January 12, 2021 | RMB Internationalization and Its Obstacles
RMB Internationalization and Its Obstacles
Happy Tuesday, and welcome new subscribers!
Today’s focus:
Attempting to understand US-China Competition in the simplest possible terms
RMB internationalization and its obstacles
Attempting to understand US-China competition in the simplest possible terms
The intensifying US-China relationship of recent years seems to encompass every possible discipline. From game theory to technology to finance to culture, it’s all relevant to some degree.
My stated objective for writing and publishing these notes is to coax out the essence of the relationship between two civilizations. If we frame US-China relations as a grand competition at best or a noxious security dilemma at worst, I’ve found former Australian Prime Minister Kevin Rudd’s condensed assessment of US-China relations to be most practical while still holding on to the critical nuances.
Rudd asserts that the United States possesses three core strategic advantages over China, and moving forward, I intend to assess US-China relations through the lens of one of these three categories:
Military
Currency (US dollar)
Condensing US-China relations into these basic categories may be too simplistic for some. Still, to forecast a general trajectory given various political and economic inputs and constraints, it’s probably good enough.
RMB internationalization and its obstacles
In the context of our basic framework, let’s do a basic recap.
Before the new year, we analyzed US semiconductor dominance in the context of an intensifying US-China technology competition. Yesterday, we introduced the significance of the US dollar’s dominant position in the global financial system and briefly touched upon the concept of ‘RMB internationalization.’
The focus of today’s notes is the question of RMB internationalization and its obstacles..’
An underlying question we’re trying to answer is, “Can China’s currency supplant the US dollar as the dominant currency in the global financial system?”
This isn’t as straightforward a question as it may seem, and to get our answer, we must first cover some basic concepts.
As I mentioned, today’s notes focus on RMB internationalization's core obstacles, which is tied to the concept of ‘capital account liberalization.’ Capital account liberalization is essentially the ceding of government control of a fiat (or digital) currency to allow the currency’s valuation to float freely on the international foreign exchange market.
What makes the Chinese Yuan (RMB) different from other reserve currencies is that its value is not determined by the market forces of supply and demand. Instead, the RMB is ‘pegged’ to the US dollar, allowing China’s currency regulators to ‘fix’ the value of the RMB to any value they’d like.
‘Fixing’ the currency to a narrow trading range allows the RMB to remain quite stable and creates conditions that are highly beneficial for China’s economy, especially exports. I won’t go into the details of the mechanisms behind the RMB-dollar peg. Still, I will stress that China is highly dependent on holding massive dollar foreign exchange reserves to maintain the value of the RMB.
Although the RMB’s peg to the dollar provides numerous benefits to China’s economy, some argue that such a practice constitutes ‘currency manipulation.’ Which, many argue, unfairly tips the scales in China’s favor and adversely impacts global trade for the rest of the world.
China can fix the RMB value because it operates what’s known as a ‘closed capital account.’ To explain this concept in the simplest terms, China’s regulators tightly control the capital that moves in and out of China by making it difficult to convert RMB into other reserve currencies such as the US dollar, Japanese Yen, Euro, etc.
Obstacles to free currency conversion can deter institutional investors from buying RMB-denominated assets (stocks, bonds, real estate, derivatives, etc.). Hypothetically, imagine a European institutional investor purchases Chinese corporate bonds by converting Euros to RMB. There’s a risk that the investor will encounter obstacles or red-tape if they decide to sell their Chinese assets and convert their RMB back to Euros. This additional risk is already exogenous to the existing investment and regulatory risks of buying any asset.
To conclude today’s notes, if you manage to take away anything from it, I hope it’s this: The greatest obstacle to wider adoption of the RMB in the international market is that Chinese currency regulators often place barriers to converting the RMB into other currencies.
For additional reading on RMB internationalization, I highly recommend ‘Understanding the Implications Behind Capital Account Liberalization in China’ by Taylor W. Loeb. I also recommend ‘International Trade Law Concerns With China’s Digital Currency: How Sovereign-issued Stablecoin Can Destabilize International Trade’ by Harrison Dent (thanks to @PAstynome for the recommendation).
I especially recommend Harrison Dent’s piece, and I’m considering dedicating multiple notes to analyzing the concepts he introduces.
Thank you for reading!
Best,
Kevin
Photo by Jonathan Allison on Unsplash