China Levels the Global Playing Field by Hayden Briscoe, AllianceBernstein
It’s a powerful vision for the world’s future. The US and China: two growth powerhouses; two major currencies.
At the heart of China’s much-publicized economic reforms are the internationalization of its currency—the yuan renminbi (RMB)—and the liberalization of its capital markets. It’s no exaggeration to say that these changes will affect not only China, but the world.
When China succeeds, the result is likely to be a more balanced global economy and a more level playing field in terms of choice of currency for trade settlement.
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The RMB is likely to achieve reserve currency status in Asia and, potentially, Latin America. The People’s Bank of China (PBC) should become a major liquidity provider to global business. In this respect the PBC would challenge the Federal Reserve and European Central Bank. The Fed’s global dominance would be checked in another way, as the RMB’s rise would mean that the US dollar would no longer transmit the Fed’s monetary policy decisions as pervasively as in the past.
The key to assessing the likelihood of these scenarios becoming reality lies in understanding the dynamics that drive China’s reform agenda.
From World’s Factory to World’s Banker
Like many emerging countries, China has traditionally conducted its international trade in US dollars. That era effectively came to an end at the height of the global financial crisis in September 2008, with the collapse of US investment bank Lehman Brothers. The event caused dysfunction in global credit markets and a sharp drop in world trade, as exporters and importers experienced difficulty in sourcing US-dollar funding. The experience brought home to Chinese government officials, business people and the general public the risks of being so dependent on the US dollar.
The government’s first response, through the PBC, was to establish bilateral currency agreements with some of the country’s largest trading partners, including Australia and Brazil. In 2010, it took a first step toward internationalization of the RMB by agreeing with the Hong Kong Monetary Authority to make the currency deliverable into Hong Kong. The offshore currency was designated CNH (to distinguish it from its onshore counterpart, CNY), gave rise to the CNH bond market and began to make RMB settlement possible for those involved in trade with China.
By the second quarter of 2012—just two years after its inception—the CNH had become the settlement currency for 10% of China’s global trade. A year and a half later, the proportion had doubled to 20% (Display). We see potential for it to double again or even reach 50% in the next few