Download The Impact of Global Financial Crisis on RMB Internationalization

The Impact of Global Financial Crisis on RMB Internationalization
ZHAO Xijun, SONG Xiaoling
School of Finance Renmin university of China, Beijing, P. R. China, 100872
[email protected]
Abstract: Determinants of an international currency include: economic and trade size, financial
development, confidence in currency, network externalities, historical inertia, and so on. Changes in
indicators closely related to these factors show that, the impact of global financial crisis on the countries
of major international currencies and China is different. With the global financial crisis, RMB
internationalization faces more opportunities than challenges. The pace in RMB internationalization
should be accelerated, to help RMB turn into one pole in the multi-polar monetary system.
Keywords: Global financial crisis, International monetary competition, RMB internationalization.
1 Introduction
Foreign scholars’ study on the international currency theory is much earlier and fruitful. Empirical
research is more focused on the international currencies as pound, dollar, Euro and yen. With China's
rapid economic rise, the issue of RMB internationalization gradually enters their perspective. Barry
Eichengreen 2005 provides historical perspectives on reserve currency competition and discusses the
prospects of the dollar as an international currency. Hopes that RMB could become a major international
currency 20 or 40 years from now are highly premature. Benjamin J. Cohen 2008 suggests that, with
huge and well connected economic base, the opportunity for RMB’ internationalization is obvious, but
China's underdeveloped financial system and financial markets, cumbersome capital control, make
RMB internationalization face difficulties. Financial Times (2003) puts it, the emergence of the RMB as
an international currency will be… a natural result of China’s booming economy. Domestic scholars
make deep study on the need, feasibility, costs and benefits of RMB internationalization, at the same
time put forward the basic conditions and the strategic vision. Li Daokui and Liu Linlin (2008) discuss
the factors behind the internationalization of a currency, econometrically estimate determinants of the
shares of major currencies, which provides a useful reference for the economic analysis of RMB
internationalization. The ongoing global financial crisis makes RMB internationalization very topical
issues again. But more from a macro-level discussion and qualitative analysis, analysis combined with
quantitative and qualitative is much less. Combining theory with practice, qualitative with quantitative
method, this paper systematically analyzes the impact of the global financial crisis on current
international monetary pattern and RMB internationalization.
（ ）
（ ）
2 Determinants of an international currency
An “international currency” is a currency which fulfils one or several of the classical money
functions-medium of exchange, store of value and unit of account-for non-nationals or non-residents of
the issuing country, be they private or public agents. The internationalization of a currency begins when
an individual agent or institution residing in a country other than that of this currency accepts or uses it
as a medium of exchange, unit of account or store of value (Philipp Hartmann, 1998). Scholars have
different views in determinants of an international currency, main points are as follows:
2.1 Economic and trade size
The currency of a country that has a large share in international output, trade and finance has big natural
advantage (Menzie Chinn and Jeffery Frankel, 2005). Compared with economic, trade may play an even
more important role. Rey (1999) puts that pound sterling remained the dominant international currency
as long as Great Britain’s foreign trade exceeded the corresponding volume of the US. Although in 1870
475
Ⅱ
the US had surpassed the UK in terms of economic size (measured by GDP), only after World War
when the exports of the US overtook significantly the exports of the UK, had the dollar replaced the
pound as the international key currency.
2.2 Financial market liquidity
To attain international currency status, financial markets must be not only open and free of controls, but
also deep and developed. The qualities of “exchange convenience” and “capital certainty” – a high
degree of liquidity and predictability of asset prices—each of which is essential to minimizing
transactions costs, thus more acceptable and popular as an international currency. The key to both
qualities is a set of broad and efficient financial markets, exhibiting depth and resiliency (Benjamin J.
Cohen, 2008). Rainer Beckmann, et al. (2001) advanced that, the continuous strength of the dollar until
now is primarily based on the superior efficiency and liquidity of US dollar financial markets that long
before the European and Asian markets could develop.
2.3 Network externalities
Currencies derive their popularity, in part, from scale economies in use—what specialists call network
externalities. International currency must promise a wide transactional network, since nothing enhances
a currency’s acceptability more than the prospect of acceptability by others. The greater the volume of
transactions conducted in or with an economy, the greater will be the economies of scale to be derived
from use of its currency(Benjamin J. Cohen, 2008). Network externalities lead to switching costs. Kevin
dowd and David Greenway (1993) develops a model about currency competition, network externalities
and switching costs, and explains why agents are often reluctant to switch currencies, even when the
currency they are using appears to be manifestly inferior to some other.
2.4 Confidence in the value of the currency
The relative stability in the value of a currency is also an important precondition for the development of
an international currency. Confidence that the value of the currency will be stable and particularly that it
will not be inflated away in the future is critical. Barry Eichengreen (2005) raises that, an inflation rate
that ran at roughly 3 times US rates over the first three quarters of the 20th century, in conjunction with
repeated devaluations against the dollar, played a major role in sterling’s loss of reserve currency status.
2.5 Historical Interia
International monetary preferences are “sticky”, characterized above all by path dependence and a
noticeable tendency toward inertia. Stickiness of preferences gives leading currencies a natural
advantage of incumbency(Benjamin J. Cohen, 2008). This makes change in international currency come
relatively slowly. It took literally decades for the dollar to supplant sterling atop the currency Pyramid.
Krugman(1980), Hartmann and Issuing(2002) and Mckinnon(2002) have commented that once an
exchange structure is established, it resists change unless it experiences a sufficiently significant shock.
2.6 government attitudes towards currency internationalization
The empirical analysis of international monetary reveals that, the government attitudes towards currency
internationalization can play a pivotal role. Amercian governament’ attitudes towards
internationalization of the US dollar has been positive, which speeds the internationalization and
domonance of US dollor. Nevertheless, for more than four decades after World , other countries
maintained capital controls and tight financial regulations that limited the liquidity of their markets,
rending their currencies less attractive as repositories for reserves and accentuating the dominance of the
dollar. (Barry Enchengreen, 2005).
Ⅱ
3 The Impact of Global Financial Crisis on RMB Internationalization
476
A certain amount of RMB has begun to show up in neighboring economies as a result of growing
cross-border trade and tourism by Chinese citizens. Some factors would influence on the further
internationalization of RMB. The crisis also impacts on these factors to some degree.
3.1 Share in world output and world trade
Strong currency is determined by strong country, and the status of a country's currency is supported by
its economic scale and comprehensive national strength. Years of double-digit growth has already made
China’s economy, in purchasing-power terms, the second largest in the world after the United States.
Since reform and opening up, China has grown to an international trading power. In 2007, China's
foreign trade share in world increased to 7.7%, and maintains third place in the world rankings. With
such a huge and well connected economic base, the opportunity for network externalities is
obvious(Benjamin J. Cohen, 2008).
Indicators
Real GDP
(annul percent
change)
Current Account
Balance
(annul percent
change)
Exports of goods
and services
(percent of total
for world)
Table 1 Economic Indicator in the Global Financial Crisis
(International Currency Countries and China)
United Euro
United
Developing
Japan
Year
China
States
area
Kingdom
Asia
Advanced
economics
2005
2.9
1.7
1.9
2.1
10.4
9
2.6
2006
2.8
2.9
2
2.8
11.6
9.8
3
2007
2
2.7
2.4
3
13
10.6
2.7
2008
1.1
0.9
-0.6
0.7
9
7.7
0.9
2009
-2.8
-4.2
-6.2
-4.1
6.5
4.8
-3.8
2010
0
-0.4
0.5
-0.4
7.5
6.1
0
2005
-5.9
0.4
3.6
-2.6
7.2
4
-1.1
2006
-6
0.3
3.9
-3.4
9.5
6
-1.3
2007
-5.3
0.2
4.8
-2.9
11
6.9
-1
2008
-4.7
-0.7
3.2
-1.7
10
5.8
-1.1
2009
-2.8
-1.1
1.5
-2
10.3
6.4
-1
2010
-2.8
-1.2
1.2
-1.5
9.3
5.7
-1
2005
10.1
29.5
5.3
4.5
6.7
12.1
68.9
2006
9.8
29
5
4.6
7.2
12.6
67.3
2007
9.6
29.5
4.7
4.2
7.8
13.2
66.4
8.4
13.8
65.1
2008
9.3
28.6
4.5
3.9
Note: italics for the IMF projections.
Source: IMF “World Economic Outlook, April 2009; April 2008”.
Compared with the United States and Europe countries, Asia and China’s economy suffered relatively
smaller direct impact during the global financial crisis. Even in 2008 when the negative impact on
China's economy become obvious, the GDP growth of China still maintained 9%. According to IMF
projections for 2009 and 2010, China's economy should be significantly better than the major
international currencies countries.Financial crisis will have a negative impact on China's foreign trade
inevitably. With the economy growth of United States and the world slowdown in the crisis, China's
exports face greater downside risks. However, the Chinese exports to the United States focusing on
labor-intensive products and low-cost products, the income elasticity relatively small, the influence of
economic downturn and decline in income on demand for these commodities is unclear. Judging from
the data, China's foreign trade in crisis didn’t deteriorate obviously. The exports of goods and services
increase year by year, and still maintain a rather large current account surplus.
477
3.2 Financial markets and financial institutions
The internationalization of RMB makes it an inevitable requirement that China's financial market,
especially the capital market should be sufficiently large and balanced structure to match its currency
status. In recent years, China's financial sectors have made rapid development, the reform of financial
markets is deepening gradually, and the breadth and depth of capital markets expands continually.
However, compared with the economic and trade scale, China's financial market is still relatively
backward. There is a structural conflict of country with “big trade” and “small finance”.
A financial market with less risk and more earnings will be more attractive, and the currency will be
more acceptable as an international currency. In the paper, the exchange rates and stock indexes of
current major international currency countries and China in the year from 2006 to 2009 is selected to
make a comparative analysis of the risks and earnings. The exchange rate data are from International
Monetary Fund daily statistics on currency per SDR (Special Drawing Rights), and the stock data are
from Yahoo stock market weekly statistics1. Appreciation of a currency is estimated as the growth range
per year of exchange rate. Appreciation of a stock market is estimated as the growth range per year of
stock indexes. Volatility of a currency is estimated as the standard deviation of the log first difference of
the SDR daily exchange rate. Volatility of a stock market is estimated as the standard deviation of the
log first difference of the weekly stock index. To facilitate comparison, the appreciation and volatility
data of the exchange rate and stock index is standardized. The risk index and earnings index of the US
dollar and Dow Jones Industrial Index is set to be 1 (or -1, for a negative earnings), as a benchmark, to
calculate the rest of other currencies or stock indexes.
Table 2 Risk Indexes and Earnings Indexes of Financial Markets
Exchange rate
Stock indexes
Year
2006
2007
2008
2009
cumulati
ve
Index
US
dollar
Euro
area
Yen
Pound
RMB
United
states
Euro
area
Japan
UK
China
R
1.00
0.96
1.48
1.02
0.92
1.00
1.10
1.68
1.13
2.12
E
-1.00
1.13
-1.60
1.81
-0.21
1.00
0.88
0.35
0.62
7.74
R
1.00
1.26
3.16
1.62
0.97
1.00
0.89
1.39
1.04
2.70
E
-1.00
1.28
-0.11
-0.47
0.30
1.00
1.00
-3.22
0.64
28.90
R
1.00
1.24
2.28
1.52
0.95
1.00
0.96
1.26
1.17
1.41
E
1.00
-0.97
10.36
-11.3
3.99
-1.00
-0.13
-1.31
-0.93
-2.32
R
1.00
1.52
1.97
1.66
1.08
1.00
2.30
1.01
0.92
1.06
E
-1.00
0.70
-3.65
7.16
-0.96
-1.00
6.84
2.99
-1.79
20.73
R
1.00
1.22
2.24
1.77
0.96
1.00
1.36
1.26
1.10
1.67
1.24
2.20
-2.21
1.70
-1.00
1.65
-1.71 -1.12 6.85
E
-1.00
Note: 1.the data on stock market and foreign exchange is up to July 6th, 2009. 2. in the “index” column, “R”
for risk indexes, “E” for earnings indexes.
Source: IMF exchange rate data from the database on the SDR exchange rate data; index data from Yahoo's
website.
From the cumulative risk indexes and earnings indexes, it can be seen that RMB exchange rate is
low-risk, higher-earnings. RMB shows preserve and increase value in the crisis again. China’s stock
market is high-risk, high-earnings. The global financial crisis had a "spillover effect of volatility" on
China's capital market in system reform.
The crisis also made Chinese financial institutions suffer losses, but compared with those of United
States and Europe countries, China’s direct loss is much smaller. When the banking industry of United
1
Note: Dow Jones Industrial Index in the United States; DJ Euro STOXX 50 in Euro area; NIKKEI 225 in Japan;
FTSE 100 in United Kingdom; Shanghai SE Composite index in China.
478
States and Europe countries suffering huge shock, the financial institutions of China ushered in historic
development opportunity, and the international status is further enhanced. As “Frankfurter Allgemeine
Zeitung” reported in February 2009, the ranking of the world's largest bank in market value is severely
disrupted by the financial crisis. The Citibank, Bank of America and the Swiss bank, formerly
dominating the top of the bank, slipped one after another. For the first time, four Chinese-funded banks
advanced into the top ten.
3.3 The stability of the RMB
In the credit currency system, the competition of international currencies observes "reverse Gresham's
Law": currency with stability, facility and safety would eventually become the dominant currency.
Practice tells that, to maintain the stability of currency play a key role in currency internationalization
and currency substitution. During the Southeast Asian financial crisis in 1997, the ultra-stability,
value-added of RMB makes residents in some East Asian countries and regions keep RMB as an
international reserve currency. During current financial crisis, US dollar, Euro, Yen and pound fluctuate
violently, which greatly influenced their functions as international currencies. Contrastively, the
relatively stability of RMB (see Table 2 and Fig 1) facilitates its internationalization.
130
120
RM B
euro
yen
pound
US dollar
110
100
90
80
20
05
20 01
05
20 04
05
20 07
05
20 10
06
20 01
06
20 04
06
20 07
06
20 10
07
20 01
07
20 04
07
20 07
07
20 10
08
20 01
08
20 -04
08
20 07
08
20 10
09
20 01
09
-0
4
70
Fig 1 Real effective exchange rate of international currencies and RMB (2005:01-2009:05)
Note: Monthly averages; 2005=100.
Source: BIS.
3.4 History inertia
The financial crisis makes the status of US dollar face some challenges, and the international monetary
system will have a fundamental adjustment. The already weakened confidence in US dollar would face
further challenge. The attractiveness of US capital market would reduce. The diversified development
trend of the world economy, trade, reserve system and the rise of emerging markets would challenge the
US economic hegemony. However, the international monetary theory and empirical analysis shows that,
the network externality, inertia and high switching costs makes international currency substitution not an
easy job accomplished overnight. The hegemonic status of US dollars would not decline rapidly. The
conversion of international monetary system from unipolar to multiple would take rather a long time.
479
Year
Table 3 Official foreign exchange reserves, international bonds and notes by currency
Foreign exchange reserves (%)2
Bonds and notes (%)3
US dollar
Euro area
66.50
24.52
3.32
24.52
37.90
46.05
3.20
7.65
66.13
24.73
3.11
24.73
36.95
46.86
3.09
7.87
66.52
24.40
2.98
24.40
37.13
46.66
2.94
8.04
65.48
25.09
3.08
25.09
36.42
47.33
2.77
8.24
65.35
25.17
2.89
25.17
36.20
47.60
2.70
8.19
65.18
25.31
2.76
25.31
36.04
47.59
2.56
8.26
64.17
26.14
2.68
26.14
35.42
48.05
2.70
8.21
64.13
26.27
2.92
26.27
34.93
48.84
2.68
7.90
63.18
26.68
3.12
26.68
33.80
50.04
2.91
7.54
62.85
26.79
3.34
26.79
34.00
49.70
2.68
7.83
64.42
25.62
3.19
25.62
35.90
47.49
2.91
8.07
64.05
26.50
3.23
26.50
36.18
47.84
3.30
7.49
64.97
25.89
2.91
25.89
37.47
Source: IMF COFER database, March 2009; BIS database, March 2009.
46.72
2.99
7.75
：
2006：Q2
2006：Q3
2006：Q4
2007：Q1
2007：Q2
2007：Q3
2007：Q4
2008：Q1
2008：Q2
2008：Q3
2008：Q4
2009：Q1
2006 Q1
Yen
Pound
US dollar
Euro area
Yen
Pound
In the beginning of the crisis, the reserve share and exchange rate of dollar declined continually.
However, when the crisis intensified, the share of dollar both in official foreign exchange reserves and
bonds and notes started to rise. It reveals that, on the one hand, the dominant position the United States
has not yet been changed, supported by whose current political, economic, financial, trade and military
strength. There is no currency strong enough to challenge US dollar in short-term. On the other hand, it
demonstrates the inertia in international currencies. With many uncertain factors, investors still prefer to
use dollar. Confidence in Euro and other currencies still can not contend with that in US dollar.
RMB internationalization requires a stronger comprehensive national strength of China. Compared with
current major international currency countries, there is still a wide gap for China to span. The long
transformation process of the international monetary system will provide relatively sufficient time for
China to practice skills hardly, boost RMB to become one pole in future multi-polar monetary system.
3.5 Government attitude toward RMB internationalization
The financial crisis strengthens Chinese government’s will of promoting RMB internationalization.
During the financial crisis, Chinese government not only plays a more proactive role in the international
monetary system reform, but also pays highly attention and actively promotes RMB internationalization,
and has made encouraging progress.
On December 12, 2008, China and South Korea reached a currency swap agreement of 1,800 billion
yuan. For the first time, RMB had gone out of the country officially. In order to meet the needs of
international trade settlement, China has signed agreements with eight trading partners. On July 1, 2009,
“Regulations on RMB trade settlement pilot Scheme” is unveiled and implemented. The pilot scheme to
make it possible for cross-border trade to be settled in RMB is considered a key step in RMB
internationalization. In the mean time, the setting up of the financial center in Shanghai and China's
capital market reforms has sped up. These all have improved the trade and financial conditions for RMB
internationalization.
．Conclusion
4
2
3
Share of total allocated reserves.
Share of total issues; amounts outstanding.
480
The global financial crisis impacts on China's economic, trade, financial markets and financial
institutions. Through above analysis it can be seen that, compared with the direct and giant impact on
European countries and the United States, the impact on China is much smaller on the whole. In the
crisis, the opportunities of RMB internationalization outweigh the challenges. China should seize the
opportunity firmly and actively create conditions to speed up the process of RMB internationalization.
Measures should be taken: 1. Take trade as a breakthrough, gradually improve the using conditions of
RMB, and promote RMB internationalization in a planned, step-by-step way. 2. A global developing
strategy should be established. China's capital market should be developed into an international financial
center, the world's financial resources allocation center, to support RMB internationalization. 3. To
maintain the relative stability of RMB value, gradually promote the system reform of RMB exchange
rate, to avoid a greater impact on financial stability caused by the jump in China's economic reforms. 4.
Improve the financial market supervision system, to maintain the relatively stability of capital markets
and financial systems, effectively control the risk during RMB internationalization.
Acknowledgements
Financial support from the National Key Technologies R&D Program (Grant No. 2006BAJ07B01).
References
[1]. Barry Eichengreen. Sterling’s past, Dollar’s future: Historical perspectives on reserve currency
competition. NBER WP 11136, May 2005:1 29
[2]. Benjamin J. Cohen. Toward a leaderless currency system. Orfalea Center for Global & International
Studies. Paper 49, Jan. 2008: 1 18
[3]. George S. Tavlas. Internationalization of currencies: the case of the US dollar and its challenger Euro.
The International Executive, 1997, 39(5): 581 597
[4]. Helene Rey. International trade and currency exchange. CEPR Discussion Paper 2226, Sep. 1999
[5]. Kevin Dowd, David Greenaway. Currency competition, network externalities and switching costs:
towards an alternative view of optimum currency areas. The Economic Journal, 1993,103 (420):
1180-1189
[6]. Li Daokui, Liu Linlin. RMB Internationalization: An Empirical and Policy Analysis Journal of
Financial Research, 2008 (11):1 16
[7]. Menzie Chinn and Jeffrey Frankel. Will the Euro Eventually Surpass the Dollar as Leading International
Reserve Currency?. NBER Working Paper 11510, June 2005
[8]. Paul Krugman. Vehicle currencies and the structure of international exchange. Journal of Money, Credit,
and Banking, 1980, 12(3): 513 526
[9]. Philipp Hartmann, Otmar Issuing. The international role of the euro. Journal of Policy Modeling,
2002(24): 315-345
[10]. Philipp Hartmann .Currency Competition and Foreign Exchange Markets: The Dollar, the Yen and the
Euro. Cambridge: Cambridge university press, 1998: 11 39
[11]. Rainer Beckmann, Jürgen Born, Wim Kösters. The US dollar, the euro, and the yen: an evaluation of
their present and future status as international currencies. Published in: IEW Diskussionsbeiträge,
2001(38): 1 22
～
～
～
．
～
～
～
～
481