Why the renminbi cannot yet compete with the dollar

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HUDSON LOCKETT: 2020 has been a banner year for the Chinese markets and the Chinese currency. Foreign investors have invested billions in renminbi-denominated stocks and bonds. This is good news for Beijing. It is strengthening its position as a global financial powerhouse and advancing one of its main long-term goals – to ensure that the renminbi finally emerges from the shadow of the dollar and becomes a fully-fledged global reserve currency. But achieving dollar-level status will require a change in mentality in Beijing, where a culture of hoarding power reigns. In order for the renminbi to truly match the prestige of the dollar, they will have to break that instinct and give up control.

The dollar has dominated international finance for decades. And America has benefited from the alleged exorbitant privilege that goes with it. Because they always pay in their own currency, the United States can’t really run out of cash. Simply put, the global demand for dollars means the country can always print more without a huge impact. This is one of the main reasons America can run a huge deficit without fear of default.

US businesses also benefit from not having to worry about currency risk since everything is priced in their home currency. Trade, commodities, finance, just about everything that matters in the global economy and the areas in which China wants to have more of a say, is valued in dollars. But as China has started to compete with the United States in international affairs, the renminbi is not even close to the dollar’s pull yet.

China is making progress in improving the renminbi’s status by opening up its stock and bond markets to foreign investors. China’s economic recovery from the COVID-19 pandemic has boosted its stock market and boosted onshore bond yields, attracting well over $ 100 billion from profit-seeking foreign investors. However, while its financial markets can accept foreign money, they do so primarily through cross-border exchange programs that link China’s stock and bond markets with those in Hong Kong. These stock and bond connection schemes are specially designed to accommodate foreign investment while maintaining a limit on the amount of Chinese currency that can flow.

Foreign investments can be withdrawn relatively easily. But Chinese investors are subject to much stricter rules. As a result, it doesn’t matter how much money the Chinese central bank prints. Only a tiny part can make it offshore. And this arrangement helps Beijing to keep control over the renminbi exchange rate. But it also limits the amount of renminbi that other countries can accumulate, and therefore the global standard of the currency.

Flash data shows that the renminbi’s share in international transactions is languishing at around 2%, still well below its 2015 high of just 3%. And Hong Kong, which has its own currency and financial system but is politically part of China, accounts for about 3/4 of those payments. This is, at least in part, by design.

Even though China allows more foreign cities to serve as clearinghouses for the renminbi, policymakers in Beijing are very reluctant to allow the currency to accumulate abroad. And for central banks, the supreme importance of the dollar remains an obvious fact. IMF data shows that they hold about $ 230 billion in renminbi assets in their foreign exchange reserves, compared to nearly $ 7 trillion in US dollars.

Five years ago, Beijing seemed on the right track to quickly internationalize the renminbi. But these efforts were complicated by the decision to maintain a soft peg to the US dollar. When the greenback surged, it carried away the renminbi, making Chinese exports less competitive as the domestic economy lost strength. This prompted the People’s Bank of China to weaken the renminbi with a one-time devaluation of nearly 2% in the summer of 2015.

The stated objective of the move was to reform the market, so as to allow the renminbi’s trading range, which is set each morning by the central bank, to be more inspired by the foreign exchange markets. But it scared off investors who cashed in their renminbi assets and sent the currency down a historic route. Unable to convince investors to stop selling and be accused of flirting with a currency war, China has imposed strict capital controls and strangled the renminbi market in Hong Kong in an effort to stabilize the currency.

Since 2015, China’s foreign exchange policy has become much more transparent and market-oriented. And few traders today live in fear of a devaluation like the one in 2015. But the exchange rate is far from floating.

And so far, China’s capital account is still far from fully open. To have a truly global renminbi and all the benefits that come with it, Beijing will need to let the currency go where market forces and its citizens want to prevail. For now at least, that seems far away.

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