Reserving a place for the renminbi

Despite growing speculation, the renminbi won't displace the US dollar as the pre-eminent reserve currency any time soon. But it will be increasingly important to the world outside China.

Lowy Interpreter

The idea that the renminbi will become an important reserve currency, perhaps displacing the 'exorbitant privilege' enjoyed by the US dollar, has been given added impetus by a blueprint for China's international capital reforms just published by the Chinese central bank, the People's Bank of China.  

current commentary suggests a two-fold conclusion. The renminbi won't displace the dollar as predominant reserve currency any time soon. But the renminbi will become more important in international transactions, and China's growing international capital linkages have important implications for us all.

Whatever 'exorbitant privilege' the US dollar had as the predominant reserve currency in the quarter-century following World War II has largely disappeared, thanks to floating exchange rates and free international capital movements. 

The US dollar already has rivals for reserve-currency status and the world adapted easily to this. The dollar has gone from being over 80 per cent of official reserves in the 1970s to being just over 60 per cent now. Until recent fumbles, the euro was making a strong bid to be an alternative (but secondary) currency for official reserves, making up 25 per cent in 2003, up from 18 per cent only a few years earlier.

The UK demonstrates that reserve currency status can be largely lost without changing much: the decline of sterling mirrored, but didn't exacerbate, the UK's declining place in the world and the end of the British Empire.

What would China have to do to make the renminbi a reserve currency?

It would have to offer open access to a range of low-risk assets providing an assured adequate return. These investments need to be readily traded in markets that are deep enough to ensure that the price won't fall sharply as the assets are sold. Foreigners need assurance that they could convert their renminbi into foreign currency at a fair exchange rate.

All this requires a well-established bond market with depth, breadth and resilience. It has to have strong legal certainty and a track record of stable performance. It probably requires a floating exchange rate. China has none of these preconditions, and is in no hurry to create them because it would mean giving up all the panoply of controls and regulations that keep the exchange rate stable and guard against the potential huge volatility of unrestricted capital flows.

What's more, the advantages of being a reserve currency simply aren't worth the price.

Originally published by The Lowy Institute publication The Interpreter. Reproduced with permission.

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles