlement is the lack of RMB in the foreign market. Referring to experiences of “Marshall Plan” and overseas loans in Japanese yen, money must be “lent”. In addition, more feasible plans are suggested, for example, developing off-shore financial services in Shanghai and Hong Kong, accelerating the launch of international board of Shanghai stock exchange and encouraging foreign companies to list A-share and issue RMB bonds on the Shanghai Stock Exchange and Hong Kong Stock Exchange.

Seventhly, the circumfluence mechanism of overseas RMB needs to be established. If there is no normal channel for circumfluence of overseas RMB, it would flow back to China illegally, which results in active trading of illegal private banks and smuggling currency. This not only threatens China’s financial security, but also impedes RMB to be regarded as a reserve currency in neighboring countries and regions. In addition to expanding the use of RMB in cross-border trade, China should promise that overseas RMB can be used to purchase Chinese goods and government bonds, and directly invest in China.

Eighthly, Hong Kong dollar is proposed to link to RMB. There has been a tighter economic relationship between Hong Kong and mainland China. Hence, the fact that Hong Kong dollar was pegged to US dollar for a long time is not only adverse to the economic development of Hong Kong, but also against RMB internationalization. The currency that Hong Kong dollar is pegged to should switch from US dollar to RMB by Hong Kong Special Administration Region Government.

III Prospects for RMB internationalization

RMB internationalization is on the way, but in general, it is still at the early stage. International currency always serves as a medium of exchange, a unit of account and a store of value in the international trade, which is expected to occur in third-party transactions without involvement of China. By now, labor migration is the main force to push RMB flow across border, which means RMB tends to be more popular in places inhabited by a large number of Chinese people. However, in the international financial market, RMB is merely a trading symbol applying to Non-Deliverable Forward, etc. It cannot be employed for international settlement, and is independent of international cash flow. Therefore, RMB internationalization still has long way to go.

The USD-dominated international monetary system has been modified. The fact of decline of Japanese yen and the lack of Asian currencies is far from matched to the “three pillars” of global economy. China is expected to become the second largest economy in the world in 2010 and the new situation needs RMB to be one of international currencies in urgency. Furthermore, East-Asian trade liberalization and investment facilitation need a medium of exchange to deepen financial cooperation and to form regional monetary integration, which provides an opportunity for RMB regionalization. China is becoming the Asian economic leader who has the responsibility to promote regional economic development and expand the role of Asia.

There is a dispute of monetary hegemony between Japanese yen and RMB in East Asian financial cooperation. In the short term, China should actively participate in the “10+3” financial cooperation and promote RMB integration to Asian financial system. In the long term, different from Japan, China does not have historical problems on issues of politics and diplomacy in East Asia. The responsible attitude of Chinese Government has gained recognitions from most countries and brought about good reputation.

In the upcoming decade, RMB has the potential to be the same influential as Japanese yen, British pound and other secondary international currencies. With appropriate operational strategy in the right direction, RMB, the US dollar and the Euro are likely to form the “three pillars” of international monetary system in the mid-21st century.

 

References:

[1] McCauley R. N. “Dollar Appreciation in 2008: Safe Haven, Carry Trades, Dollar Shortage and Overhedging”, BIS Quarterly Review, December, 2009.

[2] Ronald McKinnon & Gunther Schnabl. “Current Account Surpluses and Conflicted Virtue in East Asia: China and Japan under the Dollar Standard”, August 4, 2006. http://www.stanford.edu/~mckinnon/papers/China_and_global_credit_crunch_SCID.pdf.

[3] European Central Bank. “The International Role of the Euro”, European Central Bank, July, 2008.

[4] Robert J. Samuelson. “‘A New Economic Order: Rich nations must sell to the poor”. May 10, 2010. http://www.newsweek.com/2010/04/30/a-new-economic-order.html.

[5] Xiaochuan Zhou. “Reform the International Monetary System”, 2009. People’s Bank of China Website, http://www.pbc.gov.cn/english//detail.asp?col=6500&ID=178

[6] HongCai Xu. “The Great country’s financial strategy”, China Machinery Industry Publishing House, May 2009.

[7] Simon Tilford. “Rebalancing the Chinese economy”. November 2009. http://www. cer.org.uk/pdf/pb_rebalancing_china_nov09.pdf.

[8] Jianwu He & Louis Kuijs. “Rebalancing China’s Economy: Modeling a Policy Package”. World Bank China Research Paper No.7, September 2007.