As historians will note, one can be the world’s largest economy without also having its most widely accepted reserve currency.
Angus Maddison estimated that the size of the United States’ economy overtook that of Britain in the 1890s; however, not until Britain left the gold standard in 1931 did the US dollar replace the pound sterling as the world’s most widely accepted legal tender.
In nominal terms, China’s economy will likely not overtake that of the US until the mid-2020s and so, if precedent is any guide, the US dollar will likely remain the world’s top dog in the kennel of currencies for some time yet.
But do not expect the sunset on the ‘Dollar Empire’ to last three decades – unlike Britain, the United States does not have a formal empire that will underwrite its ‘Dollar Area’ as Britain had in the ‘Sterling Area’.
Partly because it will lead to a paradigm shift that will rewire the world of finance, China has approached the internationalisation of the renminbi with patience and deliberate caution.
But there are clear signs that the pace of this process has now picked up.
Medium of exchange
About 25 per cent of China’s international trade – some RMB10 trillion (AU$2.11 trillion) – is now invoiced in renminbi; indeed, in December 2013, HSBC reported that the Chinese currency overtook the euro to become the second most used currency in trade finance after the US dollar.
Bilateral agreements with Russia, Japan, Thailand and Vietnam now permit trade to be settled in Chinese renminbi instead of US dollars.
What to watch out for in 2015: Malaysia adding an RMB-priced option to its all-important-to-Australasia oil benchmark, Tapis.
Standard of deferred payment
Following the introduction of the ‘dim sum’ bond in 2007, the RMB-denominated bond market ballooned in size to reach over RMB125 billion (AU$26.42 billion) in 2013.
Corporates like McDonalds and Caterpillar, multilaterals like the World Bank and even sovereigns like the UK, British Columbia and New South Wales have tapped this market.
What to watch out for in 2015: The Hong Kong-Shanghai Connect arrangement expanding from equities to include bonds and accelerating the process of internationalising access to China’s domestic debt markets, as a result potentially disintermediating the half-way house ‘dim sum’ bond option.
Unit of account
Whilst the renminbi does trade within a daily-defined band, since October 2012 it has also moved within a narrow range of up to 2 per cent either side of RMB6.15 to the US dollar.
There is growing evidence that, in a currency world buffeted by incontinent central banks printing vast quantities of money and intimidated central banks abandoning currency pegs and even offering negative nominal deposit rates, the People’s Bank of China is trying to keep the renminbi relatively stable, thereby increasing its ability to qualify as an internationally acceptable unit of account and indeed a store of value.
Given this growing consistency, it is hardly surprising that since 2008, the People’s Bank of China has also been able to arrange 29 currency swaps with other central banks, including those of five of the G7 countries.
Illustrating the spill-over effects into other money functions, not only have these arrangements increased direct renminbi-denominated trade, thereby cutting out the ‘middle-man’ US dollar, the central banks of the countries involved have effectively added these swap-lines to their foreign exchange reserves.
What to watch out for in 2015: The People’s Bank of China finally agreeing a swap arrangement with the US Federal Reserve.
Store of value
Central banks from Nigeria to Saudi Arabia have indicated intentions to diversify part of their reserves into renminbi, thus confirming its growing reputation as the next big thing in the world of reserve currencies.
Though it is hard to prove, there is a growing suspicion that many central banks have already quietly added the renminbi to their foreign exchange reserves in anticipation of the day when this becomes commonly acknowledged practice.
Azerbaijan has even transferred AU$2.36 billion of its sovereign wealth fund assets out of US dollars into Chinese renminbi.
What to watch out for in 2015: A reweighting of the IMF’s own store of value, the Special Drawing Right, that sees the inclusion of the renminbi and at a weight above that of the British pound and Japanese yen.
Reaching out
China is now proactively seeking to expand its economic influence globally, using its currency as an instrument by which to advance its interests.
China’s emerging strategy for advancing its interests appears to be to fill out Continental Asia and the Indian Ocean basin with infrastructure investment, after which ‘All their trade routes will lead to Beijing’.
This will be achieved via such mediums as the proposed Asian Infrastructure Bank and the Silk Road Infrastructure Fund.
The recently expanded Shanghai Free Trade Zone (FTZ) – enlarged from 28 to 120 square kilometres – is setting up its central district, Pudong, to be China’s City of London.
From February 2014, the renminbi became fully convertible within the FTZ allowing ‘residents’ to hold unlimited quantities of foreign exchange.
In November 2014, the Shanghai-Hong Kong Connect programme linked the two cities’ stock exchanges, hinting that a full-scale merger will eventually occur.
Their combined market capitalisation ranks them third in the world behind the NYSE and Nasdaq.
In the meantime, expect 2015 to witness the expansion of the Stock Connect programme to include the counters of the Shenzhen Stock Exchange – China’s Nasdaq – and its broadening from just trading equities to include bonds and ETFs.
Michael Power is a global strategist at Investec Asset Management.
