The People’s Bank of China (PBOC) is in a bind. On the one hand, the country’s leadership wants to make the yuan a global currency by 2050, replacing the dollar as the world’s preferred reserve currency and primary medium for world trade. On the other hand, China remains very much an export-oriented economy that needs low production costs to sustain its prosperity. The first of these goals would tend to bid up the yuan’s value, but the second need demands a cheap yuan to help hold down the cost of everything Chinese to the rest of the world. The inherent contradiction imposes on the PBOC quite a balancing act between keeping the yuan cheap for immediate economic needs and boosting its value to serve Beijing’s longer-term ambitions for it.
Leadership in Beijing is aware of the problem. To facilitate the long-term ambition, they plan to free China of its reliance on a cheap yuan by shifting the focus of the economy from exports to domestic spending. They are also aware that a global yuan will require a vast expansion of China’s financial system and its associations abroad. Beijing has taken steps on both these fronts. On financial enlargement, Beijing has launched what it calls the “dual-currency plan.” To be sure, China has long had a strange, two-track approach to currency, with one part for foreign transactions and another for domestic transactions. But this “dual-currency plan” gets to something more fundamental. According to PBOC’s former Deputy Governor Hu Xiaolian, the plan, despite its name, would build a “multi-tiered” capital market in China with links to domestic needs as well as overseas markets. It would, she said, be the largest, most active financial market in the world. Given China’s relatively small and inactive financial markets at present, this is an impressive ambition, even with a 30-year time horizon.
All these plans clearly recognize what China needs to do to set the yuan up as it wants, but the effort promises to be significantly more difficult than party functionaries seem to think. It would be tough enough, though not impossible, for China to re-orient its economy and build the financial system of which Hu dreams. But to put the yuan on top as Beijing wants, China would also have to engineer a complete re-alignment in long-established and deeply entrenched practices among the world’s central banks, traders, and businesses.
First, take the extensive financial links envisioned in the “dual-currency plan.” Such a network would require considerably more openness and transparency than Beijing has allowed to date. Indeed, Beijing’s insistence on control and secrecy has thwarted financial development to date. It has kept foreign financial firms and their expertise out of China, except under very select circumstances. It left the country’s financial sector largely in the hands of the state-owned banks and accordingly small and backward relative to the rest of that economy, much less the rest of the world’s developed nations. No doubt Beijing could change policy, and it has begun to loosen some of the strictures against foreign financial ventures. But the envisioned buildup of China’s financial sector, a huge task in any circumstances, will be that much more difficult because it would require from Beijing an unlikely shift away from its seemingly systematic insistence on secrecy and control.
Re-orienting the economy away from its dependence on exports and toward a domestic growth engine will probably be easier for Beijing’s controlling culture, but it will be far from easy. The shift will have to proceed according to a delicate balance. At each stage, the economic benefits to the domestic growth engine that a rising yuan would produce by increasing the wealth and global buying power of Chinese consumers and domestic businesses would have to more than offset the export setback of such a currency move. Making the prospective shift that much more difficult are other plans coming out of Beijing, such as the vaunted “Made in China 2025” that by seeking global production dominance in biotech, artificial intelligence, aerospace, and electric vehicles, among other products, will look to exports and so also want a cheap yuan.
Evidence of the difficulty is clear in a recent PBOC decision. The yuan has risen more than 10 percent against the dollar since last May. Worried over exports, the authorities have expressed concern about sustaining export flows. The Bank, which well knows that a yuan rise serves Beijing’s global ambitions for the currency, has nonetheless bowed to immediate needs. To prevent the yuan from rising farther and hopefully push down its value, the PBOC has, among other things, raised the amount of foreign reserves banks must keep on deposit with it. That will force these banks to sell yuan to buy dollars, euros, yen, and the like and so force down the yuan’s value next to these and other currencies. Exports will benefit, as will the “Made in China 2025” plan, but the action nonetheless sets back the longer-term ambition to seat the yuan as the world’s reserve currency.
Harder still will be the task of altering the world’s trading and financial habits. Beijing has worked to do this. It has established the Asian Infrastructure Bank as a counterweight to dollar-based international lenders, such as the World Bank. It has insisted when it can that import-export contracts denominate their provisions in yuan. But these efforts have only succeeded when China is the dominant party in the deal. Otherwise, much global trade and banking has continued as before with a dollar focus. According to IMF (International Monetary Fund) figures, the dollar dominates some 88 percent of all foreign exchange transactions. The next closest currency is the euro at 32 percent. To be sure, the proportion of trades in the dollar has declined marginally over the years, but the prominence is nonetheless clear. Similarly, some 80 percent of all import-export transactions are denominated in dollars, whether an American is a party to the contract or not. Dollars constitute some 60 percent of all reserves held by the world’s central banks, including the PBOC. The next most used currency is the euro at 20 percent. Here, too, the degree of dollar dominance has declined marginally from the past, but still the dollar remains prominent. Things can change, but the state of affairs nonetheless suggests that Beijing’s 30-year horizon is a tight one.
China’s goals are plausible. Though the country’s demographics give reason to doubt future rapid growth, China’s economy is nonetheless huge, and its financial potential is prodigious. Its authoritative system has the ability to move faster than most market-oriented economies, though, as should be clear, some of those authoritative aspects of China’s system will work against this effort to boost the yuan’s role, not the least because it runs at cross purposes to other goals, such as the “Made in China 2025” effort or Beijing’s reluctance to relinquish even modest amounts of control or grant even a little transparency. But if the goals are plausible, that is all they are. Likelihoods suggest that China’s plans for the yuan, if they ever come to fruition (and that is a big “if”), will do so only over a much longer time horizon than Beijing has included in its plans.
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