Give China a Reserve Currency
As former U.S. Secretary of State Colin Powell famously advised, China favors "overwhelming force" in its campaigns, military or otherwise. Most recently, in a direct challenge to the global economic architecture established by the U.S. and its allies after World War II, Beijing has pledged nearly $200 billion to various new lending institutions and funds -- to bolster trade with Europe, establish a footprint in the Indian Ocean, build infrastructure across Asia and generally increase the mainland's influence worldwide.
A new push to establish the renminbi as one of the world's reserve currencies adds to this campaign. The move would confer prestige, take America down a peg and attract more investment. Viewed that way, Washington should fear the yuan joining the ranks of the dollar, euro, yen and British pound, right? Wrong. Increased use of the yuan internationally will force China to restructure more radically than its leaders may realize. It also could stabilize the country's rickety financial system, to the benefit the U.S. and the rest of the globe.
While People's Bank of China Governor Zhou Xiaochuan hasn't said so publicly, I'll bet that his push for the International Monetary Fund to add the yuan to its Special Drawing Rights system is a backdoor gambit to promote reform at home, more than a geopolitical power grab. Zhou is an unabashed liberalizer, a trusted disciple of former Premier Zhu Rongji, the man who in the 1990s took on state-owned companies and tossed more than 40 million of their employees out of work. Amid speculation Zhou, 67, may soon be replaced, he could be trying to cement the reform process his mentor began.
The issue has taken on new urgency after an exchange on Sunday between Zhou and IMF Managing Director Christine Lagarde. Zhou clearly had little interest in sticking to the session's ostensible subject -- “Sound Monetary Policy in the New Normal” -- and quickly pivoted. In 2010, the IMF said the yuan couldn’t be added to the 45 year-old SDR basket because it wasn’t "freely usable." Zhou made a case for how much things had changed by 2015.
He's only partly right. The yuan is strengthening versus the dollar, rather than being artificially depressed in order to boost exports. Foreign investors can trade Shanghai-listed stocks through a link with Hong Kong’s exchange and have greater access to Chinese stocks and bonds more generally. But the yuan's growth offshore is still more a function of speculation than genuine acceptance of the currency as a store of value. The capital account remains tightly controlled, a vestige of the 1997 Asian financial crisis.
Truly freeing the yuan would loosen Chinese leaders' grip on their massive economy. In fact, that's why it should be encouraged. In March 2014, Zhou tried to liberalize short-term interest rates. By July, the PBOC was backpedaling, fueling speculation that a higher power had intervened. Zhou also seems to get overruled every time he clamps down on excessive credit. Since June 2013, each time the central bank has moved to rein in bubbles, it's eased up soon afterward. Even Zhou can only achieve so much as long as a micromanaging Communist Party is looking over his shoulder.
It's time for a stealthier approach. The beauty of entering the SDR universe is the quid pro quo required of Beijing. China would have to open its capital account, revolutionizing the ways companies do business and unleashing a variety of knock-on effects. Beijing would have to internationalize its banking system, prod state-owned enterprises to tighten governance and competitiveness and improve the quality of assets in general. It would have to stop treating the breakdown of its $3.8 trillion of currency reserves like a state secret. Exports would become more expensive as the yuan rises, accelerating the shift toward services and boosting domestic consumption.
"True internationalization would force China to become more transparent and embrace market forces," says strategist Marc Chandler of Brown Brothers Harriman. "In the 1997-98 Asian crisis, many countries welcomed the internationalization of their economies as a force to adopt best practices and weaken the local rent-seeking elites. If China were to open up its capital account and allow fuller convertibility of the yuan, it would become more integrated into the world economy. It would strengthen international standards."
Zhu Rongji attempted a similar strategy by championing China's inclusion in the World Trade Organization. That cajoled Beijing to welcome foreign investments and adopt international commercial norms. Today, one of the greatest threats facing the global economy is the possibility -- slim, but not unthinkable -- of a Chinese debt crisis. Anything that puts the mainland's financial system on a more stable foundation should be welcomed, not feared.
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