Slow and steady is how China is liberalising the renminbi - as it should

Tom Plate says China is right to delay opening up its capital account before reforms are fully carried out

PUBLISHED : Monday, 12 October, 2015, 5:33pm
UPDATED : Monday, 12 October, 2015, 5:33pm

The long march of the American campaign that ends in the crowning of our new president is well under way, as you have noticed. But I am not sure the great Chinese people should be allowed to watch.

Former top US national security official Zbigniew Brzezinski, who, at a fairly bouncy 87, is moving into the professor-ish throne of foreign-policy zen master, the one long filled by 92-year-old Henry Kissinger, said he worries about "an increasing uncertainty as to what exactly ought to be the definition of China's role in the world".

Tell me about it! The more the US can talk to China "seriously and responsibly", he said, "the greater the chance that perhaps we can do more together instead of increasingly becoming preoccupied with suspicions that each is deliberately turning against the other". Let us give that a standing ovation - but also note the limitations of a process that works best only when trust is maximised.

Beijing would be doing everyone a favour - not just itself - by staying the course that is best for it, even if it seems slow for us

US advice to China hasn't always been that great, and its conduct hasn't always been that inspirational. The Chinese are as aware of our flaws as we of theirs. Neither one of us always does the walk after giving the talk.

In the bad advice category, let's start with the early 1990s when Washington began pounding Beijing on the need to swing open its capital-conversion door. Then comes the Asian financial crisis to reveal exactly what happens when you mix wide-open currencies with pathetically weak institutions. Surveying all the currency carnage around Asia back then, Beijing drew back.

That financial crisis may well have been the tipping point. "Chinese policymakers studied the 1997-98 financial storms, and they drew the right lessons," admitted Barry Eichengreen, professor of economics and political science at the University of California, Berkeley, in an enlightening interview in the October issue of The Oriental Economist, the smart New York-based monthly newsletter.

He added: "More than a century of historical experience teaches that open capital accounts can be an engine of volatility, that capital flows can reverse on a dime, and that financial markets, economies, and political systems can find it hard to cope with the consequences."

READ MORE: Business leaders' confidence in yuan currency remains low

Even so, there would be a big upside to easy convertibility of the renminbi. Banks and corporations have a constant need to accumulate reserves in real money or liquid securities. Over the past several decades, something like 60 per cent of all central bank reserves have been deposits of dollars, which account for no less than 85 per cent of worldwide foreign-exchange transactions. Close to half the world's exports get priced in dollars.

In Washington and New York, this amounts to a tremendous ego trip, and yields absolutely enormous global US financial leverage. But given the pressures of the expanding global economy, the smart money is betting that, before long, another currency will have to step up to the plate; by itself, the US dollar is spread too thin. Would logic not suggest that the currency of the world's other largest economy should be an option? The euro has been a weak player, and the world long ago lost its yen for the yen when the Japanese economy went sleepy-weepy in the 1990s. So who's left? The franc?

READ MORE: What price will China have to pay to make renminbi an international reserve currency?

Beijing's reluctance about swinging wide open its currency to global interchange is certainly understandable. You run huge risks if you have an open capital account without strong markets and financial institutions. No one needs to lecture the Chinese that they're not there yet. "China is trying to build deeper and more liquid financial markets, but in the last few weeks, it's tightened a variety of capital controls because of the weakness of the currency and the instability of financial markets," Eichengreen explains.

Rocked by sinking equity price levels and a slowing economy, the Chinese have been knocked off balance.

They do want to rely less on foreign trade and grow more from domestic demand. So Beijing would be doing everyone a favour - not just itself - by staying the course that is best for it, even if it seems slow for us. Internationalising the renminbi has to follow reform. Go the other way and you might just blow up the stability of the world economy in trying to "firecracker" reform into existence overnight.

Beijing is the first to admit much is to be done. The dark side - the shadow banking system - needs to be lit up like the Lunar New Year; the corporate bond market has to move towards international standards; and the stock market brought into at least some measure of transparency before the Chinese currency can go major-league global. After all, a prematurely totally open currency could trigger floodgates of renminbi outflow - and would have the wholly ironic effect of reducing its value in international currency markets. (Tired congressional hectoring about the evils of an artificially weakened renminbi has no real currency today - and from the get-go was always overstated by US politicians fronting for Wall Street.)

A solid Chinese renminbi as an international option for currency holders could be a very desirable development. But on this issue - unlike, for instance, global warming - Beijing will be listening to its own best voices and not US advice.

They have heard it from us all before. As Brzezinski put it, in a larger context: "We have to face the fact that we're now living in a world that has the United States preeminent but not really dominant." Our money still talks but we're getting near bottom with the dollar as the only real glue for the international currency system.

Professor Tom Plate is the author of the Giants of Asia series, and the Distinguished Scholar of Asian and Pacific Studies at Loyola Marymount University in Los Angeles