24 October 2016
If the renminbi took over the leadership of the global financial system from the US dollar, the economic impact would be significant. Photo: Bloomberg
If the renminbi took over the leadership of the global financial system from the US dollar, the economic impact would be significant. Photo: Bloomberg

What if the renminbi competed with the US dollar?

Last month, The Economist published a special report called The World If – a compilation of scenarios about what might happen across politics, business and technology.

One of the topics it considered was what would happen if the renminbi rivalled the US dollar, and when this might be.

Many in China think it only a matter of time.

Chen Yulu, a leading economist, says it will take 15 years.

Wei Jianguo, deputy head of a major think tank, puts it at 20.

Officials are more circumspect: currency internationalization will be a long process, its pace determined by the market, says Zhou Xiaochuan, the central bank’s governor.

What difference would it make if China’s currency did vie with the dollar for global pre-eminence?

Scholars have looked for clues in the transition from the British pound to the US dollar, but that took place around the middle of last century in a very different context.

The dollar and the pound were both convertible into gold at fixed rates, making the leap of faith for those switching from one to the other much less of a risk.

Today, reserve currencies are not backed by gold.

Their value is more slippery — a function of supply and demand.

The shift from the pound to the dollar reflected a passage of economic power between two allies with shared democratic values and economic ideas that had started decades earlier.

China’s leaders talk of the renminbi’s internationalization in peaceful terms.

A more diverse monetary system will breed financial stability for the world, they say.

But China’s rise poses a bigger threat to America than America’s did to Britain.

Over the past five years, China has built a network for renminbi trading around the world, and America has not tried to thwart it.

America has good reason to worry about the renminbi.

Its emergence as a credible alternative to the dollar would undermine American power.

Sanctions against Iran and North Korea have had bite because of the dollar’s centrality to global finance.

When Lehman Brothers collapsed in 2008, the US Federal Reserve provided emergency swap lines to banks around the world.

If a crisis hits in two decades’ time, China could play a similar role.

It is assembling the framework to lend such support by establishing currency swaps with many countries, from Argentina to Russia.

The economic consequences of the renminbi’s rise would be momentous.

The “exorbitant privilege” that goes with being the issuer of the dominant currency would ebb for America.

Because there is so much demand for dollar assets — more than 60 percent of all the reserves of global central banks is held in dollars — America and companies based there can sell bonds for higher prices than they could otherwise.

Since bond yields move inversely to prices, this means it costs less for Americans to borrow — so it is easier for the government to fund its deficits and for firms to raise money.

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The Economist is one of the most widely recognised and well-read current affairs publications.

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