Welcome to the multicurrency reserve system
Renminbi’s dollar depegging: Beijing’s worst-kept secret
by David Marsh
Mon 11 Jan 2016
Sorry about the mild panic on stock markets – so what else is new? – but financial practitioners and observers should really get wise about the renminbi. The fundamental point about the International Monetary Fund’s approval last year for the renminbi to enter the special drawing right is that the Chinese currency should not, and will not, be pegged directly to the dollar.
The writing has been on the wall for some time. Clearly, if the Chinese authorities want – as they certainly do – the renminbi to become a reserve currency, it cannot be equivalent to the dollar. If it was, there would be no point in the currency entering the SDR. A move towards dollar depegging has been the worst-kept secret in Beijing for years.
So there is no reason for the exaggerated fuss now the Chinese authorities have decided to keep the currency stable against a basket of 13 trading partners rather than the greenback.
This is all part of a move towards the much-trumpeted multicurrency reserve system, in which a batch of currencies will be competing for status and value vis-à-vis the dollar.
Markets are digesting, too, the perfectly predictable (and predicted) likelihood that Chinese growth will slow. A senior Chinese official has just told us something blindingly obvious – that the country will struggle to achieve economic growth above 6.5% between 2016 and 2020.
International stock markets have had a torrid start to the year, but it should have been fairly clear they were heading for a correction. A member of the European Central Bank executive board in April 2013 said that German equities were in bubble territory. Since then the German market (aided by the weak euro and ECB asset purchases) has moved 20% higher.
An OMFIF report on the renminbi and the multicurrency reserve system in January 2013 noted that ‘after six years of gradual appreciation against the dollar – amounting to 30% in nominal terms since 2005, as part of China’s modification of the currency peg – the renminbi no longer seems fundamentally undervalued against the dollar. For much of this period, markets treated the renminbi as a one-way bet. However, over the course of 2012 and 2013, repeated periods of slight weakness indicated that this view could have to change.’
The Chinese authorities have made clear that the currency can move down as well as up. Massive accruals of foreign exchange reserves have tailed off and given way to outflows, in line with China’s own perception that holding official reserves of more than $3tn was excessive.
Essentially, China is aiming for a system under which barriers between pools of renminbi on onshore and offshore markets are slowly dismantled – an aim that latest turbulence has hindered.
As part of China’s catch-up with the West, the State Council, the People’s Bank and other agencies are learning the rudiments of running an international currency. But the West needs to guard against hubris or arrogance. Pivotal moments in the history of reserve currencies backed by centuries of capitalist development – Britain’s departure from the gold standard in 1931, the US break with gold in 1971, drastic US monetary tightening after 1979 or Germany’s disruptive policies on the D-mark in the European post-1990 currency upheavals – are hardly models of smooth management.
All the same, Beijing’s assumption of reserve currency status is fraught with unique hazard. Never before has either a developing country or a Communist-run state won a seat at the top table of world money – and China is both.
In the past 30 years, the world has seen sizeable increase in reserve holdings, far-reaching trade and investment globalisation, the rise of emerging market economies, and the spread of financial markets linked by instant communications.
As a result, a far greater weight of global capital is jostling to find a home across a great variety of time zones in a much broader variety of instruments. Reaching a steady equilibrium will take time – and this is what the multicurrency reserve system is all about. Fasten your seatbelts! The transition will not be orderly.
Note: the evolution of the multicurrency system has been on OMFIF’s agenda since it was established in January 2010. One of the first analyses was by David Marsh in the Financial Times in August 1979 (see enclosed facsimile).
David Marsh is Managing Director at OMFIF.
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