With the launching of the Asian Infrastructure Investment Bank, the Silk Road Fund and various speeches by the People’s Bank on RMB in the last month or so, there are signals that the pace of RMB internationalization seems to have gathered momentum. 

What are the real benefits and risks of RMB internationalization? Basically, there are five major reasons why the RMB should be more internationalized.

Firstly, China achieved a $10 trillion GDP status last year, becoming the second largest economy in the world next to the U.S., if you exclude the European Union as one entity. As one of the largest trading nations in the world, China today accounts for roughly 13 percent of world GDP, slightly more than 10 percent of global trade, but turnover in the RMB in global FX markets remains still less than the Australian or Canadian dollars and way behind the U.S. (roughly 60 percent of FX turnover), the Euro (20 percent), pound Sterling and the Yen. It seems natural that the currency of a major economy should have roughly the same share in global trading and exchange.

The second reason is that since China is a major importer of commodities and exporter of consumer goods, payments and settlements in the currency of your major supplier is good for currency risk management for both buyers and sellers. With the growing sophistication of Chinese financial institutions in supporting trade and the creation of a global RMB clearing and settlement system by this year, transactions costs in trading through the RMB could be as cheap and robustly settled as in the dollar or the euro.

Thirdly, since China is already the largest importer of commodities, such as iron and coal and also crude oil, increasingly more commodities are likely to be priced in RMB and not necessarily in dollars.

The Chinese would like to pay in RMB and if the sellers feel comfortable investing in RMB because of liquidity and long-term returns, there is no reason why some of the key commodities will not be priced in RMB.

Fourthly, RMB internationalization is good for China as a reform driver. Major reforms in China have historically come from “reverse pressure”, not just from internal needs, but because China becomes more engaged in global affairs and becomes subject to global standards and rules. The move to join the WTO in 2001, which required huge internal adjustments and concessions to comply with WTO rules, was initially considered by many within China as a “sellout” but China was a major beneficiary from joining WTO in terms of both trade and investments. Hence, RMB internationalization, which will require more capital account liberalization, internal reforms in interest rate and exchange rate liberalization and more liquidity and competitiveness in domestic banking, insurance and capital markets, are seen to be good not only for China, but also for global financial markets.

Fifthly, and this is not obvious to many observers, there is an imperative for the RMB to join the international reserve currency group, such as the IMF’s Special Drawing Rights’ component currencies. Some people think that China wants this for the prestige, but in reality, if China does not join soon, the IMF and the World Bank will not have enough liquidity to deal with the coming global financial crisis.

Global financial assets have risen to roughly $275 trillion (not counting derivatives), roughly three and a half times world GDP, mainly because, as the McKinsey Global Institute recently pointed out, global leverage is growing faster than GDP. At the same time, the central banks’ balance sheets have ballooned to nearly 8 percent of total financial assets, mainly because of quantitative easing by the advanced central banks, primarily the Fed, ECB and Bank of Japan.

Because central banks lend against collateral, a lot of the so-called risk-free bonds are tied up in central banks. Liquidity in such sovereign debt has become more volatile, as the large global banks are required to maintain higher capital for them even to market-make in these assets. As the emerging market debt begins to rise in the face of higher real interest rates, more volatile capital flows, and geopolitical risks, it would not be surprising if in the next decade, there is another round of financial market spikes, if not outright crash.

Currently, the Bretton Wood twins, the World Bank and IMF have total balance sheets of $800 billion (or slightly more than 3 percent of global financial assets). Since the U.S. and European members, which control the majority shares of the multilateral institutions are unwilling to increase their capital because of fiscal constraints, these safety nets will not have enough money to deal with impending financial crises that require more and more funding to resolve.

China’s Silk Road and Maritime Silk Road strategies, plus the AIIB, BRICS Bank and the Silk Road Fund are all attempts to fulfill the global need for infrastructure spending, improving trade and global liquidity in the event of another shock to the system. Thus, for the U.S. to openly lobby against their creation and membership is a little bit like cutting one’s nose to spite one’s face.

Getting RMB totally internationalized is likely to be a long and tortuous road. After all, it took the U.S. dollar 70 years to overtake the pound sterling, emerging as the dominant currency backed by an overwhelming dominant military force after World War II.

One cannot but reflect that the yen challenged the dollar in the 1990s, only for the euro to overtake it as the number two reserve currency in the last decade. Was it pure coincidence that both economies got into crises because their internal structures were not ready to take the stresses and strains of internationalization?

In other words, the road to RMB internationalization will not be smooth as Silk, but it could come sooner and in more different ways than most people think.

By Andrew Sheng

Andrew Sheng writes on global issues from an Asian perspective. ― Ed.

(Asia News Network)