There is a lot of speculation that the dollar is losing ground to the Chinese renminbi and that sooner or later the Fed will share the global stage with Chinese monetary authorities. Chinese government officials and Jeremiad western economic forecasters who claim that the renminbi will replace the dollar as the world’s premier currency certainly have not helped assuage American fears.
However, contrary to the increasingly shared belief that the Chinese are coming, the dollar’s status is not in danger nor is the renminbi a realistic hard currency alternative.
The status of the dollar is important because the U.S. standard of living is dependent upon its global status. The ability of U.S. citizens to pay for imported goods and services and finance government deficits is in large part a result of the dollar’s reserve status.
Pessimistic economists are worried about the dollar’s status because they think that that the Fed is printing too much money and that confidence destroying inflation will result. When a currency experiences inflation, the scarcity value of the currency goes down and its value relative to other currencies is reduced. While citizens of the country whose currency is being inflated don’t have a choice but to own and transact business using their native money, foreigners have a choice and won’t buy into a currency that is susceptible to devaluation. If foreigners don’t want to own a currency it can’t be a global reserve currency. Dollar worriers say that U.S. inflation is the inevitable result of Fed policy and inflation will give our Chinese competitors the opening to replace the dollar with the renminbi.
These economic forecasters are correct to be worried about inflation caused by an overactive central bank. The problem is that they are talking about the wrong country. The vast expansion of currency is occurring, the only problem — or bright spot depending on whether your first language is English or Mandarin — is that it’s occurring in China.
As it turns out, the Chinese don’t have monetary discipline. They run their mint at warp speed and print mountains of currency that is creating high domestic inflation. According to statistics published by the People’s Bank of China, the rate of growth in M2 (the most commonly used measure of money around the world) has been 142.96% over the last five years. Set forth below is the amount of M2 for both the renminbi and U.S. dollar since the end of 2004.
|Chinese and U.S. M2|
|As Reported By The People's Bank of China and The Federal Reserve|
|Chinese M2 As Reported By The People's Bank of China||U.S. Dollar M2 As Reported By The Federal Reserve|
(100 million Yuan)
|Annual Growth Rate||5 Year Growth Rate||Billions of $||Annual Growth Rate||5 Year Growth Rate|
The reason the extraordinarily fast growth in renminbi is that Chinese monetary authorities use newly minted renminbi to buy foreign currency acquired through exports. Given the size of the Chinese trade surplus, it takes a lot of renminbi to buy up all of the dollars, euros, pounds, yen, Libyan dinar - and pretty much any other foreign currency that foreigners send to China in exchange of manufactured goods. By purchasing foreign currency held by its citizens, China is able to control the renminbi exchange rate and prevent its citizens from holding any foreign currency. Chinese citizens are forced to give up their dollars to the government and accept renminbi as a domestic substitute. Unfortunately for Chinese nationals, daily domestic inflation eats away at the value of the renminbi that they are forced to accept as a result of their labor.
As any tourist in China knows, Chinese nationals are fully aware of the value of the currency they are forced to accept. They would gladly keep dollars over the renminbi — if their government would let them.
Economists and pundits predicting the rise of the renminbi need to understand that for the Chinese currency to assume the status of a reserve currency people all around the world — Chinese citizens included — have to want to own the currency. Forcing people to own it is not a stable or acceptable substitute.
It will take a cultural and political earthquake to motivate the Chinese ruling elite to give up its domestic monopoly on controlling and owning foreign currency. The Chinese leadership has to get comfortable with the idea of allowing its citizens, and citizens of other countries, the right to own, trade and invest any currency that they want, including the renminbi, and to be able to effect that decision electronically without government interference.
Chinese leaders aren’t anywhere near ready for American, European and Japanese citizens, as well as Chinese nationals, to vote with their pocket books and sell the renminbi if they disagree with Chinese economic or political policy. Having a freely traded currency is a form of instant voting in a global economic ballot box that is inconsistent with the political culture and fabric of Chinese central authority. There isn’t a lot in the Chinese political atmosphere that suggests the leadership is ready to accept the unsolicited judgments of the capital markets or bow to the economic will of its own people all around the world.
The dollar retains its status as the global reserve currency not only because of the economic power of the U.S. economy but because of the economic democracy that our system of government embraces and promotes. The dollar is the world’s reserve currency because foreigners want to own and transact business in dollars more than any other currency. The dollar is the currency of choice for international business and the storehouse of value that the world turns to whenever there is a flight to quality in the global capital markets.
So, the answer to the question of whether or not we’ll be trading in renminbis over dollars in 20 years is “no”; on its current path, the Chinese renminbi isn’t going to be a reserve currency of choice. Maybe the renminbi has a chance to run with the Libyan dinar, but it has a long way to go before it will be ready for prime time.