The Limits of RMB Internationalization
The current international monetary system is certainly unjust. Gold was produced internationally. It therefore could not be controlled by a single country, and was a multilateral unit against which all currencies were measured. In contrast, the “dollar standard” means that just one country’s currency is the unit in which all others are measured. This gives the U.S. a type of “monetary monopoly,” and hence many advantages in the international monetary system. But nothing can be done about this until another unit replaces the dollar in defining international prices. Until that happens, international crises, even those originating in the U.S. as in 2008, will not weaken the dollar’s position. As Eswar Prasad comprehensively documented in his book The Dollar Trap, “The global financial crisis has strengthened the dollar’s prominence in global finance.”
Because the actual operation of the international monetary system inevitably allows flows into the dollar, capital account liberalization, which would be necessary to achieve full internationalization of the RMB, constitutes an extremely destabilizing economic force. Joseph Stilitz, Nobel Prize laureate in economics, concluded after reviewing the history of financial crises: “Capital account liberalization was the single most important factor leading to the crisis. I have come to this conclusion not just by carefully looking at what happened in the [Asian] region, but by looking at what happened in the almost 100 other economic crises of the last quarter century... capital account liberalization represents risk without a reward.”
“Risk without reward” is thus a necessary consequence of the structure of the international monetary system; also capital account liberalization that simply creates a flow into dollars. Large scale RMB “internationalization,” which would require liberalization of China’s capital account, therefore, would lead to a large outflow of China’s capital into the U.S. and dollar assets, to the detriment of investment in China. For this reason, as leading Chinese economist Yu Yongding put it: “China has to maintain its capital controls in the foreseeable future. If China were to lose control over its cross-border capital flows, it could lead to panic and capital outflows would turn into an avalanche, and eventually bring down the whole financial system.”
China therefore can undoubtedly develop limited RMB internalization within a global monetary system that continues to be dominated by the dollar – particularly for trade. But any notion that the RMB could challenge the dollar’s position, or escape the dangers ensuing from liberalization of the capital account, is an illusion which could, at worst, seriously damage China’s economy.
John Ross is a senior research fellow at Chongyang Institute for Financial Studies, Renmin University of China. From 2000 to 2008 he was director of economic and business policy in the administration of Mayor of London Ken Livingstone. He previously served as adviser to several major international mining, finance and equipment manufacturing companies.
