Reform of Global Reserve System and RMB Internationalization

Dr. Liqing Zhang

Professor and Dean

School of Finance,

Central University of Finance and Economics

October 23-24, 2014, University of Birmingham

Outline

1. Reform of the GRS: Proposals, Viability and

Policy Agenda

2. RMB Internationalization

Reform of the GRS: Proposals, Viability

and Policy Agenda

The main feature of the Current GRS

The US dollar centered reserve system is not only instable but also unequal

Triffin Dilemma Dollar’s Exorbitant Privilege Capital Flows from poor countries to rich

countries

Main Proposals and their Viability 1) Return to golden standard

Good at discipline, but totally unrealistic. 2) World single currency and world central bank

World single currency should be issued by world central bank and backed by a single monetary policy (Cooper 1987).

In the transitional period, other periphery countries may peg their exchange rates to the major international currencies.

Eventually, the unification of major currencies may evolve into a single currency.

Good for overcoming the problems that current system is facing with. The institutional construction is the key condition, which will be largely depend on the political will of the major economies.

3) SDR based reserve currency system More recently proposed, SDR should play as a global

reserve currency in parallel with other major international currencies, and gradually replace US dollar as a dominant reserve currency (Zhou 2009, Stiglitz 2010)

Similar to the world single currency proposal. But it is supposed to be realized under the IMF framework and does not need an establishment of new institution.

US has no incentive to push SDR approach. So it will hardly get support from IMF unless it can successfully be reformed.

4) Multi-polar reserve currency system Several reserve currencies (most likely, US dollar,

euro and RMB/YEN/ACU) play equally important roles in the global reserve system. (Eichengreen, 2009)

Competition among the world’s major reserve currencies can make the macroeconomic policy in reserve currency countries more disciplined.

But, for realizing it, The euro needs to develop a solid sovereign

backbone through forming common fiscal policy. RMB, the Chinese currency’s international usage

and/or the Asian monetary integration needs to be developed ASAP.

5) New dollar standard US dollar continues to play a dominant role in global

reserve system; Fed provides sufficient liquidity to the rest of the world during the international financial crisis.

Compared with the current system, US should strictly maintain non-inflationary growth and fiscal sustainability domestically.

The US and non-reserve currency countries should timely pursue policy adjustments to correct persistent current account imbalances.

If US economic policy could be more disciplined, the New Dollar Standard might be the easiest way of reform. However, it would be very difficult for US to give up the freedom of policy-making. And actually, neither the non-reserve currency countries would give up.

In Conclusion, None of the proposals can be easily realized. The world single currency approach and SDR approach

are most ideal, but it can only be reached in the long run.

The new dollar standard is also good if US can be fully disciplined in policymaking. But it seems to be of very limited possibility, neither in the short run nor in the long run.

The multi polar reserve currency system could be a realistic and second-best choice, but it takes time.

Policy Agenda At global level,

Enhancing the role of SDR by issuing and allocating it annually, with an equivalence of USD 200 billion each year. Though it will only be reachable in LR , it does not mean we should give up efforts from now on.

Strengthen IMF surveillance over systemically important economies.

Making G-20 summit a productive mechanism for macroeconomic policy coordination. In the near future, it would be important to having the G20 Mutual Assessment Process really work.

At national level By returning to normal monetary policy, fiscal

consolidation and various structural reforms, US and other deficit countries should avoid possible rebound of current account deficits.

Through persistent efforts of enlarging domestic demand and various structural adjustments, including switch to a more flexible exchange rate regime, China and other surplus countries should avoid fundamental external disequilibrium.

At regional level, EU countries should strengthen its mechanism of

macroeconomic policy coordination, including creating common fiscal policy and bank union, in order to defense its outcome of regional monetary integration.

Although not very optimistic, Asia countries should gradually push forward the its monetary and financial integration process, by strengthening the role of AMRO and making CMIM more effective.

RMB Internationalization

Main Development Since 2009

Currency Swap Agreements in RMB

Reasons Behind the Rapid Development of RMBI

Rapid economic growth and increase of cross-border trade are the fundamental reasons.

The appreciation of RMB is an important factor. International financial instability since 2009 has

created a strong need of currency swap among central banks. Given that the IMF is not active, bilateral and regional arrangement become increasingly important.

The RMBI is basically a market driven process, institutional changes did play some role: liberalization of financial sector, including the trade settlement arrangement (in 2009) and the capital flows (RQFII)

Benefits and Pitfalls of RMBI Benefits: Globally,

When more currency competitions are present, the main reserve currency issuing county may become more careful with its monetary policy, particularly the abuse of ease monetary policy.

If RMB eventually becomes a part of the multi-reserve currency regime, the problem with Triffin Dilemma could be alleviated in some degree.

Regionally, RMBI is likely to be a new vehicle of the Asian monetary and financial integration. While more and more intra-regional trade and

investment are denominated in RMB, Asian countries will have an increasingly strong motivation to keep their currencies pegged to RMB and eventually make RMB a reserve currency in this area.

When RMB becomes an important currency for denomination, pricing and store in value in this area, the chance for Asian countries to create a fixed exchange regime or single currency zoo may increase.

Nationally, China may gain certain benefits Chinese firms may reduce exchange rate risks and

costs in their external trade and investment. RMBI may benefit the expansion of overseas

business of Chinese enterprises, including financial institutions.

RMBI may push forward China’s domestic economic reform, because a more opened economic structure would request more domestic reform.

RMBI may push forward China’s financial development, as our early study shows (Zhang and Tao, 2014).

By RMBI, China may collect certain seigniorage. RMBI may reduce China’s demand for US dollar

reserves.

Pitfalls: The main pitfall of RMB’s internationalization will

complicate the environment of China’s monetary policy; the domestic interest rate may largely affected by international factors.

RMBI may create strong demand for RMB denominated assets in both onshore and offshore market, which may induce asset bubble and financial instability.

Strong demand for RMB denominated assets may lead to further appreciation and hurt China’s real economy.

Mistakes in pushing forward RMBI, such as recklessly accelerating liberalization of capital account, may trigger macroeconomic and financial.

Most of the risks are transitional and may become less important in the LR.

Future of the RMBI RMBI will take time, owing to the fact that China’s

domestic financial market is still undeveloped and its capital account is not fully opened.

But it is wrong to argue RMBI is unlikely to make further progress before China fully liberalize its capital account.

In the coming years, RMBI will continue to increase and mainly develop through offshore market (HK, Tokyo, Singapore, London,….)

The target of building up Shanghai into an international finance center may be a vehicle to realize the RMBI through onshore market.

The competition from other currencies, including USD and other currencies, may certainly play a role in the process of RMBI.

Thank You!