I wanted to add few follow up and more tangential thoughts to my BloombergView piece on China is what’s preventing the RMB from being a real global currency. I add them here because they simply are more tangential or too long to put into that specific piece.
First, believe it or not, I want the RMB to become a global currency, believe it will be good for China, and the world. Do not confuse my criticism of the very real technical and policy short comings with my larger world. It is internally contradictory and delusional to believe that the RMB is a freely and widely traded international currency as of late 2015. However, that does not mean that the RMB should not become an international currency and the very real benefits that would bring to global finance.
Second, Beijing cannot make the RMB international without essentially abandoning the USD peg. With all the ways that Beijing is actually restricting RMB internationalization, it is taking these steps to avoid losing control of RMB pricing. For instance, the PBOC is providing swap agreements to other central banks to facilitate trade but not the physical RMB. By signing swap agreements, Beijing maintains control over the pricing of the RMB. However, if central banks were free to trade RMB with either each other or the market, this would essentially sideline Beijing as the price setter. This would send a lot more RMB into the global market place and set a second price for RMB. They are having enough trouble fighting constant skirmishes with the offshore RMB in Hong Kong having to intervene almost weekly to reduce the CNY/CNH differential. Imagine the difficulty they would have if there were trillions of RMB around the world. It would essentially break the RMB/$ peg and that is a step Beijing is simply not prepared for yet.
Third, it is important to note that Beijing is taking very subtle ways to internationalize as the headline but underlying that are enormous restrictions. The central bank reserves are the best way to highlight this trend. Most central banks do not actually hold or have an account with RMB. They have a swap agreement where they set aside some currency in there reserves that they can swap for RMB when needed, for instance to pay for Chinese exports, but they do not possess RMB. This does internationalize the RMB to a very small degree but most people enormously over estimate the degree and fail to grasp the importance of the financing structure.
Fourth, I am very sympathetic to the very difficult position that Beijing and the PBOC find themselves in. Whenever a country releases a currency, even in the best of times, there can be large movements. Now imagine you are essentially ending 70 years of financial repression, assuming they adhere to their 2020 timeline, against the backdrop of slowing growth, rickety banks, and profound political sensitivities to liberalization. Furthermore, never before has an economy the size of the Chinese liberalized its currency. When this eventually happens, RMB internationalization will ripple throughout the global economy. Beijing is acutely aware of what they are up against and I am profoundly sympathetic.
Fifth, what Beijing continues to fail to grasp is that international investors want a robust, transparent, and predictable market mechanisms. Investors understand that prices go and down, frequently for no reason, but the absolute embarrassment of Chinese financial regulation has caused every investor to pause. Investors and CB’s have distinctly less appetite for assets if they question the regulatory structure, whether they will be able to access their assets, whether the rules will change retroactively, or what the rules everyone needs to follow. If Beijing wants to gain international confidence in the RMB, it needs to stop the absolute embarrassment that is its financial regulation.
In closing, I want give a special mention to S&P who once again proving that credit ratings agencies are the embarrassment of financial and economic research world. Credit ratings agencies have a well deserved reputation of writing whatever an issuer wants or downgrading after they’ve filed for bankruptcy. The only reason global credit ratings agencies aren’t the worst in the world is because of Chinese ratings agencies. Yesterday, S&P maintained a stable outlook on Chinese sovereign debt. In maintaining this rating, S&P cites (and no I am not making this up) China’s “strong external metrics”, “support for commercially oriented SOEs will be more limited”, and “credit in China to grow roughly in line with nominal GDP”. Seriously, S&P says that credit in China will grow in line with nominal GDP. What they base that on, other than pixie dust and unicorns, I’m not entirely sure. Leaving aside the absolute factual inaccuracies of these assertions, S&P as the hired gun it is, fails to grasp basic economics. What is arguably the most amazing is that they cite China’s strong external asset position relative to external liabilities. They are essentially saying, China has lots of USD in the PBOC and not a lot of external debt. However, they ignore the contingent liabilities like local government debt Beijing has essentially guaranteed or the FX implications of saying, China has a good credit rating because it has reserves. However, Chinese sovereign debt is almost 100% domestic. The difficulties of using USD to pay off domestic debt in RMB has already been covered but much more problematic than S&P seems to grasp. Really astounding that people pay them for such absurdly poor research.