china's new international financial strategy amid the global financial crisis

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22 China & World Economy / 22 35, Vol. 17, No. 5, 2009 ©2009 The Author Journal compilation ©2009 Institute of World Economics and Politics, Chinese Academy of Social Sciences Chinas New International Financial Strategy amid the Global Financial Crisis Ming Zhang* Abstract The Chinese Government has stepped up its drive to reconstruct its international financial strategy after the sub-prime crisis developed into a global financial crisis in 2008. The main aim of the strategy is to reduce the countrys dependence on the US dollar in foreign trade, cross-border capital flows and foreign exchange reserve management. The strategy can be divided into three tiers: renminbi internationalization, regional monetary cooperation and reconstruction of the international monetary regime. So far, the Chinese Government has fared well in the application of all three tiers. We hold that the Chinese Government should continue in the same direction in a coordinated manner despite various challenges it faces. Key words: global financial crisis, global financial strategy, renminbi internationalization, regional monetary cooperation JEL codes: F33, F36, F42, F55 I. Introduction The global financial crisis as a result of the US sub-prime crisis has provided valuable lessons for the Chinese Government. On the one hand, the US Government has adopted very loose fiscal and monetary policies to save its financial system despite the negative externalities of these policies and the risk of future inflation and dollar depreciation. As the biggest official creditor of the USA, the Chinese Government has found that its excessive dependency on the US dollar in foreign trade, in international capital flows and in foreign exchange reserve management bears huge risks. On the other hand, although the sub- prime crisis dealt a heavy blow to the US economy, the US dollar has continued to rise against the euro since the third quarter of 2008 because of the dollars role as the predominant international currency and because of the safe haven effectof its treasury market. The * Ming Zhang, Assistant Research Fellow, Institute of World Economics and Politics, Chinese Academy of Social Sciences, Beijing, China. Email: [email protected].

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Page 1: China's New International Financial Strategy amid the Global Financial Crisis

22 China & World Economy / 22 – 35, Vol. 17, No. 5, 2009

©2009 The AuthorJournal compilation ©2009 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China’s New International FinancialStrategy amid the Global Financial Crisis

Ming Zhang*

Abstract

The Chinese Government has stepped up its drive to reconstruct its international financialstrategy after the sub-prime crisis developed into a global financial crisis in 2008. The mainaim of the strategy is to reduce the country’s dependence on the US dollar in foreign trade,cross-border capital flows and foreign exchange reserve management. The strategy can bedivided into three tiers: renminbi internationalization, regional monetary cooperation andreconstruction of the international monetary regime. So far, the Chinese Government hasfared well in the application of all three tiers. We hold that the Chinese Government shouldcontinue in the same direction in a coordinated manner despite various challenges it faces.

Key words: global financial crisis, global financial strategy, renminbi internationalization,regional monetary cooperation

JEL codes: F33, F36, F42, F55

I. Introduction

The global financial crisis as a result of the US sub-prime crisis has provided valuablelessons for the Chinese Government. On the one hand, the US Government has adoptedvery loose fiscal and monetary policies to save its financial system despite the negativeexternalities of these policies and the risk of future inflation and dollar depreciation. As thebiggest official creditor of the USA, the Chinese Government has found that its excessivedependency on the US dollar in foreign trade, in international capital flows and in foreignexchange reserve management bears huge risks. On the other hand, although the sub-prime crisis dealt a heavy blow to the US economy, the US dollar has continued to riseagainst the euro since the third quarter of 2008 because of the dollar’s role as the predominantinternational currency and because of the “safe haven effect” of its treasury market. The

* Ming Zhang, Assistant Research Fellow, Institute of World Economics and Politics, Chinese Academyof Social Sciences, Beijing, China. Email: [email protected].

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influx of cheap money has provided financing for the US Government to bail out thefinancial market while the mid-term to long-term dollar depreciation will reduce the realliabilities of the USA. In other words, after the global financial crisis erupted, China, whichis on the periphery of the international monetary system, has been put in a moredisadvantageous position than the USA, which is in the center of the international monetarysystem. China will not only continue to provide financing for the USA, but bear the potentialrisk of drastic dollar depreciation in the future.

The Chinese Government has taken a series of actions on the international financialstage, which can be divided into three tiers, moving from the near term to long term:renminbi (RMB) internationalization, regional monetary cooperation and reconstruction ofthe international monetary regime. The three-tier steps reflect the Chinese Government’sambition to reshape its international financial strategy, the aim of which is to comprehensivelyenhance the role of the RMB and some other currencies on the international market, and toreduce the dependence of China and East Asia in particular on the US dollar.

This article will discuss China’s new international financial strategy against the backdropof the global financial crisis. It is structured as follows. RMB internationalization is discussedin the next section. Regional monetary cooperation in East Asian is analyzed in Section III.Reconstruction of the international monetary regime is considered in Section IV, and thearticle concludes in Section V.

II. Renminbi Internationalization

Currency internationalization refers to the process of a specific currency of a sovereigncountry becoming an international currency. International currency plays the role of mediumof exchange, unit of account and store of value in global trade and investment. It can be acurrency of a sovereign country or a regional currency, such as the euro, or a preciousmetal, such as gold.

Zhong (2002) puts forward an idea of combining the process of RMB capital accountconvertibility with that of RMB internationalization. Based on the RMB’s circulation scenarioand characteristics, Li et al. (2004) present the view of RMB “Asianization.” Ma (2004)proposes that, in the short term, the free convertibility of the RMB could be directed andpushed forward by the government, who could intentionally control the pace and directionof the process. However, RMB internationalization is basically a spontaneous processpushed by market demand. Yi (2006) points out that an economic powerhouse cannot giveup monetary sovereignty, and that monetary competition is the most sophisticated form ofcompetition between major economic powers. He suggests that the current sustained tradesurplus should be utilized to push the influence of the RMB both regionally and

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internationally. Ba (2007) points out that RMB internationalization should undergo thethree stages of currency liberalization, regionalization and globalization. Li and Liu (2008)put forward the idea of a dual-track reform. On the one hand, Hong Kong could become aplace for experimenting with overseas RMB internationalization; on the other hand, a capitalaccount convertibility reform, set in a specific direction and in tune with the country’soverall financial reform, such as QFII and QDII, could be carried out in a step-by-step andgradualist manner on the mainland.

In the past, China’s RMB internationalization process has been fettered by four factors.First, China has not fully opened its capital account and the RMB is not freely convertible,which prevents China from popularizing the RMB overseas through its capital account.Second, the RMB’s exchange rate is not free floating and, to a large extent, is subject togovernment intervention. This has held back growth of RMB forward exchange ratetransactions in both overseas and domestic markets and, therefore, has affected thewillingness of overseas individuals and enterprises to hold RMB (because they lack toolsto hedge against exchange risks of holding it). Third, foreign investors cannot invest in thedomestic capital market directly (they can only invest in the domestic B-share stock marketor through the QFII mechanism) and RMB-denominated financial products are lacking inoverseas markets. Both have prevented the RMB from growing into an international reservecurrency. Finally, the Chinese Government has indicated little willingness to push thecurrency’s internationalization.

However, after the US sub-prime crisis evolved into a global financial crisis fromSeptember 2008, the Chinese Government obviously changed its mind and becameenthusiastic about RMB internationalization. Since the end of 2008 until now, the ChineseGovernment has made important headway in two aspects. First, the mainland has committedto a bilateral local currency swap scheme worth a total of RMB650bn with Korea, HongKong, Malaysia, Belorussia, Indonesia and Argentina (See Table 1). Second, China hasaccelerated its pilot programs that use the RMB in cross-border trade settlements. InDecember 2008, a State Council executive meeting announced that pilot programs for tradein goods using the RMB would be launched between the mainland’s Guangdong and theYangtze River Delta and Hong Kong and Macau, as well as between Guangxi and Yunnanand ASEAN. The first batch of cities for RMB settlement of trade was announced at theState Council executive meeting on 8 April 2009, and includes Shanghai, Guangdong’sGuangzhou, Shenzhen, Zhuhai and Dongguan. On 29 June 2009, the People’s Bank ofChina signed a memorandum with the Hong Kong Monetary Authority to authorize the useof the RMB in the bilateral trade settlements.

The bilateral local currency swaps and the RMB cross-border trade settlements aremutually beneficial. For example, when Argentine importers need to pay with RMB to

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purchase Chinese commodities, they can borrow RMB from Argentine commercial banks,which in turn can borrow RMB from the Argentine central bank. The Argentine central bankcan obtain RMB through currency swaps with China’s central bank. Therefore, bilaterallocal currency swaps are, to a large extent, not undertaken by the Chinese and othergovernments as a collaborative measure to tackle the financial crisis. Rather, such currencyswaps are primers for the cross-border trade settlements pilot programs using RMB. Thebest way for the Chinese Government to help other countries cope with financial crises isto sign bilateral dollar swap agreements with them, because RMB cannot currently be usedby those countries to intervene in foreign exchange markets.

Furthermore, bilateral local currency swaps, if undertaken properly, could become achannel for the Chinese Government to retrieve RMB from abroad. For example, after theyreceive RMB as payment for commodities sold to China, foreign exporters can exchangeRMB for local currencies with local commercial banks, which in turn can exchange RMBwith the foreign central bank. Ultimately, the foreign central bank will return the RMB toChina through bilateral local currency swaps with China’s central bank.

The Chinese Government is likely to continue to accelerate RMB internationalizationin the near future. On the one hand, the mainland will engage in bilateral local currencyswaps with more countries and regions, in particular with ASEAN countries such as Thailandand Vietnam, as well as with Taiwan and Russia, which are its important trade partners. Onthe other hand, China will allow more cities to launch cross-border RMB settlement of tradepilot programs, especially those that have close links with ASEAN, such as Kunming andNanning, as well as Tianjin, which is a major financial center of China.

Hong Kong could become a crucial winner in China’s RMB internationalization process.First, the four Guangdong cities that are conducting the RMB settlement of trade pilotprograms are, to a large extent, involved in trade with Hong Kong. Second, Hong Kongitself is an important free port and trade and distribution center in South-East Asia. Third,

Table 1. Bilateral Local Currency Swaps China Has Signed(by May 2009)

Time Signatories Scale (RMBbn)

December 2008 China–Korea 180

January 2009 Chinese mainland–Hong Kong 200

February 2009 China–Malaysia 80

March 2009 China–Belorussia 20

March 2009 China–Indonesia 100

March 2009 China–Argentina 70

Sources: The website of the People’s Bank of China.

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currently, Hong Kong is the place where RMB is most popular outside the mainland andalso the gateway between South-East Asia and the mainland for flow of RMB. Finally, onthe basis of the abovementioned advantages, Hong Kong could become an offshore RMBsettlement center, an offshore RMB forward foreign exchange market as well as an overseasmarket for RMB-denominated financial products. The establishment of an offshore RMBsettlement center would make it possible for the currency to be freely exchanged with anyother currencies. An offshore RMB forward foreign exchange market would help RMBholders ward off risks related to the RMB exchange rate. An overseas market for RMB-denominated financial products would provide more investment opportunities for RMBholders and, therefore, would greatly promote the role of the currency as a major regionalreserve currency. In fact, since June 2007, five mainland financial institutions have issuedseven batches of RMB-denominated bonds in Hong Kong, pooling to a total value ofRMB22bn (see Table 2). This indicates that Hong Kong could potentially become a majorvenue for launching RMB-denominated financial products overseas. Once the three marketsare formally established, RMB internationalization will enter a new stage.

Of course, a loftier goal of RMB internationalization is to make the RMB a currency thatflows freely in and is commonly used by the “Greater China” region, including the mainland,Hong Kong, Macau and Taiwan. Achievement of the goal not only depends on the closerintegration of those economies, but also on the political wisdom across the Taiwan Straitsand thus setting the groundwork will take longer.

Table 2. Renminbi-denominated Bonds Issued in Hong Kong byMainland Financial Institutions (by May 2009)

Issuer Time of issue Scale

(RMB1bn) Maturity Coupon rate Subscription

China Development Bank June 2007 5 2 3.00 1.91

2 3.05 Export-Import Bank of China August 2007 2

3 3.20 1.68

2 3.15 Bank of China September 2007 3

3 3.35 1.78

Bank of Communications July 2008 3 2 3.25 6.80

Export-Import Bank of China September 2008 3 3 3.40 2.75

China Construction Bank September 2008 3 2 3.24 1.81

2 3.25 Bank of China September 2008 3

3 3.40 4.16

Sources: The author’s summary of various media reports.

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II. Regional Currency and Financial Cooperation

Regional currency cooperation, or regional currency integration, refers to the coordinationand cooperation between countries and economies when dealing with matters relating tocurrency and finance, in particular regarding the coordinated implementation of monetaryand exchange rate policies.

Li and Ding (2006) conduct an empirical study of real supply, real demand and monetaryimpact symmetry within the regions of East Asia, the euro zone and the Southern ConeCommon Market economies. The results show that East Asia is capable of further pushingsystemized regional economic cooperation and policy coordination on the basis of existingachievements. Hann and Yuan (2007) use the standard endogeneity model of an optimalcurrency area to verify the bilateral trade and economic correlations between China andother Asian economies, and find that from the perspective of trade, the RMB has been ableto meet some initial prerequisites for currency regionalization.

According to Lou (2004), the monetary and financial cooperation in Asia will proceedin three stages. The first of these will be the formation of an internal liquidity backupmechanism within the region; then will come the formation of a relatively advanced regionalfinancial market, including a currency market and a capital market; and, finally, higher-levelregional exchange rate stability will be achieved before the region ultimately moves towardsbecoming a single-currency zone. A study by Shen (2004) shows that currently neither theRMB nor the yen could become an anchor currency in the region and that the difference inChina and Japan’s industrial structures and their trade complementarity determine that it isin the interest of both countries to promote regional currency cooperation (instead ofcurrency competition) between the RMB and the yen. Gao (2009), however, is cautiouslyoptimistic about the prospects of regional currency and financial cooperation. She concludesthat it is very important to be conscious of the difficulties China faces in figuring out itsregional financial roadmap. Such difficulties include determining how to balanceregionalization and internationalization of the RMB, ascertaining whether a united multilateralexchange rate mechanism can be established under the current “10+3” framework in Asia,and working out how best to tackle factors such as China’s capital account regulation andthe generally fragile financial regime of East Asian economies.

Compared with Europe, Asian countries have more marked differences in economiccycles and structures and they suffer from significant conflicts in history, culture, religionand politics, which makes currency and financial cooperation difficult. Therefore, EastAsian currency and financial cooperation has always been driven by crises. Only criseshave pushed Asian countries to rise above various prejudices to reach consensus. As theeruption of the 1997–1998 financial crisis in South-East Asia prompted the birth of the

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Chiang Mai Initiative, we believe that the global financial crisis in 2008–2009 will push EastAsia currency and financial cooperation up to a new stage.

The Chiang Mai Initiative, signed in May 2000, is a bilateral US dollar-denominatedexchange arrangement created under the ASEAN “10+3” framework, with the view ofmanaging regional short-term liquidity and assisting with other global financial arrangementsor institutions. The main contents of the Chiang Mai Initiative include: first, expanding thescale of the ASEAN Swap Agreement, signed in July 1997, from US$200m to US$1bn, andexpanding the participation of the swap from 5 ASEAN members to 10; second, establishinga bilateral currency exchange network between ASEAN members and China, South Koreaand Japan, which is the core of the initiative (the maximum quota of the bilateral exchangenetwork is decided by both parties and the fund is shared by them); third, establishing abilateral bond repurchase agreement network (a party can use US treasuries or bondsissued by its government as a mortgage to apply for lending from the other party toincrease sources of short-term liquidity). Table 3 shows the bilateral currency swaps theChinese Government has signed under the Chiang Mai Initiative. It has signed bilateralcurrency swaps worth a total of US$23.5bn with other East Asian countries.

Although it has strengthened the ability of countries in this region to cooperate and tocope with financial crises, the Chiang Mai Initiative has two fundamental defects. First, thecurrency swap mechanism is bilateral instead of multilateral, which means the region cannotmake full use of the funds in the currency swaps. Second, the East Asian region lacks anindependent macroeconomy monitoring agency, which means that 80 percent of the fundsin the Chiang Mai Initiative’s bilateral currency swap mechanism are subject to the IMFconditionality of loans. To a large extent, this limits the independent use of the currencyswap funds.

In May 2007, when ASEAN, China, Japan and South Korea held a finance ministers’meeting in Kyoto, Japan, the participating members, upon the suggestion of the Chiang

Table 3. Bilateral Currency Swaps Signed by Chinaunder the Chiang Mai Initiative (by May 2009)

Time Signatories Unilateral or bilateral Scale (US$1bn)

December 2001, expired by December 2004 China–Thailand Unilateral 2.0

March 2002 China–Japan Bilateral 6.0

June 2002 China–South Korea Bilateral 8.0

October 2002 China–Malaysia Unilateral 1.5

August 2003; revised in April 2007 China–Philippines Unilateral 2.0

December 2003; revised in October 2006 China–Indonesia Unilateral 4.0

Source: Gao (2009).

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Mai Initiative multilateralization working task, agreed in principle to choosing a “self-managed reserve pooling arrangement” (SRPA) as a regional multilateral capital rescuemechanism. This marked a major breakthrough by the ASEAN+3 in terms of multilateralizationof the Chiang Mai Initiative. The SRPA has the following characteristics. First, in reality itis not a real fund pool, but a capital commitment by the member countries. Second, the rightof managing the fund still belongs to the foreign exchange management departments ofthose countries. Third, there is no final conclusion as to whether to an independent agencywill be set up to monitor the macroeconomy of member countries and to manage thedistribution of funds during periods of crises.

Since the eruption of the current global financial crisis, the process of East Asian currencyand financial cooperation has accelerated. On 22 February 2009, the finance ministers’ meetingof the “ASEAN+3,” held in Phuket, Thailand, unveiled the Action Plan to Restore Economicand Financial Stability of the Asian Region. According to the plan, the SRPA under theChiang Mai Initiative multilateralization mechanism will be expanded from US$80bn toUS$120bn, 80 percent of which is expected to come from China, Japan and South Korea.Moreover, the meeting advocated the establishment of an independent regional monitoringbody to ensure effective management and use of the cooperative reserve pool and to lowerthe proportion of funds subject to the IMF conditionality of loans. In reality, that independentmonitoring body plus the SRPA have become a rudimental the Asian Monetary Fund.

At the ASEAN+3 finance ministers’ meeting held in Bali, Indonesia on 3 May 2009, theparticipants announced that the regional reserve pooling, which is worth US$120bn, wouldbe completed by the end of this year. Ministers of finance of China, Japan and South Koreareached consensus on the proportion of funding each country would contribute for settingup the reserve pool. According to the consensus, China and Japan would each contributeUS$38.4bn, or 32 percent to the pool, and South Korea would add another US$19.2bn,accounting for 16 percent of the pool. Moreover, the ASEAN members reached a consensusat the 13th ASEAN finance ministers’ meeting at Pattaya, Thailand on 9 April 2009, regardingthe proportion of funding each member should contribute for the regional reserve pooling.Thailand, Malaysia, Singapore, Indonesia and the Philippines would each contribute nomore than 10 percent of their respective foreign exchange reserves, whereas Brunei, Laos,Vietnam, Cambodia and Burma would each add no more than 5 percent of their respectiveforeign exchange reserves.

The East Asian reserve pooling arrangement and the new financial stability action planare interim and systemized measures taken by the East Asian countries to repair the inherentdefect of the Chiang Mai Initiative and to improve the region’s ability to cope with the impactof financial crises. Although the Asian Monetary Fund, proposed by Japan during the South-East Asian financial crisis, went bust as a result of opposition from the IMF and the USA, the

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new arrangement combining the East Asian reserve pooling and an independent regionalmonitoring body is in reality a rudimental Asian Monetary Fund. If the new financial stabilityaction plan can be promptly carried out, the new Chiang Mai Initiative, with an independentmonitoring body, the ability to distribute funds, and which has de-pegged from the IMFconditionality of loans, will encourage East Asian regional currency cooperation and, in turn,drive the deepening of the East Asia regional currency integration.

It is worth noting that China has actively participated in the establishment of the EastAsia bond market, which constitutes part of the East Asia regional financial cooperationinitiative. However, China’s central bank is an important sponsor of the Asian Bond FundsI and II. China is in charge of two working taskforces that promote the Asian bond marketinitiatives. The two taskforces deal with, respectively, credit guarantee and investmentmechanisms, and local currency bond issued by multilateral development banks, foreigngovernment agencies and Asian multinationals. China has also made important headwayby allowing foreign financial institutions to issue RMB-denominated bonds in China, andChinese financial institutions to issue RMB-denominated bonds in offshore financial markets.In October 2005, the International Finance Corporation and the Asian Development Bankissued the Panda bonds, worth RMB1.13bn and RMB1bn, respectively, in China’s inter-bank bond market. As mentioned above, from June 2007 until now, five mainland financialinstitutions have issue seven batches of RMB-denominated bonds in the Hong Kongmarket, amounting to a total of RMB22bn. They have all been oversubscribed, with maturityranging from 2 to 3 years and coupon rates of 3–3.4 percent.

No doubt, it is in China’s interest to promote East Asian regional financial cooperation.The Chinese economy has been deeply involved in the process of East Asian regionaleconomic integration. On the one hand, China is in a unique position in terms of the globallandscape of current account disequilibrium: while maintaining a huge current accountsurplus with the USA, China has a current account deficit with most Asian economies.Moreover, China’s processing trade accounts for as much as 54.6 percent of its total trade,whereas approximately 60 percent of trade within East Asia comes from China (Gao, 2009).Deepening currency and financial cooperation in East Asia is conducive to enhancingChina’s influence in East Asia, and will improve the status of the RMB in the region andfurther drive the region towards becoming an optimal currency area.

The rivalry between China and Japan for leadership in the process of East Asiancurrency and financial cooperation is an important factor affecting China’s deeperinvolvement in the process. For example, in terms of fund contribution to the East Asiareserve pool and voting rights, both China and Japan have the power to lead the initiative.How best to design the fundraising ratio and voting mechanism of the East Asian reservepool and the future Asian Monetary Fund will become key elements determining whether

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the East Asian currency and financial cooperation fare well.

III. Reconstruction of the International Monetary Regime

Since the collapse of the Bretton Woods system in the 1970s until now, the US dollar hasinherited the role of reserve currency in the international monetary regime. The systembased on the Jamaica Accord is also referred to as the Dollar Standard. Since the beginningof the 21st century, the most serious problem of the dollar standard has been global imbalance.It is evident in the consistent current account deficit of the USA as well as in the continuedcurrent account surplus of East Asian countries and resource-exporting economies. Aconsistent current account deficit will lead to rising net external debt owed by a countryand once the net external debt exceeds a limit, the currency of that country will face significantdepreciation pressure. Hence, an international monetary system based on that country’scurrency will become unsustainable.

Zhang (2007) analyzes the three potential adjustment roadmaps for global imbalance.One is where the financial market leads the adjustment (i.e. the East Asian countries asforeign investors will take initiatives to adjust the dollar asset portfolios). The second iswhere countries with current account surpluses appreciate their currencies en masse underthe pressure of the USA (i.e. through a new plaza accord). The third is where all countriesreach a substantial consensus on a cost-sharing mechanism so that they adjust theirdomestic policies in a pro-active way. The first scenario is the worst, while the third is theideal for both the surplus countries and the deficit countries. However, since the eruptionof the sub-prime crisis, we have not seen the USA or China actively adjust their respectivedomestic structures. The global imbalance might not improve following the end of thefinancial crisis. The future evolution of the global imbalance remains uncertain.

Compared with previous international monetary systems (the Gold Standard and the BrettonWoods system), the biggest loophole of the existing international monetary system is the lackof a check and balance mechanism governing the amount of currency issue by the countrywhose currency acts as reserve currency. Under the Bretton Woods system, the limit on dollarissue is the dollar’s peg to gold and once dollar issue exceeds the limit, other governments andinvestors would exchange the dollar for gold from the US Federal Reserve. However, this checkand balance mechanism is non-existent in the Jamaica Accord system, in which currency of acertain country becomes global (reserve) currency. Under such a system, because of the lack ofa mandatory constraint on the excessive issue of currency, excess liquidity in the global monetarysystem and the boom–bust cycle of asset prices have become normal.

Since the late 1990s, the global imbalance has worsened. The USA’s consistent currentaccount deficit has led to its continually rising net external debt. However, because of the

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importance of dollar assets in the investment portfolio of international investors, globalforeign exchange funds have flowed back to the USA through purchase of the country’sfinancial products, which has nevertheless put off the US adjustment of its current accountimbalance (Yu, 2009). However, the eruption of the sub-prime crisis has dampened confidenceof global investors in US financial products. In addition, the bail-out by the US Governmentsince the eruption of the crisis has triggered investors’ concerns of mid-term to long-termdollar depreciation. If the dollar slumps, China, the number one creditor of the USA, willincur huge losses from the dollar assets in the foreign exchange reserves.

Against that backdrop, Zhou Xiaochuan, the Central Bank Governor of China, publishedhis article Reflections on Reforming the International Monetary System ahead of the G20Summit in London (Zhou, 2009). It marks the first time that the Chinese leadership hasrevealed an explicit attitude towards the direction of the international monetary systemevolution and, therefore, has aroused great attention from the international community.

In the short term, the advocacy of reforming the international monetary system byZhou was to increase China’s bargaining power and put it in a more advantageous positionin the G20 London summit. In the mid-term, the Chinese Government has expressed itsconcern about the loose monetary policy of the USA, especially the move by the FederalReserve to directly purchase US treasury bonds, which increases the possibility of inflationand dollar depreciation in the mid-term and long term, and will endanger China’s colossalamounts of foreign exchange reserves. In the long term, China, as an important role modelof the emerging market economies and developing countries, has pointed out a directiontowards which the international monetary system could evolve in the future and has provideda series of feasible policy suggestions for making headway in that direction.

Zhou’s article points out that the Triffin Dilemma would not be solved so long as thecurrency of a certain country is used as global reserve currency, because the issuing countrycannot strike a balance between satisfying domestic monetary policy goals and meeting theneeds of global economic growth. The root cause of the current sub-prime crisis was theexcess liquidity across the world as a result of the relaxed monetary policy of the USA. Theglobal excess liquidity, in turn, pushed down the long-term interest rate of the US financialmarket, which led to rare real estate and derivatives bubbles. Therefore, “although crisis maynot necessarily be an intended result of the issuing authorities, it is an inevitable outcome ofthe institutional flaws.” If the Gold Standard system is set to bring deflationary pressure, thedollar-based system is set to bring inflationary pressure. A super-sovereign internationalreserve currency must be created to solve the Triffin Dilemma from the root.

Zhou suggests that in the short term, the issue scale and circulation scope of SpecialDrawing Rights (SDR) should be expanded to reduce the dependence of the world on the USdollar. The following measures could be taken to facilitate the SDR proposal. First, the currency

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basket of the SDR could be expanded to include currencies of emerging economies, led by theRMB (currently only the dollar, the euro, the pound and the yen are in the basket). Second,the use of SDR in pricing international trade, commodity and investment and corporateaccounting could be encouraged. SDR could also be considered in calculating the marketvalue of a country’s foreign exchange reserves. Third, the use of SDR could be expanded inglobal trade and investment. This means that SDR could not only be used in settlementsrelated to governments or international organizations, but in cross-border settlements by theprivate sector. This not only means that the SDR issue would be expanded significantly, butwould require the distribution of SDR to be more equitable so that those countries that needmore liquidity can obtain more SDR. Fourth, the attractiveness of SDR as a reserve currencyshould be enhanced by launching SDR-denominated financial assets; for example, the IMFcould issue bonds for financing using SDR as a pricing medium. Finally, the IMF could set upopen-ended funds using SDR as a pricing tool and its members could use their foreignexchange reserves (e.g. the US dollar) to purchase the funds freely (Zhang, 2009).

Of course, it might take a long time for a super-sovereign reserve currency to replacethe dollar. Although the sub-prime crisis has weakened the dollar, most of the competitivecurrencies have also been weakened. Therefore, replacing the dollar as a global reservecurrency would be a gradual and long-term process. According to Huang (2009), the currentfinancial crisis could become an important watershed in the development of the dollar.After the crisis, the dollar might no longer be so dominant. However, there is not yet anyequally powerful currency to compete with the dollar.

We believe that multi-polarization will characterize the future development of internationalmonetary system; that is, the dollar, the euro and a regional Asian currency might share therole of global reserve currency. A multi-polarized reserve currency, in nature, would introducea new competition mechanism for issuing countries. If there is too much dollar value issued,global investors might shift to euros and the “Asian yuan,” which would detrimentally affectthe USA. The introduction of a competitive mechanism will constitute a new disciplinaryconstraint on issuing countries, while the multi-polarized international reserve currency willfit into the developmental trend of the world economy and international trade.

Although reforming the international monetary system is a long-term and tough taskand might not solve the many problems that China’s economy is facing, China will still playan active role in the global efforts to reform the international currency and financial systemcentered on the platform of the IMF.

IV. Conclusion

The Chinese Government is pushing for RMB internationalization, regional currency and

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financial cooperation and the reconstruction of international financial system, and has madesome headway on each front. However, the reconstruction of the international monetarysystem requires global consensus and collective actions, and regional currency and financialcooperation needs regional consensus and collective actions. In contrast, RMBinternationalization can be pushed directly by the Chinese Government, which only needs tonegotiate with its trade partners. Moreover, because China has a trade deficit with most EastAsian countries, it has a sound foundation for pushing RMB internationalization. Therefore,RMB internationalization in the near future has become a priority of the Chinese Government.

Does conflict exist between RMB internationalization and regionalization? RMBinternationalization is a unilateral move, whereas for regional monetary cooperation, Chinaneeds to cooperate with several countries, including Japan. It is true that China can onlychoose between RMB internationalization and regional monetary cooperation in the future.However, we believe that RMB internationalization and regionalization could benefit fromeach other. If the RMB becomes a trade settlement currency in the East Asian region, China’srole in East Asian regional financial cooperation will be enhanced. China’s participation inregional currency and financial cooperation will also help to further push the establishment ofan RMB offshore settlement center and an overseas RMB-denominated bond market. Interms of the RMB’s internationalization, the following models could be applied: the dollarmodel (unilateral internationalization), the deutsche mark model (merging into regional currencyand financial cooperation and fading out) and the pound sterling model (first participating inEuropean currency cooperation and then withdrawing from the European Monetary System).At this stage, there is no hurry to choose between these models.

Therefore, given the current situation, China should push for RMB internationalization,a regional currency, and financial cooperation and reconstruction of the internationalmonetary system in a coordinated manner, despite the various obstacles.

References

Ba Shusong, 2007, “ Three stages of renminbi internationalization,” Xinjingbao (The Beijing News),6 July. Available from: http://finance.sina.com.cn/economist/jingjixueren/20070620/10373707810.shtml.

Gao Haihong, 2009, “China’s role in Asian regional financial cooperation,” Guoji Jingji Pinglun(International Economic Review), No. 3, pp. 25–33.

Han Minchun and Xiulin Yuan, 2007, “Renminbi regionalization: A trade perspective,” JingjixueJikan (China Economic Quarterly), Vol. 6, No. 2, pp. 401–20.

Huang Yiping, 2009, “Evolution of international monetary system and renminbi internationalization,”Guoji Jingji Pinglun (International Economic Review), No. 3, pp. 20–25.

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Li Daokui and Linlin Liu, 2008, “ Pushing renminbi internationalization on a dual track, ” Center forChina in the World Economy, Tsinghua University. Available from: http://www.ccwe.org.cn/journal/9/17.pdf.

Li Xiao and Yibing Ding, 2006, “Economic impact symmetry and regional economic cooperation: Acomparative study of East Asia and other regions,” Jilin Daxue Shehui Kexue Xuebao (JilinUniversity Journal Social Sciences Edition), Vol. 46, No. 4, pp. 46–58.

Li Xiao, Junjiu Li and Yibing Ding, 2004, “On ‘Asianization’ of renminbi,” Shijie Jingji (Journal ofWorld Economy), No. 2, pp. 21–34.

Lou Jiwei, 2004, “Global economic imbalance and Asian regional currency and financial cooperation, ”[online; cited June]. Available from: http://www.china-inv.cn/include/resources/luojiwei.pdf.

Ma Ce, 2004, “Pay more attention to renminbi internationalization,” Duiwai Jingmao Shiwu (Practicein Foreign Economic Relations and Trade), No. 1, pp. 8–9.

Shen Guobing, 2004, “Yen and yuan: Regional currency cooperation or competition,” Caijing Yanjiu(Journal of Finance and Economics), No. 8, pp. 28–39.

Yi Gang, 2006, Renminbi: The First Strategy to Promote Peaceful Development [online; cited June].Available from: http://finance.sina.com.cn/economist/jingjixueren/20061214/17213165502.shtml.

Yu Yongding, 2009, “Avoiding dollar trap and pushing international monetary system reform,”Caijing (Caijing Magazine), No. 8. Available from: http://magazine.caijing.com.cn/2009-04-12/110140479.html.

Zhang Ming, 2007, “Adjustment of global international payment disequilibrium and its impact onChinese economy,” Shijie Jingji yu Zhengzhi (World Economics and Politics), No. 7, pp. 75–80.

Zhang Ming, 2009, “China says “No” to dollar standard,” Nanfang Zhoumo (Southern Weekly),April 9. Available from: http://www.infzm.com/content/26664.

Zhong Wei, 2002, “Brief study of renminbi internationalization process,” Shijie Jingji (Journal ofWorld Economy), No. 3, pp. 56–58.

Zhou Xiaochuan, 2009, “Thought on reforming international monetary system,” [online; cited June].Available from: http://www.pbc.gov.cn/detail.asp?col=4200&id=279.

(Edited by Xiaoming Feng)