• Thu
  • Jul 31, 2014
  • Updated: 5:00pm
Monitor
PUBLISHED : Thursday, 06 February, 2014, 4:24am
UPDATED : Thursday, 06 February, 2014, 4:24am

Four reasons the yuan will struggle to gain acceptance

Open and well-regulated markets, transparent governance and solid banking system needed for Chinese currency’s rise to dominance

Talk to financiers in Hong Kong and you will get the impression that it is the manifest destiny of China's yuan to displace the US dollar as the world's dominant currency, probably within the next decade or two.

You can see why they think so. The fast growth of China's economy, its ascent as a trading power, the rapid spread of the yuan as a trade currency and Beijing's programme of financial liberalisation all appear to support their belief.

Factor in America's monstrous deficits and intractable budget disputes, and it seems as if the yuan's rise to pre-eminence as the world's currency of choice for international trade and investment can only be a matter of time.

Yet a look at the economic history books advises caution. Over the past 50 years, other currencies - including the deutschemark, its successor the euro, and the Japanese yen - had been tipped to steal the dollar's crown.

All failed. And the obstacles the yuan will have to overcome to unseat the dollar are just as formidable as those that defeated the three earlier pretenders.

In the 1970s, many saw the deutschemark as a competitor to the dollar. Germany's economy was growing quickly, and by the early 1980s, it had captured a 10 per cent share of global commerce, roughly the same as China today.

The mark was widely adopted as a currency for invoicing and settling international trade, even among third parties. Other countries chose to anchor their exchange rate to Germany's, and the mark found a prominent place in central bank portfolios of foreign reserves.

Yet despite these advantages, the mark's progress stalled. Part of the problem was that although Germany's trade prowess was undoubted, its financial markets could not come close to matching the breadth and depth of America's.

As a result, the mark never gained critical mass as an investment currency. Without deep and sophisticated financial markets, it stood no chance of toppling the dollar.

It looked as if things might change with the introduction in 1999 of the euro. International issues of euro-denominated debt took off, and the new currency quickly gained ground in both trade settlement and reserve portfolios.

Again the advance petered out. Although the euro achieved acceptance around Europe's periphery, it remains only a regional currency. Further afield, it is barely used.

The trouble was the weakness of European governance. It took only a few years following the euro's introduction for both Germany and France to breach the deficit limits imposed by the Growth and Stability Pact that was supposed to underpin the new currency's credibility.

Today, as much of the continent grapples with a debt crisis of the euro zone's 18 members, only Finland and Luxembourg can claim to have kept their obligations on financial discipline. As a result, international trust in the euro has been fatally wounded.

Then there was the yen. In the 1980s, the rise of Japan's currency seemed assured.

Japan had already become a trade superpower. Its banks were the world's largest. And as Tokyo dismantled its capital controls and encouraged the development of its financial markets, the yen captured close to a 30 per cent share of global currency transactions.

It didn't last. Financial liberalisation inflated Japan's bubble economy, leading to a bust and a crippling balance sheet recession. The yen's slice of global markets fell by a third, its share of official reserves by half.

Each of these episodes has lessons for China today. To get its currency generally accepted around the world, a country needs more than a widespread international trade network.

It must have deep, sophisticated and well regulated capital markets, which are freely open to foreign participants.

It must have a credible and transparent governance structure, with policymakers that can demonstrate a track record of successful financial management.

And it must have a strong and stable banking system, and solid economic prospects.

China looks shaky on all three counts. Its capital markets are underdeveloped and closed to outsiders. Its government is a black box. And with debt levels ballooning, its banking system and economy are looking increasingly fragile.

Of course, the credibility of the US government and the solidity of the US financial system have taken severe knocks in recent years.

But the US government isn't trying to get the dollar accepted by the rest of the world. It already has been.

And that's the final point. Even if China successfully meets all the other criteria, the yuan will still have to overcome the enormous inertia that favours the dollar as the world's leading currency.

History teaches us that the yuan's destiny is anything but manifest.

tom.holland@scmp.com

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realestate
A good incisive article that discusses the pros and cons of what it takes to be a world currency.China is way far away to stake a real claim to be a big power unless it transforms itself with the rule of law, openness and transparency.No one invests in a system that is opaque, its failed FTZ schemes are a result of such opaqueness.
Great article Tom!!
lucifer
Does China's political system even allow enough transparency or confidence in long-term stability to even be making such comparisons?
lexishk
5. Its design continues to glorify a mass - m u r d e r e r .
(spacing necessary to evade the SCMP censor)
chaz_hen
I do miss the old currency notes that glorified peasant workers and the ethnic minorities of China. The cult of personality continues...
ssslmcs01
Looking at the histories of the the development or lack of development of other domanant economies' currencies cannot paint a totally accuate picture of how the RMB will develop. I do believe it has potential. But we should bear in mind that any government who believes that they can portray a ruthless dictator on their currency, either has no regard for the millions of victims who suffered at his hands or that they believe that he was good for China, which we all know isn't true. For this government to demonstrate that it has developed to the level required to be the host country of a currency of international trade and to be a reserve currency of foreign countries, they will have
to stop insulting the Chinese people and the descendants of our great nation.
johnyuan
If my hunch is correct, US is trying to achieve a single economy for the entire world since after the WWII through the establishment of three institutions – Trilateral Commission, IMF and WTO. A single currency for the entire world may be is their ultimate goal if workable. When it happens, US dollars may be is the chosen one or a new currency will be created.
ssslmcs01
That would be difficult to achieve. Look at the problems that have arrisen in the Eurozone with their single currency. Economies can't compete on the same level and therefore function much better with a currency that fluctuates according to their own economic conditions.
That's not to say the Yankee's don't want a single currency, ie the Greenback.
johnyuan
To sss....
.
The Euro is not as welcome by its member countries of which each has its own long history and culture. US if it wants to use its currency as world’s single currency, its soft power as well as its Constitution may serve as a leverage. The increasing even more different immigrants in absorbing cultures from all corners of the world may too wouldn’t create a resistance.
jiawang@adb.org
History will not be kind to the "China Dream."
 
 
 
 
 

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