It was an interesting idea, but China’s ambition to enshrine the renminbi as a global reserve currency just collapsed. The announcement that President Xi Jinping may extend his term indefinitely underscored the legal and political murkiness that is 21st century China, meaning that the day investors seek safety in its government-issued paper now recedes further over the horizon.
The good news is that the global financial system may continue to rely on the US dollar as a safe haven and principal reserve currency during market turmoil. This extra demand may keep the dollar stronger than it might otherwise be, but it allows the United States to borrow cheaply and avoid difficult spending choices.
This is also the bad news. Without any financial pressures to straighten out Washington’s financial and political dysfunction, it’s hard to imagine what will force the difficult decisions around deficits and debts.
Rising China was never really likely to replace the United States as central architect of the global order, but there were hopes that at least on financial matters it might grow a partnership with the US, Europe and Japan to help establish rules for fair, transparent and stable markets. Its currency would hardly replace the dollar, but it might in some foreseeable future present an additional stabilizing alternative when markets turned volatile.
This, however, would require domestic institutions with transparency, durability, predictable governance, which endure as foundations for the dollar and the euro, but remain as distant as ever for the renminbi.
Even the 19th century Rothschilds preferred lending money to constitutional monarchs over absolute rulers because they welcomed the institutional constraints on erratic behaviour that helped ensure contracts would be honoured and loans would be repaid.
Xi’s move comes in the midst of a broader effort to crack down on government corruption and bolster the rule of law, but we have seen this movie before. One of the central tenets of modern China was the restriction to ten years of rule for the paramount leader. The notion that Xi cannot find a trustworthy successor among his 1.4 billion compatriots strains credulity.
Of course, China’s economy continues to grow impressively and financial authorities have navigated the rough patches deftly. State-owned enterprises continue to hold worryingly high debts, but the government has plenty of resources to draw upon to cushion any turbulence.
The seizure of insurance giant Anbang, which claims $310bn in assets and owns the Waldorf-Astoria in New York, points to the risks still lurking within of the Chinese financial system but confirms the government’s determination to avoid an embarrassing collapse.
Renminbi’s usage will continue to grow abroad in both finance and trade, and China’s ambitious investments under the One Belt One Road initiative will create further demand for the currency across a wide swath of South Asia, the Middle East and Africa.
Chinese authorities are also slowly relaxing controls over the exchange rate and opening up their capital account. Nearly half a trillion dollars in swap lines extended to 30-some countries are in place and they will grow beyond symbolism as financial flows expand.
Last year, the People’s Bank of China scored an important victory when the International Monetary Fund included the renminbi in the basket that calculates its reserve asset, the Special Drawing Right. The likes of Australia, Nigeria and even Germany have begun to include Chinese currency in their own sovereign reserves, although global levels remain only 1% of the total.
Yet broad usage of the currency does not on its own make for a reserve currency that can act as a safe haven in a crisis. China’s biggest obstacle to establishing the renminbi as an alternative abroad remains its institutions at home.
A global currency must have domestic financial markets that are large enough and liquid enough to absorb global flows in a crisis and to buy back those same assets when stability returns. This means a large supply of domestic bonds from issuers with transparent ownership, audited accounts and sound corporate governance. It requires independent regulators and a court system that can protect property rights against political interference.
What does this mean for the dollar? Lots of breathing room and little viable competition. The larger question remains how long investors will trust a government with no viable plan to stabilize its debt, boundless enthusiasm to block dollar transactions for its own purposes and a rapidly fraying political consensus.
The world’s financial system now needs thoughtful US leadership more than ever. The faint hope held by some that China could help shape a multipolar alternative now looks vanishingly small.
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