The winner of the year: Chinese Renminbi

"It's all for money and goods, this fighting and quarrelling" (Pieter Bruegel the Elder, 1570)

The Third Plenum of the 18th Central Committee announced a comprehensive programme of reforms that will support China’s ambitions to develop into a global superpower by the end of the decade. China is envisioned to become more market-oriented, competitive, liberal, transparent and investor-friendly. In other worlds, China will continue to go along the path of Westernization, which, symbolically, has started precisely 35 years ago during The Third Plenum of the 11th Central Committee Congress led by a legendary reform leader Deng Xiaoping. The strategy proved to be highly successful: in 1978 China’s economy was more than ten times smaller than that of the USA and produced only 2% of global economic output, whereas in 2018 China is forecasted to surpass America to become the largest economic power generating 18% of the world’s economic output. These impressive achievements more than anything else motivate Chinese political elite to keep the Western direction.

And yet the fact that China becomes like the West, by no means suggest that China likes the West. China is becoming similar to its Western counterparts in virtually every dimension except one – political system. In spite of economic liberalization, People’s Republic of China was, is and will continue to be ruled by the Communist Party. Hence, political rivalry between the West and China ought to intensify in line with growing Chinese economic power. China’s plans to create an air defence identification zone around Japanese controlled Senkaku (Chinese: Diaoyu)islands were immediately followed bya “Cold War-like” rhetoric from Pentagon. The incident perfectly illustratesthe existing tensions between China and the West that at times reminds us of the Cold War antagonism: the difference is that this time it is China and not the Soviet Union that represents the East. However, this time the battlewill not be about who will get the larger number of nuclear warheads.To paraphrase the inscription of Pieter Bruegel the Elder “It's all for money and goods, this fighting and quarrelling”. China already flooded the world with “made in China” goods, but stable and freely convertible currency is a necessary prerequisite in order to successfully compete in global financial industry. China perfectly understands that and is ready to fire off a principal weapon: Chinese Renminbi, which is actually ready to compete with US dollar and euro, even though it will not be an easy task in the world controlled by the Western powers.

The West rules the rest

The year 1991 was the year of triumph and victory for the Western World. The Collapse of the Soviet Union ended the Cold War and greatly increased ideological and military dominance of the USA and its Western allies. Symbolically, the same year witnessed the collapse of Japanese real estate market that put anend to a post-war Japanese economic miracle. With Soviet Union and Japan defeated, the West set off to dominate the world. America de-facto became the world policeman, whereas united Germany became the economic powerhouse of newly created European Union (Maastricht treaty was signed in 1992). China was a no match for the West at that time: its economy was no larger than that of France, Italy or … the State of California.

The year 2001 marked two attempts to question global dominance of the West. The September 11 attacks challenged military and ideological supremacy of the West. Just a few months later, British economist Jim O'Neill coined an acronym “BRIC” (Brazil, Russia, India and China) – a group of emerging powers that supposedly were eager and ready to challenge Western economic dominance. And yet neither terrorists nor BRIC posed a real threat to the Western World. The War on Terror gave a nice “excuse” for the USA to carry on its world police duties. Economically BRIC countries, although making a good progress, were no match for the West as well. The GDP of all BRIC states combined were still significantly lower than that of the USA or European Union alone. China was still seen as a place to produce cheap “made in China” goods whereas Russia continued to lose its influence in Eastern Europe to rapidly expanding European Union and NATO.

In fact, the largest threat to the West was the West itself. Excessive confidence and optimism led to excessive borrowing, which eventually led to global financial and economic crisis in 2008. The situation looked increasingly serious and reminiscent of the Great Depression. When credit boom suddenly went to bust, many countries were forced to impose strict fiscal discipline, while consumers massively cutback their spending fearing that the worst it still to come. With domestic consumption trapped into the vicious credit cycle everyone gave high hopes on exports to drive their economies out of the recession. The temptation to start “Beggar Thy Neighbour” type of competitive currency devaluation policies was extremely high as were the stakes. But there were precisely these “strategies” used by many countries that delayed economic recovery after the Great Depression and resulted in multiple armed conflicts in late 30’s. The world seems to have learned this lesson: the Currency War did not happen this time and precisely this no-happening allowed international trade and global economy to recover.

Currency War that did not happen

English proverb says: “A friend in need is a friend indeed”. And the best friend of the Western world during the economic crisis was China. Not only China did not embark into the Trade Wars with the USA or the European Union, but it also did not succumb to the temptation to devalue its currency in times of economic distress. China is occasionally being accused by the USA of implementing competitive devaluation practices that allegedly give Chinese producers an unfair competitive advantage over the American producers. But in fact it is not so much about China as about the USA itself.

To begin with, China’s current account surplus was a mere 1.3% in 2001, but as the USA started implementing ultra-loose monetary policy things started to change dramatically. Too cheap and too easy credit transformed Americans into the real “homo-consumericus” – to paraphrase Rene Descartes, the motto of American consumers became “consumo ergo sum” (“I consume, therefore I am”). Cheap and abundant “made in China” goods, German cars, Taiwanese computers, Saudi Arabian oil and American dream houses – all those purchases made USA current account deficit to widen from 3.7% in 2001 to 5.7% in 2006. China benefited a lot from this consumption frenzy in the USA. In just 6 years, Chinese current account surplus increased almost tenfold reaching an impressive 10% of GDP in 2007. But China was not alone. For example, Germany has increased its current account surplus from 0% in 2001 to 7.5% in 2007. So did Saudi Arabia, Sweden, Israel, Malaysia, Japan and other export-oriented countries that managed to avoid USA-like consumption boom (Spain, Greece and the Baltics were among those that did not). Hence, blaming China for growing global trade imbalances during the pre-crisis period wouldn’t be objective. Especially keeping in mind the fact that China removed the peg in mid-2005 and allowed the Renminbi to gradually strengthen against the US dollar from mid-2005 until mid-2008.

But even more important is that China decided not to weaken Renminbi during the global economic crisis in 2008 and instead allowed it to strengthen in line with the US dollar (which was strengthening vis-à-vis other currencies due to its status of save haven currency). This action had a profound effect on increasing attractiveness of Chinese Renminbi. First, doing this China made a clear signal that it will not start currency wars with its trading partners. Hence, China proved that it can be a reliable and trustworthy trading partner for the West. Secondly, China effectively transformed Renminbi into a safe haven currency i.e. anchor of stability that is sought after by international investors in times of economic crisis. By choosing not to devaluate its currency and re-pegging it to the US dollarinstead, China in fact sent a signal for international investors that Renminbi is at least as strong as the US dollar in times of turbulence. Thirdly, China’s action illustrated growing divergence between China and the rest of BRIC countries. Since the onset of the crisis the currencies of Brazil, Russia and India significantly weakened against the US dollar. Brazilian Real and Russian Rouble were particularly hard hit and lost close to 60% of its pre-crisis value while Indian Rupee depreciated by 30%. Chinese Yuan, on the contrary, gained in value until mid-2008 and then remain fixed vis-a-vis US dollar until mid-2010.

Renminbi: at least as strong as the US dollar

In fact, global economic crisis in 2008 wasn’t the first time Chinese Renminbi proved itself as an anchor of stability. During the 1997 Asian financial crash most South-East Asian countries devaluated their currencies, but Chinese Renminbi on the contrary - appreciated. This helped other Asian countries to regain their international competitiveness at the expense of China. For example, current account balance of Thailand, Malaysia, Philippines, South Korea and Indonesia turned from negative one in 1997 to positive one in 1998 and the years to follow. On the contrary, China’s trade deficit with ASEAN countries turned negative in 1998, while the total current account surplus gradually declined from 3.9% in 1997 to 1.9% in 1999 and further on to 1.3% in 2001. Were China to follow the example of other countries and devaluate Renminbi, recovery in South East Asia would have been undermined. But China decided not to devalue and instead even allowed Renminbi to strengthen symbolically. Hence, the first test was passed in 1998, the second one – in 2008, and the third, decisive one, in 2013.

In May 2013 FED announced that the era of economic stimulus (money printing) is going to an end. Warren Buffet once rightly remarked that “you never know who's swimming naked until the tide goes out” – and with FED’s announcement the tide of easy money expectations suddenly all but vanished. As a result of that,currencies of all the BRIC countries weakened against the dollar except one: Chinese Renminbi. In just four months Indian Rupee, Brazilian Real and Russian Rouble depreciated by 22%, 19% and 7%, whereas Chinese Renminbi on the contrary – appreciated by 1%. It shows that Renminbi is building up credibility as safe and stable currency that tends not to lose value in times of economic turbulence – property so needed and sought after by international investors. Hence, contrary to other currencies of BRIC countries, Chinese Renminbi fulfils the necessary condition to become one of the global reserve currencies. China’s case becomes even stronger keeping in mind the fact that Japan – its long-standing rival in Asia – is implementing Abenomics economic policy as a consequence of which Japanese Yen depreciated significantly… It’s now Japan and not China who would rightly deserve accusations of encouraging global currency war. Especially given that current account surplus in China dropped to 2.2% of GDP in 2013 and is expected to narrow further to a mere 1% in 2015.

Making Renminbi global

An yet, keeping stable exchange rateis definitely a necessary, but by no means a sufficient condition to become global reserve currency. It is financial liberalization that is needed. The ruling Chinese Communist Party was unwilling to liberalize financial markets fearing that foreign capital inflows and cheap capital could destabilize domestic economy. However, The Third Plenum of the 18th Central Committee seems to be a game-changer. Measures have been announced that in less than a decade could potentially make Chinese Renminbi among the top three global reserve currencies. There are two ways in which China will liberalize and globalize Renminbi: gradual widening of trading bandaround the official fixing rate determined by the People's Bank of China and experiment with Shanghai (andpossibly Guangdong) free trade zones.

First way: Gradual widening of trading band

Prior to mid-2005 Renminbi was fixed to US dollar with occasional devaluations to retain international competitiveness of Chinese manufacturing production and keep trade balance in surplus. For example, China’s trade balance moved into negative territory in 1993 and was immediately followed by Renminbi devaluation the year after. However, devaluation of Renminbi in 1994 proved to be the last one, since improving productivity and rising export volumes helped China to keep international trade surplus. Hence, the Renminbi remained fixed to the US dollar until mid-2005 when significant trade surpluses started to accumulate threatening the stability of the global trade. As a result, China decided to unpeg Renminbi from the US dollar and introduced a managed float regime. Specifically, Renminbi was allowed to fluctuate +-0.3% around the official fixing rate determined by the People's Bank of China. The band was widened to +-0.5% in 2007, +-1.0% in 2012 and is expected to be widened further on to +- 1.5% in the beginning of 2014.It is important to mention that between mid-2008 and mid-2010 Renminbi was temporarily re-pegged to the US dollar, but this event did not change the general tendency for Renminbi to gradually increase its exchange rate flexibility and eventually transform Renminbi from fixed to floating currency – an essential feature aiming to become global reserve currency.So far, the experiment goes smoothly: Renminbi gradually but surely appreciates against US dollar approaching 6 Renminbi per US dollar mark (the rate was 8.27 when the peg was abandoned in mid-2005).

However, more freedom for currency necessitates more freedom for financial market as a whole. First, capital controls should be gradually lifted. For example, China imposes limits on the amount of foreign currency an individual can take in a given year. Existing regulation is that each individual is not allowed to take more than 50000 US dollars per year. However, these regulations become superficial given that many people find ways to bypass the law. In addition, the recent upsurge of the usage of virtual global currencies, such as Bitcoin, could make these restrictions even harder to enforce. Another issue is interest rate liberalization. Under existing regulation, commercial banks’ deposit rates cannot exceed the benchmark deposit rate set by the People's Bank of China by more than 10%. For example, one year benchmark deposit rate currently stands at 3%, hence, Chinese savers can receive for their one-year deposits no more than 3.3%. China also used to impose similar limits on lending rates, but those restrictions were removed in July 2013. And yet, it will be a real challenge for China to eradicate deposit rate control, since it would seriously hurt banks’ profitability and may potentially destabilize Chinese financial system, which is dominated by state-owned banking groups. Hence, this road to Renminbi globalization will be gradual and potentially with some set-backs if experiments do not bring desired results.

Second way: Shanghai free trade zone

At the same time China is moving in other direction in trying to make Renminbi more freely convertible and used by international community. On September 2013, China opened up the Shanghai free trade zone with no restrictions on capital movement and interest rates. The experiment is expected to last three years and if it proves to be successful thecapital and other controls will be gradually lifted in other provinces and later on – on a national scale. In fact, Shanghai is already not alone as Guangdong free trade zone is expected to be opened in early 2014. If those experiments succeed, China expects to liberalize Renminbi by the end of 2015. Hence, as soon as in 2016 a powerful rival will come to global stage with an aim to challenge US dollar and euro and together Western absolute dominance in the world of money.  

The battle for money: ChinAmEurica

The Cold War between the West and the Soviet Union left the world littered with dangerous nuclear warheads. On the contrary, Sino-American rivalry will leave it covered with “made in China” goods, US dollars and Chinese Renminbi. It’s because China and America are like newlyweds firmly tied into the marriage of convenience. China is the biggest creditor of the USA, whereas the USA is by far the biggest export partner of China. This simply means that America without China would experience severe financial crisis, whereas China without America would delve into deep economic crisis. However, as Benjamin Franklin once put it “Where there's marriage without love, there will be love without marriage”. Love, after all, is not war and this is very good news for the global economy. To paraphrase anti-war slogan of the Cold War period, the Sino-American rivalry will “make money, not war”. Europe and the rest of the world can greatly benefit from this battle; hence, contrary to the situation during the Cold War, countries should strive to get into the front line of this battle.

The battle for money between China and the West will make both parties more prosperous. On one hand, China’s rivalry won’t allow the West to become overly complacent and relaxed. Rivalry is a necessary condition for capitalism to flourish – and China is the perhaps the best country to take over the role of a key competitor. On the other hand, increasing pressure from the West will prompt China to speed up reforms and challenge the West in the world of money and finance. China clearly understands that and seems to be ready to globalise Renminbi as soon as in 2016.

Finally, China, together with the USA and European Union, is supposed to become one of the three global powers, responsible for safeguarding stability and prosperity of the global economy. And yet, the fight for ChinAmEurica as a new world order for decades is not going to be easy for anyone.