With reference to the global role of the dollar, I decided to go through reading the Eichengreen white paper, the remainder of which focused on the sorry state of the euro and the rapid yet confusing rise of the renminbi.
The euro-matter is predictable enough, for what can be said about the euro that hasn't already been said enough? Essentially, when the very existence of a currency is oft called into question, what hope can there be for a more 'global' role?
But Eichengreen is wise about this and instead of dwelling on the myriad of problems plaguing the euro, he looks to the future.
If anything, the EZ crisis illustrated the difference between the US and the Euro bond markets. When european governments at one point looked to the east for funds, there was naturally a sense of indifference and lack of desire from most central banks and sovereign funds.
In fact, Li Diaoku a Chinese monetary policy committee member in the PBC stated, "The last thing China wants is to throw away the country's wealth and be seen as just a source of dumb money".
Words indeed!
But what if the Euro survives and emerges with reparable scars? What if public finances stabilize, economies start growing and labour conditions improve? What if Germany takes the high road because:
1) For every inept borrower (south), there is an inept lender (north)
2) German exports (automobiles, machinery etc.) have benefited enormously from sharing the same currency as other Southern countries - a competitive exchange rate has been an integral factor in their economic renaissance
3) The shock of a euro abandonment - bond dumping, capital flight, bank runs etc and the accompanying contagion effect that could knock over economies like dominos (think east-asia '97)
4) The ideal of European integration would be severely undermined if the euro doesn't survive.
If the euro's flaws are fixed and tough decisions are made, we might have some essential systems in play such as centralized regulation, a common deposit-insurance scheme - i.e: a legitimate banking union. Perhaps if debts are partially guaranteed there might be some semblance of a pseudo yet effective fiscal union.
Eichengreen quotes Jean Monet, who famously stated that, "Europe is forged in crises, and will be the sum of the solutions adopted for those crises".
And while historically that may be true it doesn't change one crucial part - There are solutions, the challenge is to apply them.
Everyone would love to cling to the safe knowledge that Europe will do what is necessary to save the union but the longer the delay, the lesser the chances. It's a long, dreary road ahead.
--------------------
The renminbi, on the other hand, has been on an opposite trajectory. China's implementation of the trilemma is simple - independent monetary policy and a severely restricted capital account by which they can keep the renminbi pegged to the dollar. While that does wonders for export-driven growth it cannot be a model for a reserve currency. And this leads us to its internationalization. Invariably, minor measures to liberalize capital flows cannot lead to a coherent globalization of the currency. Barriers have to be broken and flexibility needs to be induced. Eichengreen mentions a few instances from policy makers in China:
- In August 2010, a pilot scheme was introduced that allowed select offshore FI's to invest in China's bond market using renminbi funds
- In 2011, regulators permitted offshore renminbi to be used by investors i the Chinese stock market.
- In early 2012, HM Treasury and the Hong Kong MA agreed to permit the trading of offshore renminbi in London.
The key, as he argues, is the private financial market and their adoption of the renminbi. This will lead to central banks diversifying their reserves and participating in bilateral swap agreements (eg. the Chiang Mai initiative). And so there exists a broad step-by-step framework from China's perspective:
Use in invoices and trade transactions -> facilitate use in a range of international financial transactions -> encourage its adoption as a reserve currency.
The problem is this (both charts are for China):
The trading volume has grown extremely fast but the size has stabilized and is in slight decline. Moreover, if the outstanding stock is rapidly growing, the trading volume fails to provide a good enough measure of liquidity. A more relevant metric is the turnover ratio, which is basically the ratio of the value of the bonds traded and the average outstanding amount of bonds; and China's bond turnover ratio for government debt is extremely low.
The Chinese economy is enormous, but it's bond market isn't. Even without comparison to the US, it is neither deep enough nor liquid enough to complement a global role of the renminbi. Moreover, most of the bonds of the government and corporations are held to maturity (hence not actively traded) which leads to an extremely low turn-over and the fact that it won't take a large transaction to affect prices.
Inevitably, China cannot proceed without real reform. If the renminbi has to be accepted in a more international role, these are a few steps that must be implemented:
1) Capital account liberalization and hence the halt of dollar-pegging - a willingness to accept the inability to keep the renminbi artificially low and provide an export boost.
2) Bank reform, so that foreign investors can place deposits freely in Chinese banks and banks are no longer directed towards lending to local governments for projects, or to property developers in order to achieve construction objectives.
3) A more liberal corporate environment and strict implementation of law and property rights.
Point 1) is the anti-thesis to the Chinese growth-model. Dependence on exports, a monitored and pegged renminbi, and bank lending that can be adjusted and directed to whims and wills all have to be eroded and erased for the currency to be accepted.
Essentially, as Chinese policy makers have often claimed, the economy needs to be rebalanced. In a fragile, post-crisis world characterized by dampened external demand, this could be much required by removing significant vulnerabilities of the export sector to global shocks and externalities.
Eichengreen's view is that such a monumental paradigm shift in theory, even if accepted, will not happen overnight - which is why the dollar is the only alternative on the table even though the renminbi is fast catching up and the US fiscal doldrums might exacerbate such a process.
Even if those statements hold some truth, it is still immensely difficult to dislodge an incumbent for poor performance when the alternative either isn't ready or isn't up to the mark - just look to the US presidential race!
The euro-matter is predictable enough, for what can be said about the euro that hasn't already been said enough? Essentially, when the very existence of a currency is oft called into question, what hope can there be for a more 'global' role?
But Eichengreen is wise about this and instead of dwelling on the myriad of problems plaguing the euro, he looks to the future.
If anything, the EZ crisis illustrated the difference between the US and the Euro bond markets. When european governments at one point looked to the east for funds, there was naturally a sense of indifference and lack of desire from most central banks and sovereign funds.
In fact, Li Diaoku a Chinese monetary policy committee member in the PBC stated, "The last thing China wants is to throw away the country's wealth and be seen as just a source of dumb money".
Words indeed!
But what if the Euro survives and emerges with reparable scars? What if public finances stabilize, economies start growing and labour conditions improve? What if Germany takes the high road because:
1) For every inept borrower (south), there is an inept lender (north)
2) German exports (automobiles, machinery etc.) have benefited enormously from sharing the same currency as other Southern countries - a competitive exchange rate has been an integral factor in their economic renaissance
3) The shock of a euro abandonment - bond dumping, capital flight, bank runs etc and the accompanying contagion effect that could knock over economies like dominos (think east-asia '97)
4) The ideal of European integration would be severely undermined if the euro doesn't survive.
If the euro's flaws are fixed and tough decisions are made, we might have some essential systems in play such as centralized regulation, a common deposit-insurance scheme - i.e: a legitimate banking union. Perhaps if debts are partially guaranteed there might be some semblance of a pseudo yet effective fiscal union.
Eichengreen quotes Jean Monet, who famously stated that, "Europe is forged in crises, and will be the sum of the solutions adopted for those crises".
And while historically that may be true it doesn't change one crucial part - There are solutions, the challenge is to apply them.
Everyone would love to cling to the safe knowledge that Europe will do what is necessary to save the union but the longer the delay, the lesser the chances. It's a long, dreary road ahead.
--------------------
The renminbi, on the other hand, has been on an opposite trajectory. China's implementation of the trilemma is simple - independent monetary policy and a severely restricted capital account by which they can keep the renminbi pegged to the dollar. While that does wonders for export-driven growth it cannot be a model for a reserve currency. And this leads us to its internationalization. Invariably, minor measures to liberalize capital flows cannot lead to a coherent globalization of the currency. Barriers have to be broken and flexibility needs to be induced. Eichengreen mentions a few instances from policy makers in China:
- In August 2010, a pilot scheme was introduced that allowed select offshore FI's to invest in China's bond market using renminbi funds
- In 2011, regulators permitted offshore renminbi to be used by investors i the Chinese stock market.
- In early 2012, HM Treasury and the Hong Kong MA agreed to permit the trading of offshore renminbi in London.
The key, as he argues, is the private financial market and their adoption of the renminbi. This will lead to central banks diversifying their reserves and participating in bilateral swap agreements (eg. the Chiang Mai initiative). And so there exists a broad step-by-step framework from China's perspective:
Use in invoices and trade transactions -> facilitate use in a range of international financial transactions -> encourage its adoption as a reserve currency.
The problem is this (both charts are for China):
The trading volume has grown extremely fast but the size has stabilized and is in slight decline. Moreover, if the outstanding stock is rapidly growing, the trading volume fails to provide a good enough measure of liquidity. A more relevant metric is the turnover ratio, which is basically the ratio of the value of the bonds traded and the average outstanding amount of bonds; and China's bond turnover ratio for government debt is extremely low.
The Chinese economy is enormous, but it's bond market isn't. Even without comparison to the US, it is neither deep enough nor liquid enough to complement a global role of the renminbi. Moreover, most of the bonds of the government and corporations are held to maturity (hence not actively traded) which leads to an extremely low turn-over and the fact that it won't take a large transaction to affect prices.
Inevitably, China cannot proceed without real reform. If the renminbi has to be accepted in a more international role, these are a few steps that must be implemented:
1) Capital account liberalization and hence the halt of dollar-pegging - a willingness to accept the inability to keep the renminbi artificially low and provide an export boost.
2) Bank reform, so that foreign investors can place deposits freely in Chinese banks and banks are no longer directed towards lending to local governments for projects, or to property developers in order to achieve construction objectives.
3) A more liberal corporate environment and strict implementation of law and property rights.
Point 1) is the anti-thesis to the Chinese growth-model. Dependence on exports, a monitored and pegged renminbi, and bank lending that can be adjusted and directed to whims and wills all have to be eroded and erased for the currency to be accepted.
Essentially, as Chinese policy makers have often claimed, the economy needs to be rebalanced. In a fragile, post-crisis world characterized by dampened external demand, this could be much required by removing significant vulnerabilities of the export sector to global shocks and externalities.
Eichengreen's view is that such a monumental paradigm shift in theory, even if accepted, will not happen overnight - which is why the dollar is the only alternative on the table even though the renminbi is fast catching up and the US fiscal doldrums might exacerbate such a process.
Even if those statements hold some truth, it is still immensely difficult to dislodge an incumbent for poor performance when the alternative either isn't ready or isn't up to the mark - just look to the US presidential race!
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