Economic reforms alone won't put the renminbi in the dollar's league

Scarcely a week passes without news about the ascendance of the renminbi. But China has a long way to go before its currency can rival - let alone displace - the US dollar as the dominant global reserve currency.

To be sure, China already plays a significant role in international trade and finance, with major financial centres like London and Frankfurt eagerly lining up for renminbi business. Recent speculation that China's economy may soon be as large as America's has boosted this interest further, causing many to believe - whether ruefully or gleefully - that the renminbi will soon dominate.

Moreover, the Chinese authorities have launched a raft of reforms aimed at opening the economy and making it more market-oriented, and have announced plans to liberalise interest and exchange rates and continue to ease restrictions on cross-border capital flows. All of this will strengthen the renminbi's claim to reserve-currency status.

But China is missing one crucial ingredient: the world's trust. To achieve currency dominance, China needs more than economic and military might; it requires a broader and more credible set of public and political institutions. And it is here that the US shines - at least relatively speaking.

This was never more apparent than in the aftermath of the global financial crisis. Even though America's financial markets nearly collapsed, its public-debt levels rose sharply, and the Federal Reserve was forced to undertake massive monetary expansion to support the economy, the dollar strengthened relative to most other currencies.

That is because global investors seeking a safe haven automatically turn to US Treasury securities in times of global financial turmoil. Foreign investors now hold more than US$5.7 trillion of these low-yielding securities, not to mention large quantities of other dollar assets. And the dollar's share in global foreign-exchange reserves has held steady since the crisis.

This can be explained partly by the fact that the United States boasts the world's deepest and most liquid financial markets. But the most important factor supporting America's currency dominance is the institutionalised system of checks and balances that operates among the executive, legislative and judicial branches of its government.