The article first appeared in the International Monetary Review, October 2022, Vol.9, No.4.

Jaya Josie, member of IMI International Committee, Visiting Professor of Zhejiang University International Business School.

While the current geopolitical crisis and the threat of sanctions against China may seem like an opportunity to raise the issue of the internationalization of the Renminbi. However, this climate of war in Europe and sanctions, and the threat of more US and European sanctions against the China provides an ideal opportunity to review the progress of the internationalization of the Renminbi. The currency disputes between the Renminbi, US Dollar and the Euro can be traced back to 2002 after China formally joined the World Trade Organization (WTO). The 2002 Sixteenth National Congress of the Chinese Communist Party (CCP) made several decisions for further economic reforms. Among other decisions these included lowering tariffs as a way to stimulate the economy and promote export growth. In this period there was great pressure on China to compensate for the increasing trade deficit faced by the USA. China made some adjustments but the problem persisted and the USA became more aggressive in trying to pressurize the People’s Bank of China. These pressures eventually led to the CCP deciding to take proactive positions on the issue of the Renminbi.

In China’s 13th Five Year Plan (2015) for the period 2016 to 2020 there was a commitment to promote the internationalization of the Renminbi (RMB). One of the key reasons for the internationalization of the RMB was to avoid falling into the US monetary policy trap of dollar shortages and lowering borrowing costs. Furthermore from 2006 there was extreme pressure for China to lower the value of its currency so that the USA could avoid a growing trade deficits with China. Thus a key reason for the internationalization of the RMB was an attempt to avoid US monetary policy obstacles, such as shoring up against dollar shortages, and gaining lower borrowing costs. In the ten years from 2009 to 2019 almost 20 trillion yuan was exchanged across borders although this amount only made up 2% of global foreign reserves. To promote the internationalization of the RMB China met all the preconditions to becoming an international reserve currency. China’s currency was now backed by a large economy; it had a high global trade volume, and net creditor status with its international investments being larger than its foreign debt. These preconditions were strengthened by China’s membership of the WTO.

Despite China’s advantageous economic position, the US dollar and the Euro still have foreign currency hegemony because foreign investors and traders still prefer to use the US dollar. This maybe because the use of China’s currency is governed by rule of law and the perception that its economy is too tightly controlled by government. What, then, is China’s path to an internationally formidable RMB? For the BRICS group, emerging and developing economies there is still preference for the use of the Dollar and the Euro for financial transactions despite the high rate of volatility of these currencies in the foreign exchange markets. In such a scenario the internationalization of the RMB for use as a reserve currency may eventually present with the same dilemma and instability as the US dollar and the Euro are currently facing in world markets today. In this article we briefly discuss the dilemma and instability of using a reserve currency for international transactions and we propose an alternative to mechanism for international payments and transactions.

In 22-23 March 2017 (Josie, 2017), we presented, in a paper, the possibility of using an alternative means of international payments for BRICS, developing and emerging markets to mitigate the risks of high volatility in foreign exchange markets. We argued that following the 2008 global financial crisis two consequences emerged for BRICS and developing and emerging market economies (DEME); volatile international capital flows and recognition of the risks of dollar dependence in trade & growth. In addition, we argued, that there was the real risk of the reemergence of the so-called Triffin’s Dilemma due to the increasing evidence of the financialization of the global economy & low productive investment. Triffin’s Dilemma is a well known paradox developed in the 1960s by Robert Triffin. Although the paradox initially related to the capital account of international transactions other monetary economists argue that the paradox has become prevalent in the current account and is now ubiquitous in the financial markets because of the increasing financialization of the global economy and the lack of regulation in exchange controls as was advocated by Triffin (Faudot 2022).

The paradox of the Triffin’s Dilemma as applied to the US dollar can best be explained in the following way; if the USA stops issuing US dollar balances for international finance this will lead to global stagnation and deflation; on the other hand, if the USA continues to issue more US dollars as an international reserve, the US dollar risks losing confidence in the currency (Rojas, 2016). In a more recent article Faudot (2022) suggests that Triffin in the 1960s highlighted the unsustainability of the Bretton Woods international monetary system because the world economy uses a national currency for international settlements, however, the national economy issuing the reserve currency for international settlements must record a balance of payment deficit. This arrangement is unsustainable in the long run as the external accounts of the issuing country will gradually deteriorate and undermine the confidence in its currency and create global volatility perturbations. The definition of the balance of payments implies that it cannot be in deficit as deficits have to be always financed. In the USA conventionally, the deficit is represented by the sales from the US gold stock, additions of foreign dollar balances and other liquid claims on the USA (Faudot, 2022). The global economy is caught between the need to end the balance of payment deficits and the need to provide the world economy with an international reserve currency.

According to Faudot (2022) Triffin’s work is more than just about this paradox. Triffin’s thesis goes to the heart of exchange control policy. Fuadot (2022) argues that Triffin advocated for effective exchange control policies as a way of overcoming the paradox. Although exchange control policy is essential in controlling money supply, used as a reserve currency for international transactions Triffin’s work also exposes the shortcomings of exchange control policies in the internationalization of reserve currencies. Today in China the internationalization of the RMB and its use for international transactions risks presenting a similar dilemma that the US dollar and the Euro is experiencing.

The current conflict in Europe is already putting the EU in general, and Germany in particular under great strain. In a recent essay in the Monthly Review Online (Posted Oct 08, 2022) Michael Hudson (2022) asks the question What will happen to the Euro without Germany? The author paints a gloomy picture for Germany following the blowing up of the Northstream Gas pipelines and the possibility of Germany having to pay Russia for gas that it cannot receive. According to Hudson (2022) the next decade will be a disaster for Europe as the strength of the Euro was based upon Germany’s industrial exports. The Euro was the mechanism that helped Germany avoid an export surplus and price its goods and services out of world markets. Now with sanctions against Russia raising the prices of imported gas, oil, aluminium and fertilizer and, as industrial production requires higher energy this will likely mean declining Euro value against the dollar and a squeeze on multinational profits. In this scenario what is the alternative for emerging markets and the developing world for coping with the rising cost of living and exchange rate instability? Our paper (Josie, 2017) was an attempt to propose an alternative approach for the BRICS group and developing and emerging economies.

In the paper (Josie, 2017) we argued that the international finance system can’t keep pace with changes in the developing world. Short-term capital flows transmit instability and fails to provide liquidity management to deal with volatility. In cross-border transactions there is a shortage of good quality safe assets. Furthermore, US$ dominance limits the ability to mitigate capital flow volatility, credit or legal risk to strengthen the liquidity safety net for developing countries. In addition the IMF’s financing with liquidity-driven balance of payments contingencies did not achieve its intended objectives. In such a context the BRICS should have considered the feasibility of its own mechanisms for settling financial transactions and removed the necessity for payments in two-way foreign exchange trades via the US$. In 2017 and beyond BRICS cooperation between China and Russia grew substantially through using own currency settlements as two-way trade increased and negotiations on a package of currency swaps began. China promoted the use of RMB and investment via the China-Russia Investment Fund targeting greenfield investment, equity investment, bond issuance, mergers & acquisitions.

In the paper (Josie, 2017) we suggested that BRICS should move to a more multilateral functional development approach to trade, integrating value chains, and include services to advance intra-BRICS economic cooperation. Multilateral financial cooperation in a time of crisis requires systemic liquidity management tools to deal with extreme episodes of volatility. The BRICS and developing economies could consider their own currencies for financial relationships. Developing and emerging economies in general could consider swap arrangements for supporting liquidity to move away from a unipolar currency dominance towards a multi-currency world. As more and more developing and emerging economies are joining the BRICS New Development Bank (NDB) the CRA mechanism could be strengthened using gold reserve commitments. One option that developing and emerging economies may wish to consider is the adoption of using the RMB as an international reserve currency for financial transactions. However, China is wary of the risk that an international reserve currency may also fall into the trap of the Triffin dilemma. In view of this risk China is seriously considering moving towards using multiple Central Bank Digital Currencies (mCBDC) for international financial transactions. China, India, and Russia have already started piloting retail CBDC platforms for transactions. While this system is being developed BRICS and, developing and emerging markets could deepen financial integration and introduce instruments such as collateralised lending arrangements and credit rating systems to mitigate credit risks.  

Bibliography:

Faudot, Adrien, July 2022, Robert Triffin and the Case for Exchange Controls, Cahiers d’economie Politique/Papers in Political Economy n° 81(2):163-189, University of Grenoble

Josie, Jaya., (2017); Paper BRICS Finance: Multilateral Cooperation in a Time of Crisis, BRICS Think Tank Forum of Financial Cooperation, Beijing

Rojas, Pierre-Hernan 2016; “Triffin Dilemma and Regional Monetary Approach: An Appraisal”, Working Papers Ideas, hal-01298999

Hudson, M, 2022; Michael Hudson on The Euro Without Germany MROnline, Monthly Review; Monthly Review Essays; posted 08/10/2022; https://mronline.org/2022/10/08/michael-hudson-on-the-euro-without.