This week’s news that Brazil and China have signed a $30 billion currency swap agreement gave a renewed boost to excited chatter over the rising influence of China’s currency, the renminbi (RMB). The belief, in many quarters, is that the renminbi is well on its way to becoming an “international” currency—and many, both inside and outside China, are convinced it will inevitably eclipse the U.S. dollar as the world’s leading reserve currency. China is destined to surpass the U.S. as the world’s largest economy, the thinking goes, so just like everyone uses dollars now, they will soon be using RMB.
I would argue that this excitement is vastly over-hyped. China’s much-heralded swap agreements with Brazil and other countries give the impression that those nations are now holding RMB as a reserve currency. They are not. After the Lehmann Brothers collapse in 2008, international markets for trade financing in dollars seized up for several days, until the Fed stepped in to provide more dollars to get the markets working again. China’s swap agreements are an emergency backstop in case that ever happens again. In the meantime, no actual money is being swapped. If it ever came to that, Brazil’s temporary stocks of RMB would be used for the limited (but important) purpose of keeping trade alive until a more readily traded currency, like dollars or euros, became available again. There are three basic criteria for a nation’s money to serve as an attractive global currency:
1) There must be a great deal of demand to buy what your country has to offer;
2) There must be a ready place for them to put your currency, while waiting to spend it;
3) There has to be a ready way people in other countries can get their hands on your currency in the first place.
China’s renminbi only fulfills one of these criteria, the first: there is a great deal of global demand for what makes. Plenty of people around the world would be happy to pay in RMB to buy Chinese goods. But where would they save and invest that RMB in the meantime? About 40% of the world’s capital markets are in dollars; China accounts for just 4%. Much of that is in Hong Kong dollars, not RMB, and most of it is in riskier stocks, not the safer bonds that are good for stockpiling money. Because China’s domestic markets are mostly closed to foreigners, and the RMB isn’t freely convertible, moving money into and out of Chinese investments isn’t easy. That may be gradually changing, but it won’t happen overnight, and right now there’s no good place to put large quantities of RMB.
Of course, that assumes you, as a foreigner, can get your hands on large quantities of RMB in the first place. China runs large trade surpluses and, until very recently, has been receiving more investment funding than it sends abroad. Through both channels—the current and the capital account—China has been a net importer of currency. For the RMB to be widely accessible beyond China’s borders, China must export currency. That means running a trade deficit, or opening the doors to a lot more investment money flowing out of China than China's control-minded leaders have been comfortable with so far (allowing money to flow abroad like that could pose serious challenges to the way China's closed financial system currently functions).
The main point that a lot of people miss: for the RMB to become a truly global currency, China’s entire relationship with the rest of the world economy would have to change, in ways the Chinese have strongly resisted so far. (This is the main reason, by the way, that Japan, even when it was riding high in the 1980s, deliberately chose not to embrace a much larger international role for its currency, the Yen).