The End of the Renminbi Regime
What should China do to maintain its rapid economic growth in this decade?
- China is today where America was in the inter-war period, and where Japan was in the 1980s. It is the dominant holder of global savings and reserves, but with a twist.
- China may feel like an increasingly confident teenager, but it needs to grow up, and quickly.
- The trouble is that China's economic strategy seems still to be focused inappropriately on quite a rigid currency regime and the expansion of heavy industrial capacity.
China could try and encourage other countries to hold more renminbi assets, since it has already replaced the United States as the biggest trading nation in a group of countries that now accounts for nearly half of its trade: Japan, Russia, Malaysia, Hong Kong, Singapore, Australia, Taiwan, the Philippines, South Korea and Indonesia.
Moreover, it signed a trade agreement with Brazil in 2009 whereby some trade would be settled in renminbi. However, China’s financial and capital markets are far too narrow in depth and breadth, and it is not at all clear that foreigners want to hold assets denominated in renminbi, for reasons ranging from liquidity to the Chinese legal system to overall financial governance.
The constructive thing for China to do would be to announce a significant revaluation of its currency, coupled with an accelerated program for the dismantling of remaining controls over capital movements, and new arrangements for increased currency management flexibility, if the authorities are not willing to allow a freely floating currency.
This would take the sting out of protectionism and aid and abet the process of global re-balancing as other nations took advantage of improved opportunities to export to China. It would take pressure away from the EU and Japan, whose currencies have appreciated too much against a U.S. dollar that cannot fall against China’s pegged currency.
Most importantly, it would help the Chinese economy to shift to a different structure, in which it would increase the production of goods and services for home consumption, and become more self-reliant and a stronger global partner.
The trouble is that China’s economic strategy seems still to be focused inappropriately on quite a rigid currency regime and the expansion of heavy industrial capacity — and the West is losing patience.
Trade friction could become increasingly severe. By 2012, the U.S. presidential election campaign will be in full swing, while China will be preoccupied with preparations for the 18th National Communist Party Congress, at which new leaders will be installed.
China is caught in a trap. Within the next five years, and preferably sooner, it is going to have to confront the conflict in its domestic and external monetary policies once and for all. It can no longer expect the economy to grow at 8-10% per year for any length of time without significant changes in either the renminbi and/or domestic interest rates.
To keep the renminbi under control, in what is tantamount to exchange rate protectionism, the authorities are compromising local monetary and financial stability, and also putting themselves and the United States on a collision course that could result in grave outcomes for world trade and its own social stability.
Sooner or later, this trap will be broken. In the best case, China will reform its domestic financial system voluntarily and in a timely way, allow the renminbi to become significantly more flexible, and replace gradualism in monetary and financial affairs with a more robust domestic growth strategy embracing rural and social reforms.
China is today where America was in the inter-war period, and where Japan was in the 1980s. It is the dominant holder of global savings and reserves, but with a twist. America and Japan both supplied copious amounts of private capital into the global economy, but in China’s case, it is government capital.
The network of financial relations across the world is intrinsically more political. Moreover, financial immaturity or, indeed, financial nationalism, threaten to frustrate any real chance that it might act at a global level, from which it would also doubtless gain. Unscrambling domestic and external policy conflict would mean having to work with the United States and global institutions.
It would mean addressing matters that would most likely be seen as interference and as a threat to national interests as defined by the Communist Party. The United States cannot be oblivious to these tensions, and has vested interests in trying to ensure that China does not react, as it has done on many occasions in the last two millennia, by turning inwards and building barriers to the world.
In a nutshell, the world has to make the case that China and other emerging markets should restructure their economies, modernize and deepen financial systems, and allow excessive savings-investment imbalances to diminish. What that means in practice is raising the incomes of the poor and of rural citizens, and improving the provision of and access to education, health care and social insurance.
It means expanding the collection and investment of people’s savings, and strengthening the mechanisms to distribute corporate profits to citizens and investors.
The IMF could play an important role in this process, providing confidence in arrangements that would allow emerging markets to focus more on domestic growth and borrowing, and offering financial insurance against the risk of destabilizing capital and currency flows under some circumstances.
China protests that it is still a poor country, not a global power. The reality is more complex. It is relatively poor still, but it is far too important nowadays in global trade and finance not to take global responsibility for leadership and change in the global economy.
China may feel like an increasingly confident teenager, mature enough to have strong views but not old enough yet to take full responsibility, but it needs to grow up, and quickly. Otherwise, its astounding economic successes to date could be compromised or reversed.
Editor’s Note: This feature is excerpted from George Magnus’ book, “Uprising: Will Emerging Markets Shape or Shake the World Economy?,” published by Wiley on December 28, 2010. Copyright 2010 George Magnus. Reprinted with permission of the author.