The world is getting impatient with the US dollar’s dominance in the global markets. Countries from China to Russia and Europe have been questioning its super reserve currency status.
Even the European Central Bank (ECB) has become critical of the currency’s global role. In August 2014, it said in a research report that “the dollar’s dominance should not be taken for granted”.
Global central banks are starting to diversify their reserves out of the dollar. Meanwhile, China’s renminbi (RMB) has been building up momentum toward its internationalization through foreign trade settlement, currency swap agreements and expansion of the offshore RMB market.
In just five years, the RMB has become the second most used currency in trade finance, overtaking the euro and coming after the US dollar, and the seventh most widely used payment currency in the world, according to SWIFT.
Beijing has appointed six offshore RMB clearing banks in Asian and European centers to aid in the expansion of the offshore RMB market. Thirty-one foreign central banks have signed RMB swap agreements with China worth more than 2.4 trillion yuan (US$391 billion).
The list of offshore RMB clearing banks and central bank swap agreements will grow in the coming years. Earlier this month, the British government announced its plans to become the first western government to issue a sovereign bond denominated in RMB before the end of this year, with an expected size of 2 billion yuan.
Empirical research also shows that an RMB bloc is developing in Asia, looking set to displace the US dollar bloc in the region. Since 2008, the RMB has increasingly become an anchor currency in Asia which the regional currencies have tracked more closely than the US dollar and the euro. The RMB is also being studied as an alternative asset held in official reserves.
If China continues structural reforms to liberalize its capital account, the RMB is likely to become the third major reserve currency after the US dollar and the euro within a few years.
This may sound shocking, but it is not. Each of the current third-largest reserve currencies, the Japanese yen and the pound sterling, accounts for only 4 percent of global central bank reserve allocation. From its current less than 1 percent share of the global official reserves, and given its internationalization momentum, it is not difficult for the RMB to climb to more than 4 percent in a few years.
These developments have led some to argue that the RMB might be in the process of unseating the US dollar as the global reserve currency. While the world may have lost confidence in some of America’s economic policies, the more relevant point is whether other countries’ (notably China’s) policies command more confidence. This doubt underscores the inertia of the US dollar’s global dominance.
The strength of the dollar in the wake of the subprime crisis, even though it was of the United States’ own making, consolidates its safe-haven role. The depth and liquidity of the US Treasury market means that it is the only major financial market to function smoothly during a financial crisis.
The euro has structural problems that are creating doubts about its long-term survival. The yen is hamstrung by Japan’s debt-deflation quagmire and the lack of structural reforms. The Swiss bond market is too small to accommodate central bank reserve flows, let alone the cross-border private sector and speculative flows.
So the dollar remains the only super reserve currency by default. The RMB will erode but not displace its global status simply because China suffers from a credibility problem behind its closed capital account.
To China, the big question is whether it can use the RMB’s internationalization as a means to kick-start deeper structural reforms to resolve its credibility problem. To the world, the process of the RMB’s ascent will cause volatility to the global monetary order, but it will inevitably have to incorporate the RMB as a major currency in the future.
You can run but you cannot hide from the RMB.
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