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Eswar Prasad explains why a new version of the renminbi will fail to challenge the US dollar's dominance

Eswar Prasad explains why a new version of the renminbi will fail to challenge the US dollar's dominance

A few years ago, China’s currency seemed to be rising inexorably to global dominance. The renminbi had become the fifth most important currency for international payments, and in 2016, the International Monetary Fund included it in the basket of major currencies that determines the value of Special Drawing Rights (the IMF’s global reserve asset).

Since then, however, the renminbi’s progress has stalled. Its share of international payments has fallen below 2%, and the share of global foreign-exchange reserves held in renminbi-denominated assets seems to have plateaued at about 2%.

Earlier this year, China rolled out a central-bank digital currency, making it one of the first major economies to do so. Trials of the so-called Digital Currency/Electronic Payment (DCEP) have started in four cities, and the government recently announced plans to expand the tests to major metropolises such as Beijing and Tianjin, as well as Hong Kong and Macau. But the DCEP on its own will not be a game changer that elevates the renminbi’s role in international finance.

True, China has leapfrogged the United States and other advanced economies in the technological sophistication of its retail payment systems. It seems plausible, therefore, that the digital renminbi will give China an edge in the competition for global financial-market dominance.

But the reality is more sobering. The DCEP will initially be usable only for payments within China, although this could change over time. For all the hype about the new digital currency, China’s Cross-Border Interbank Payment System, introduced in 2015, is a more important innovation that makes it easier to use the renminbi for international transactions.

This payment system is also able to bypass the Western-dominated SWIFT system for international payments and thus circumvent US financial sanctions, a tempting prospect for many governments. Russia – or, for that matter, Iran and Venezuela – will now find it easier to be paid in renminbi for their oil exports to China. As the renminbi becomes more widely used, other smaller and developing countries that have strong trade and financial links with China might start to invoice and settle their transactions directly in that currency. The DCEP could eventually be linked up to the cross-border payments system, further digitizing international payments.

Still, the DCEP by itself will make little difference to whether foreign investors regard the renminbi as a reserve currency. After all, the Chinese government still restricts capital inflows and outflows, and the People’s Bank of China still manages the renminbi’s exchange rate. Neither policy is likely to change significantly anytime soon.

Renminbi boosters will point out that the government has eased restrictions on capital flows and signaled its intention eventually to open the capital account fully, and that the PBOC has pledged to reduce its currency interventions and let market forces have their way. But whenever shifts in capital flows put significant pressure on the renminbi, the government invariably reverts to command-and-control mode and tightens capital controls and exchange-rate management. Foreign investors, including central banks, will therefore remain skeptical about the prospect of unfettered capital flows at market-driven exchange rates.

In any event, foreign and domestic investors are unlikely to view the renminbi as a safe-haven currency in times of global financial turmoil. That requires trust, which is fostered by adherence to the rule of law and well-established checks and balances in the political system.

Some argue that the rule of law does exist in China, and that the country’s non-democratic, one-party system of government contains enough self-correcting mechanisms to prevent policymakers from running amok. But these arrangements are not a credible or durable substitute for an institutionalized system of checks and balances such as that in the US, where the separation of the executive, legislative, and judicial branches serves to constrain the exercise of power.

US President Donald Trump’s administration is doing all it can to weaken America’s institutions, undermine the rule of law, and erode the Federal Reserve’s independence. But in international finance, everything is relative. America’s economic dominance, deep and liquid capital markets, and still-robust institutional framework mean that the US dollar still has no serious rival as the world’s leading reserve currency.

Any global gains the renminbi has made in recent years, both as a means of payment and as a reserve currency, have mostly come at the expense of currencies such as the euro and the British pound. Even when the IMF added the renminbi to the four existing currencies in the SDR basket and gave it a 10.9% weighting, it was mainly the euro, the pound, and the Japanese yen that gave way, not the dollar.

China’s new digital currency and its cross-border payments system will together enhance the renminbi’s role as an international payments currency if the government continues to reform the country’s financial markets and remove restrictions on capital flows. But they will hardly put a dent in the dollar’s status as the dominant global reserve currency.


Eswar Prasad is Professor of Trade Policy at Cornell University’s Dyson School of Applied Economics and Management and a senior fellow at the Brookings Institution. He is the author of Gaining Currency: The Rise of the Renminbi. Copyright: Project Syndicate, 2020, published here with permission.

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10 Comments

It might not dominate USD but it's certainly the future for currency, no surprise they are on to it before others are. It's amazing that this article gets no comments though, no one has any thoughts outside our little island bubble?

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If the Reinhart-Rogoff hypothesis is right-negative impacts from Debt/GDP ratio above 90%, then either there will be a sudden loss of confidence in the US$ or it will, like the US itself, go into a long Japanese type decline.

I think the latter is more likely and the US$ will retain its status for some time to come,but whether the Renmimbi on its own will ever be able to replace it, is a big question.

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It will be interesting to see what impact the digital Yuna has on other cryptocurrencies such as Bitcoin since most of it's users are Chinese (Up to 90% at one stage).

Also keep in mind that digital currencies controlled by governments will allow for granular control over people’s affairs and surveillance long before proper safeguards can be contested in the rule of law.

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By 2050, China's GDP will be twice of the US'.

It would be unimaginable that 世界人民不用人民币。

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lets get through this Covid saga first.. you are quite ahead of yourself!

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Did not you watch the video clip of a massive pool party took place in Wu Han.

The only country having a positive economic growth in 2020, according to IMF, will be China.

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Are you following the crisis in Melbourne? Only take one rogue person to infect the whole city!
Yeah they have have as many pool parties as they wanted, only needed one person with Covid. Until they have a vaccine, pool party is just nut!

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I can see it taking over because thats what China wants. It only takes them to get onside with a few other big countries that are also already pissed off with the USD being the reserve currency and its game over. Covid is just accelerating the process by years, the USA is in serious trouble economically and still will be when China is back to business as usual, this is the turning point.

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The US is in a long-term, terminal and irreversible economic and social decline. The loss in confidence in the US$ is only a question of when, not if.
This is compounded by Trump's America overall dismal attitude towards international cooperation. Moreover, the US have been more and more extensively bullying other countries (not just China, but the European Community too, for example, when it comes to the Iran's treaty) with the threats of sanctions / duties etc. It is only time before the rest of the world gets sick and tired of such attitudes, and they start decoupling more and more from the US.
When this happens, it is going to be game over for the US$. And the funny thing is that much of it is self-inflicted.
I can clearly see China taking over, in the future, the past US role in economic terms (which, in historical terms, is just a reversion to mean - after all, China has been one of the most advanced countries in economic terms for millennia, at least until the middle of the 18th century).

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