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GAO Liankui:RMB Internationalization Should Not Be Done with Undue Haste

 

China’s enthusiasm for the internationalization of the Renminbi (RMB)is, to a large extent,traceable to the appreciation of the RMB. We must remember, however, that it is not the RMB in China that appreciates, but the RMB held by foreigners. Because many foreigners have started saving RMB,China thinks that the time is ripe for RMB internationalization. It is not that simple. As a matter of fact, the appreciation of the RMB only serves as an “efficacy-enhancing ingredient” for RMB internationalization; it is not a“prescription.”The appreciation of the RMB is not enough to justify proceeding with internationalization.
 
As we all know, currency is only a commodity, though a special one. In economics, international currency belongs to the public good; it is a natural monopoly. This explains why there isonly one main worldcurrency.Without doubt, that currency today is the US dollar. If we lookat history, the internationalization of the yen eventually failed. Even the euro, which isalready international,is difficult to get outside of the European Union.
 
The status of U.S. dollar as an international currency was determined by the political and economic agreements that were made during a particular historical period. The euro became one of the world currencies througha regional currency mechanism. Neither the American approach nor the German approach is appropriate for RMB internationalization. It will take a complex and long process to internationalize the RMB.
 
Three Functions of an International Currency
 
An international currency serves three roles: clearing, investment, and reserve. As a clearing currency, for example, the US dollar isused for oil trade in most countries, while only a few use the euro, and no one is willing to use the RMB. As an investment currency, the US dollar is used by countries to invest, becausecommodities purchased on the international market are based on the US dollar. As a reserve currency, the US dollar and not the RMB is used by the central banks of various countries.
 
These three roles will determine the success of RMB internationalization. It is not going to work if the RMB flows only one way – going overseas.If the RMB flows back to China only through China-funded banks, it will not perform the three roles and will form a “tortuous trap.” This is the lesson which the yen internationalization taught us.
 
Chinashould estimate the risk, instead of only focusing on return. Risk and return have to beproportional in normal business activities. This would not be the case in early RMB internationalization. Promoting RMB internationalization early willcause high risk and low return, butthe other way around if the promotion ispostponed. The balance of risk-return has to be basedon timing, while the choice of timing depends on China’s national strength.
 
A big gap still exists between the national strengths of China and the U.S. From the perspective of economic aggregates, China needs about 15 years to catch up with the U.S. RMB internationalization may require China to become a trade deficit country or a country focused onforeign investment. However, these two are harmful to the current economic development ofChina. Trade deficit is certainly harmful, while economic capability is needed in investing in foreign countries. China is now only at the stage of attracting foreign investment. This means that the conditions forsuccessfully internationalizing the RMB do not yet exist. 
 
External Impetus is Needed
 
RMB internationalization is essentially a process of capital account liberalization. Relying on offshore financial market development is not sufficient as the capacity is limited and China does not yet control pricing. Domestic and international experiences show that control over capital account is important. Excessive speed or over-liberalization willlead to volatility of short-term international capital flow and severely affect the stability of the domestic asset price and financial market. It is impossible for RMB internationalization to bypass the process of capital account liberalization.
 
Some people believe that RMB internationalization would promote a healthy marketization of domestic capital market rate, financial institutions, market access, and bond market. However, how many advantages would the reform bring to China? Is the reform necessary? These questions have to be discussed.
 
Now is the era of financial derivatives pricing. China could strive for pricing power by internationalizing theRMB, but it will be verydifficult.It is not only the issueof the currency; it needs market construction, which is a reflection of comprehensive national power. National power first needs to achieve a certain level. When it becomes a powerful nation,China will notneed to promote RMB internationalization. At that time, RMB internationalization willoccur by itself because of external demand.
 

 
GAO Liankui is a researcher at Shanghai Jiao Tong University
 
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