China 2056

Article Title:

JI Xiaonan Recommends that China Increase its Gold Holdings to 10,000 Tonnes

Author:

CAI Jing, reporter for the Qi Lu Evening Newspaper.

Date Published:

2009-12-01

Source:

This article originally appeared in both the paper and electronic versions of the Qi Lu Evening Newspaper, a local newspaper in Shandong Province that was founded in 1988 and currently belongs to a media group called “Dazhong Baoye Jituan” (The Masses News Group). The original Chinese version of this article, with a picture of Mr. JI Xiaonan, can be seen online here: http://www.qlwb.com.cn/display.asp?id=464616

Text:

“We recommend that China’s gold reserves reach 6,000 tonnes within 3-5 years so that within 8-10 years they can be raised to 10,000 tonnes.” At the Third China Asset Security Forum held on November 28, JI Xiaonan, the chairman of the State Council’s State-Owned Enterprise Supervisory Board Focusing on Large-Scale Industry, declared that while optimizing the composition of its foreign exchange reserves, China should classify gold as its core [foreign exchange reserve component].

The security of financial assets became the focal point of this forum and gold clearly became a major topic of conversation. Since the eruption of the latest financial crisis, the United States [government], which possesses 8,000 tonnes of gold reserves, has become saddled with huge debts, however, it hasn’t sold a single gram of gold. Even though a few countries in Europe, such as Germany, France, and other countries with relatively large gold reserves, have suffered massive [financial] shocks, they have not only not sold any gold but have instead increased their gold holdings. A few countries in the Middle East are also continuously increasing their gold holdings.

JI Xiaonan believes that since our country’s foreign exchange reserves are already greater than US$2 trillion, with 70% in US dollar denominated assets, the current composition of foreign exchange reserves makes the security of our country’s national wealth to a very large extent dependent on other countries; thus if the US dollar continues to depreciate, it will certainly lead to a considerable shrinking of the [value of the] foreign exchange reserves of our country. Under normal conditions, when the US dollar depreciates, gold appreciates. If we take part of our country’s foreign exchange reserves and switch them to gold reserves, we can hedge the losses from the depreciation of our country’s US dollar denominated assets, mitigate [our] foreign exchange reserve risks, maintain the security of [our] national wealth, and at the same time this would also be beneficial to the strengthening of the RMB’s ‘power of discourse’ during the process of the reconstruction of the international financial order.

This viewpoint gained the support of the famous economist Mr. LI Yining.

My Commentary:

Before commenting on the contents of this article, let me first present the background information on JI Xiaonan that I have discovered so far. JI Xiaonan was born in the city of Yancheng, Jiangsu Province. He worked for several years for various ministries and departments of both the State Council and the National People’s Congress of the People’s Republic of China (PRC), including: the State Systemic Reform Commission, the State Council Human Affairs Ministry, the State Economic and Trade Commission, etc. At different times he has been the research director and head of the Policy and Law Department of the State Economic and Trade Commission, and the research director of the State-owned Assets Supervision and Administration Commission of the State Council (SASAC). Since November of 2004, JI Xiaonan has been the chairman of the State Council’s State-Owned Enterprise Supervisory Board Focusing on Large-Scale Industry. This supervisory board answers to the SASAC Office of the Supervisory Board Work, which was formed by the State Council in the year 2000 in order to “[…] supervise the situation of the preservation and appreciation of the state-owned assets of the large-scale industry state-owned enterprises.” I have not been able to find any evidence that JI Xiaonan is a member of the Communist Party of China (CPC).

Now turning to the main topic of this article, it is clearly related to the broader goal of “RMB internationalization”. In my previous translations and commentaries, I have demonstrated that strengthening the RMB’s international position is currently being advocated in the official Chinese press as an integral part of China’s long-term goal of creating a “moderately prosperous society” (xiaokang shehui) by 2020, the centenary of the CPC (Communist Party of China). However, I have also pointed out that the authors of the Chinese articles I have thus far translated stopped short of advocating a form of gold backing for the RMB, even though historically this seems to have been the key to the success of the internationalization of both the British Pound and the US dollar. To the best of my knowledge, this article represents the first time that the idea of converting a significant portion of the PRC’s foreign exchange reserves into gold has been publicized by the mainland Chinese media. It is also significant that the proposal was made not merely by a private individual or intellectual but by a State Council official. I find it very interesting that JI Xiaonan considered it to be within his realm of responsibility to even offer advice regarding the composition of China’s forex reserves, a matter which one would assume would be decided by the State Council’s State Administration of Foreign Exchange (SAFE) or perhaps the People’s Bank of China (PBOC). The fact that he spoke out on the matter, and that this was then reported by the closely-monitored Chinese media, suggests that there is probably a lively debate going on at the highest levels. It is worth mentioning that “famous economist Mr. LI Yining”, who supposedly supports JI Xiaonan’s opinion, is also from Jiangsu Province. LI Yining became famous for his early proposal to transform China’s state-owned enterprises into joint-stock companies and he is currently the vice-chairman of the Subcommittee on the Economy of the CPPCC National Committee.

I find JI Xiaonan’s analysis of the importance of the gold reserves of both the US and the Euro-zone fairly convincing from a historical perspective and agree that China could radically increase its monetary independence by shifting reserves out of US treasuries and into gold. Such a move could also theoretically strengthen the international standing of the RMB, but would have to be accompanied by other policy reforms. One thing that JI Xiaonan does not mention is whether the RMB (which are liabilities of the PBOC) would merely be backed by a certain quantity of gold and other forex reserves (which are the assets of the PBOC) or if the gold would ultimately act as a reserve fund for an RMB that is convertible into gold. It seems to me that gold convertibility would, at least initially, be required for the RMB to become an international reserve currency as successful as the British Pound or US dollar.

There are, of course, both theoretical and practical problems associated with this diversification out of US treasuries and into gold. First of all, the entire Chinese economy is currently built on the foundation of using low labor costs to attract foreign direct investment into China, channeling that investment into industries that primarily produce consumer goods for export, and then using a significant portion (about 40%) of the foreign exchange reserves obtained by means of this large trade surplus to buy US treasuries with which to guarantee the stability of the RMB-USD peg. This peg is, in turn, essential for ensuring the low labor costs that keep the whole economic system going. If China were to sell a large portion of its US treasuries, or other US dollar denominated assets, and buy gold, it is difficult to imagine how it could maintain its high RMB-USD peg. The RMB would appreciate significantly, Chinese labor costs would rise, Chinese exports would become much more expensive, and China’s trade surplus would thus shrink. This kind of reform would necessitate a radical transformation of the foundation of China’s economy and would bring with it enormous challenges. Although the CPC has recently emphasized the need to move away from an export-driven economy and “increase domestic demand” for consumer products, it remains to be seen to what extent it wishes to transform the Chinese economy. Secondly, it is unclear whether China can practically reach the 10,000 metric tonne level of gold reserves by around 2020, which is recommended by JI Xiaonan. China currently has 1,054 metric tonnes of officially-reported gold reserves. In order to reach the 10,000 tonnes level by 2020, China would have to sell some of its US treasuries to buy gold on the open market. But such a move would have an extremely negative impact on the value of China’s remaining US dollar denominated assets and would simultaneously drive up the price of gold to new record highs. Even if China wanted to sell all of its $800 billion in US treasuries, it is very unlikely that it could get even close to 9,000 tonnes of gold. In fact, it is possible that JI Xiaonan’s mere suggestion that China should increase its gold holdings may have already made it more difficult to achieve: On Dec. 2, 2009, the day after his suggestion was published in the Chinese media, the USD price of gold rose to the new record high of $1215.80 per troy ounce.

Article Title:

International Experiences and Lessons and the Conditions for RMB Internationalization

Author:

PAN Yingli, Shanghai Jiao Tong University economics professor specialized in money and banking and international finance.

Date Published:

2009-05-22

Source:

This article originally appeared in the Wen Hui Bao newspaper and was later reprinted in the “Theory” section of the People’s Net, the online version of the People’s Daily: http://theory.people.com.cn/GB/49154/49155/9346759.html

Text:

The world-wide financial crisis has already loosened the foundation of the US Dollar standard both in terms of the economic base and government credibility, thus giving the internationalization of the RMB [renminbi: (lit.) “the people’s money”] a chance. However, success in the internationalization of the RMB requires three basic conditions: sustainable economic development, a system that has a sound market economy foundation with the protection of property rights as its core, and the establishment of Asia’s most important international financial centre.

In the recent modern history of the world, when it comes to the internationalization of sovereign currencies, there have been the successful experiences of the British Pound and US Dollar as well as the lessons of the failure of the Japanese Yen. Summarizing the basic experiences and lessons of the internationalization of these three sovereign currencies can aid our mental framework when pondering the promotion of the internationalization of the RMB.

The Experiences of the Internationalization of the British Pound and the US Dollar

First, when the internationalization of the British Pound and the US Dollar were getting under way, both Great Britain and the US were already the world’s most advanced industrialized nations and had accumulated abundant amounts of capital. When the gold standard was caught in a raging storm, the US accumulated vast gold reserves. This paved the way for the country’s currency, with the help of the nation’s strong economic position, to achieve internationalization.

Second, in the international balance of payments, both Great Britain and the US created favorable balances of trade by means of exports and exported their national currencies with the help of foreign direct investment. Great Britain used overseas British Pound loans to promote the use of its money as the currency of settlement and valuation in international trade. The US chose direct investment by private individuals as the ideal channel for supplying the world with US Dollars. In areas where private capital had no interest in investing, foreign aid was supplied by the US government. US industry and agriculture supplied Europe with the materials and resources it needed for reconstruction and development after the Second World War, but the US government provided the financing. In return, the other countries opened their economies and became dependent on US producers.

Third, at the point where the British Pound and the US Dollar reached the position of hegemony, Great Britain and the US took two different paths. Great Britain subjugated others with “honesty”: they used the model of marketization and gradual progress to implement the internationalization of the British Pound. Great Britain maintained the stability of the exchange rates between the British Pound and silver and gold for 360 years from 1560 to 1920. This allowed the British Pound to continue to be sufficiently trusted even after it became purely credit [or fiat] money. However, the US exploited the period of time after the Second World War, when its European allies were suffering most severe hardship and their power of negotiation was weakest, to force Great Britain and other allies to submit by means of the Lend-Lease Act and [other] credit and to promise to cooperate with the US or to accept the leading position of the US after the war. In the past nearly one hundred years, the greatest “masterpiece” of the US was that it knew itself and knew the others, used strategic plans with extreme prescience, and seized the best opportunity to implement the institutionalization of the hegemonic position of the US Dollar.

Fourth, they formed global international financial centers. Large capital markets with ample liquidity and safety - and it is especially the development of government debt markets which provides the best place for the financing and investment of each country’s government - are a necessary condition for the sovereign currency of a nation to serve as an international reserve currency.

Lessons of the Failure of the Internationalization of the Japanese Yen

Born at the Wrong Time: In the 1980’s, after going through a growth miracle, Japan’s economic strength had greatly increased, but politically and militarily it was still a vassal of the US. East Asian and South East Asian countries generally adopted the fixed exchange rate system of pegging to the US Dollar. In fact, the “US Dollar zone” caused Japan, a powerful trade nation, to have no way to promote international valuation and settlement in the Japanese Yen, and as a vassal of the US it was even less able to let other Asian nations give up pegging [their currencies] to the US Dollar and switch to pegging to the Japanese Yen.

A Lack of Stratagem: Under the guidance of the US, Japan took the wrong steps in internationalizing the Japanese Yen by accelerating the process of generating a bubble in its domestic economy and then popping it. The “Japanese Yen appreciation conspiracy theory” is very popular in our country, but in fact the September 1985 Plaza Accord, which forced the appreciation of the Japanese Yen, was a necessary result of the world’s economic imbalances. However, before the Plaza Accord, when the US took advantage of the Yen-Dollar talks to promote the opening of the Japanese financial markets and the internationalization of the Japanese Yen, this was to a very large extent a conspiracy. From this, it is not difficult to see the strategic design of the US to quickly grab the fruits of Japanese growth by means of financial capital investments while the Japanese Yen was appreciating. During the process of the appreciation of the Japanese Yen, Japan’s excessively expansionary monetary policy and the ‘opening of its doors to robbers’ by means of financial liberalization were obviously two serious mistakes. Japan’s success in internationalization, starting with an international reserve currency, vanished into thin air after the bursting of its bubble.

Insufficient from the Beginning: The failure to successfully implement the upgrading of the industrial structure and an economic remodeling caused the internationalization of the Japanese Yen to lack the support to continue. In the 1980’s, following the increase in domestic labor costs, Japanese businesses accelerated the pace of their foreign investments. The countries that [copied and] carried out Japan’s industrial shift and pursued the strategy of the export-oriented development model consistently took over Japan’s international market share. Japan originally should have sought out a new position in the international division of labor in the fields of the advanced manufacturing industry and the service industry, but the Japanese main bank system and the system of lifelong employment had no way of providing financial, technical, or labor support to the rise of the burgeoning industries. The issue of economic erosion became more serious day by day. The bursting of the bubble caused the Japanese economy to fall into a long standstill and the process of the internationalization of the Japanese Yen quickly reversed.

The Financial Sector Was Closed, Xenophobic, and Backwards: During the process of the internationalization of the Japanese Yen, Japan implemented a separation between the domestic and foreign financial markets. Innovation in the domestic markets, products, and organization was insufficient; especially innovation and liquidity amongst the tools of the money markets were insufficient and restricted the use of the Japanese Yen as an international settlement currency. Market liquidity is the fundamental factor in the improvement of the international competitiveness of a financial market, but Japan neglected the construction of exchange markets and the market liquidity of government bonds was extremely poor. Approximately one half of the Japanese government bonds were owned by public agencies and not only was market liquidity low, but there were distortions in the price mechanism of the government bond market.

The Basic Conditions for the Internationalization of the RMB and a Train of Thought for its Promotion

As one of the three foremost large economic entities in the world, China’s sovereign currency has the possibility of becoming an international currency. The world-wide financial crisis has already loosened the foundation of the US Dollar standard both in terms of the economic base and government credibility, thus giving the internationalization of the RMB a chance.

However, the success of the internationalization of the RMB requires three basic conditions: (1) Sustainable economic development. This condition depends on the success of the transformation of China’s economy with the principal characteristics being the expansion of the internal consumer markets, technological progress, industrial upgrading, and the improvement of the efficiency of economic functioning; (2) A system that has a sound market economy foundation with the protection of property rights as its core. This involves the transformation of the function of government and a relatively independent legislative and judicial order; (3) The establishment of Asia’s most important international financial center, which just means that China possess a modernized financial market system with an enormous scale, liquidity, safety, and maturity.

While simultaneously creating these basic conditions, one can still seize the opportunity and promote the gradually advancing internationalization of the RMB: (1) By means of constructing foreign sales channels and upgrading product quality, increase the dependence of foreign customers on Chinese products and simultaneously support RMB trade financing and the promotion of RMB valuation and settlement of exported products; (2) Quickly upgrade the level of internationalization of the financial services industry. On the one hand, accelerate the opening of the financial services sector to foreigners, permit the setting up of more foreign capital banking subsidiaries and permit all kinds of foreign capital backed financial organizations to engage in RMB transactions, and improve market efficiency and the quality of service by means of orderly competition in the domestic financial services industry. On the other hand, accelerate [the process of] domestic financial institutions going abroad to take over market share in the traditional financial service fields of the Asian regions and provide highly effective, convenient, internationalized RMB transactions; (3) Accelerate the development of the domestic RMB government bond market, including our country’s bond market and the bond markets of the local governments, and also [accelerate the development] of the issuance and trading in China of the bonds of foreign governments and international organizations, and increase their market liquidity; (4) Before opening up the RMB capital account (this should be after 2015 at the earliest), safely promote the indirect opening up of the market by using RMB QFII [Qualified Foreign Institutional Investor] and short-term interbank lending as the principal methods.

My Commentary:

This is another article on “RMB internationalization” and again demonstrates that strengthening the RMB’s international position is being advocated in the official Chinese press as an integral part of China’s long-term goal of creating a “moderately prosperous society” (xiaokang shehui) by 2020, the centenary of the CPC (Communist Party of China). However in this article, which appeared in the “Theory” section of the CPC Central Committee’s online newspaper People’s Net, “RMB Internationalization” is promoted as a goal in and of itself and not necessarily as a means to advance the building up of Shanghai as an “international financial and shipping center” by 2020, as was discussed in a previous article

The author does not explain what the advantages and disadvantages of having an international reserve currency are, but instead begins by explaining that the current lack of confidence in the US Dollar has afforded China the opportunity to introduce its own currency as a potential alternative. The main point of his article is to present the reader, primarily functionaries of the CPC, with a guide to promoting the international use of the RMB by reviewing the historical lessons of the British Pound, the US Dollar, and the Japanese Yen.

The author writes that in the case of the internationalization of the British Pound and the US Dollar, both countries first became wealthy industrialized nations with international financial centers, both had large gold reserves and adhered to a kind of gold standard or gold exchange standard, and both ran trade surpluses financed by granting loans to foreign countries in the national currency thereby leading to increased foreign reliance both on the nation’s currency and exports. The author implies that these three things were essential to success in exporting the national currency. One difference the author describes between the British Pound and the US Dollar is that the British Pound became the international currency by gaining the world’s trust through the Bank of England’s adherence to a stable British Pound to gold exchange rate that lasted hundreds of years while the US Dollar was supposedly forced on the world (through the Bretton Woods Agreements of 1944) during wartime when most countries were too weak to oppose it. While there may be some truth to this view, the allied countries had voluntarily sent their gold reserves to the US in the late 1930’s and early 1940’s in exchange for more easily transportable US Federal Reserve notes (when the US Dollar to gold exchange rate was fixed to $35/troy ounce) in order to prevent their confiscation by the Axis powers. After the war, they continued to be able to freely exchange the notes for gold at the $35/troy ounce rate until 1971. Of course, for the past 38 years the notes have not been redeemable for gold. Similarly, the Bank of England was also not perfect: several minor modifications were made to the British Pound to gold ratio and for 24 years, during the “Restriction Period” of 1797-1821, the bank did not redeem any notes for gold because its gold reserves had been used by the government to pay for the Napoleonic Wars.

In addition to these positive lessons from the history of the British Pound and the US Dollar, the author also draws negative lessons from the failure of the Japanese Yen to become a widely used international reserve currency. For example, he claims that Japan should not have tried to internationalize its currency while still under the military and political influence of the US. Also, he suggests that Japan should not have allowed itself to be fooled by the Yen-Dollar talks with the US, which resulted in the opening up of Japan’s financial markets before the Yen was allowed to appreciate, since this allowed US investors to profit from the appreciation. However, this criticism of Japan’s willingness to open its markets to foreign investors is difficult to reconcile with his subsequent critique of Japan’s closed financial system. Additionally, he faults Japan for creating the great inflationary credit bubble (from 1986-1990) that has been deflating ever since. However, he fails to mention that one of the causes of this credit bubble was the low interest rate policy that the Japanese central bank employed in order to keep the Yen undervalued against the US Dollar and thereby stimulate exports. In addition, the author partially blames Japan’s rigid system of banking and employment which contributed to the deterioration of Japan’s economy and thus dissuaded foreign countries from holding Japanese Yen reserves.

In conclusion, the author advises that China should take advantage of the world’s current loss of confidence in the US Dollar to gradually internationalize the RMB by sustainably growing the Chinese economy, improving the market economy and the protection of property rights, and developing Asia’s most important international financial center (presumably in Shanghai). He then proceeds to explain several technical methods that should be employed to help expand and develop this financial center.

One interesting omission is that despite pointing out that large gold reserves and a gold standard facilitated the successful internationalization of both the British Pound and the US Dollar, but were lacking in the case of Japan, the author does not openly advocate that China increase its gold reserves and implement some type of gold standard. After reviewing the monetary history of the world, I have not been able to find a single national currency that was widely accepted internationally unless it was either commodity money (like the silver Spanish dollar) or at least initially convertible to commodity money (like the gold-backed British Pound and US Dollar). It is difficult for me to understand how the Chinese RMB, a currency that is still pegged to and mainly backed by US Dollars, could become a widely trusted international currency without initially being redeemable for some kind of commodity. If the People’s Bank of China continues to only exchange US Dollars for the RMB, why wouldn’t foreigners just hold US Dollars? It remains to be seen whether it is possible for an inconvertible national currency to be successfully internationalized without first going through a confidence-building period of convertibility into commodity money. Perhaps China’s announcement in April 2009 that it has increased its gold reserves from 600 to 1054 metric tonnes suggests that the People’s Bank of China does understand the additional historical lesson of the importance of gold backing for currency internationalization. However, in order to fully implement commodity backing for the RMB, China would have to abandon its US Dollar peg, which has thus far allowed it to maintain its export-driven economy by amassing the politically important reserves of US treasuries with which to continue the currency peg and increase the US debt-fueled consumption of its exports by helping to drive down US interest rates. It remains to be seen when this will occur.

Article Title:

Correctly Understanding the Changes that Will Be Brought About by the Internationalization of the Renminbi

Author:

LU Qianjin, Assistant Professor of International Finance, Monetary Theory and Policy, and Time Series Analysis at Fudan University, Shanghai.

Date Published:

2009-04-15

Source:

This article originally appeared in the Shanghai Securities Newspaper. It was then republished in the “Theory” section of the People’s Net, the online version of the People’s Daily: http://theory.people.com.cn/GB/49154/49155/9132560.html

Text:

Recently, our country has been carrying out currency exchanges with several countries and has actively launched RMB [Renminbi: People’s Currency] account settlement of cross-border trade; the internationalization of the RMB has taken a crucial step. RMB internationalization is an important goal of the financial development of our country and we must achieve this goal from a strategic high point. However, following the export of our RMB, our country’s international current account surplus could decrease, and our money supply and mode of economic growth might also change. It will also simultaneously put greater demands on the reform and development of financial marketization. We should correctly view these changes that will be brought about because of the promotion of RMB internationalization.

For a long time, our country’s international current account has featured a doubly positive balance [in both the trade account and capital account] and our foreign exchange reserves have continued to grow. Following the promotion of RMB internationalization, the RMB assets held by foreign importers and exporters will rise, China’s international current account surplus could fall, or a negative balance could appear, and in other countries, an international current account surplus could emerge. Seen from the angle of the trade account, if we settle accounts with, and export the RMB, and our country’s trade balance becomes negative, the more the RMB is held outside the country, the greater the trade balance deficit will be (of course, this assumes that all trade is settled in RMB, if accounts are also settled in other currencies, the export of the RMB will not yet necessarily lead to a trade balance deficit). Seen from the angle of the capital account, RMB valuation and account settlement is advantageous for domestic companies that want to expand, establish overseas branches, or do mergers and acquisitions, and engage in transnational investment, production, and sales. If transnational investment increases, a capital account deficit could also appear. Of course, this will also depend on the balance of inflowing and outflowing capital. If there is a net outflow of the RMB, and the inflow of other currencies is less, then the capital account balance will be negative, otherwise it will be a positive.

In any event, viewed in its totality, as the scope of the export of the RMB becomes ever greater, the international current account could deteriorate, but the inflow of real resources from abroad will increase. As long as foreign debt is within a manageable range, the deterioration of the international current account is not a bad thing in and of itself.

With the export of the RMB, the structure of the foreign exchange funds supporting the [RMB’s] monetary base will be changed.

Regarding the increase in our country’s monetary base, it has for a long time been mainly caused by the constant increase of foreign exchange funds: the increase in foreign exchange funds on the assets side [of the central bank balance sheet] meant that the monetary base on the liabilities side could also increase. In order to prevent the monetary base from increasing too quickly, the central bank raises the legal reserve ratio [for banks] or reduces it by selling notes. Looking at the central bank’s balance sheet, [one sees that] the scope of our country’s adjustment of the monetary base by means of buying and selling government bonds and rediscounting notes has been relatively small and is by no means the main source of monetary supply. If our country’s international current account surplus falls, the main channel for supplying the monetary base will gradually transition towards relying on open market transactions and rediscount transactions, and the influence of foreign exchange funds on the monetary base will decrease. Currency exchange and RMB account settlement of cross-border trade could both lead to a decrease in our country’s foreign exchange funds, and our country’s foreign exchange reserves could also fall somewhat.

The export of the RMB could also have a major impact on our country’s domestic-foreign equilibrium. China’s economic growth method depends mainly on exports and investment. Looking at the composition of American and Chinese GDP, America’s consumption makes up around 70% of its GDP, and China’s consumption makes up 35% of its GDP, which is only about half that of America. Because it has been struck by the financial crisis, foreign demand has fallen, and China is currently striving to change its economic growth method and break away from excessive reliance on foreign demand. Exporting the RMB can promote the improvement of China’s economic growth method. The more the RMB is exported, the more the international current account surplus can fall, and China’s economic growth will rely more on domestic demand to fuel economic growth. The internationalization of the RMB and the transformation of [China’s] economic growth method are interrelated and synergistic. In addition, RMB internationalization will put new demands on China’s financial marketization reforms. Cross-border RMB circulation could influence the supply and demand for capital in China’s financial markets, and then it could influence China’s exchange rates, interest rates, commodity prices, and the price levels of financial assets. Therefore, one would have to promote marketization reforms of China’s exchange rates, interest rates, and price levels, otherwise it would be difficult to avoid the dangers of exchange rate and interest rate arbitrage, the dangers of exporting the RMB would increase and the process of RMB internationalization could be blocked.

In the financial markets, in order to make preparations for future RMB capital backflow, our country should accelerate the development of the government bond market. The author believes that this could be the main investment market for future RMB capital backflow. Currently, judging by the bond balance of the government bond market, the trading volume of the secondary markets, and the bid-ask spreads and turnover rates of the secondary markets, our country’s government bond market lacks a certain breadth and depth. Looking at the process of the internationalization of the US dollar, [one can see that] other countries collected large amounts of US dollar assets such as petro-dollars, Eurodollars, and Asia-dollars, and these US dollar assets could also flow back into America. They are mainly invested in America’s financial markets; mostly in America’s government bond market. Therefore, within a short period of time, we must actively give our financial institutions the impetus to go abroad to serve the internationalization of the RMB. We can consider expanding the establishment of branches of our country’s banks in neighboring countries and areas, we can accept RMB bank deposits, and we can provide safekeeping and investment channels for the RMB capital of various countries. In a situation where the bond market is not yet very developed, in order to regulate and control the macroeconomy, the central bank controls the money supply by means of selling central bank notes, but from a long-term perspective, government bonds will be the main tool for regulation and control and [the main] investment tool. The reason is that this is not only advantageous for maintaining the independence of the central bank’s monetary policy, but is also advantageous for promoting RMB internationalization and future RMB capital backflow. And this requires that we make great efforts to develop the capital markets, and especially accelerate the perfection of the construction of the foundation of a government bond market, while simultaneously striving to promote RMB internationalization.

My Commentary:

This article on “RMB internationalization” is interesting because strengthening the RMB’s international position is an integral part of China’s long-term goal of creating a “moderately prosperous society” (xiaokang shehui) by 2020, the centenary of the CPC (Communist Party of China). This 2020 goal, which is recorded in paragraph 9 of the CPC Constitution’s General Program, is periodically updated with specific targets. For example, in 2007, Chairman HU Jintao announced the target of quadrupling China’s 2000 nominal per capita GDP (which was at USD 800) by 2020, thus yielding a per capita GDP of USD 3200. However, this may now occur about a decade early, in which case the target will probably be raised. Not all of the CPC’s targets for this long-term goal of achieving a “moderately prosperous society” by 2020 are purely economic in nature. For example, China’s PLA (People’s Liberation Army) has set the target of “achieving complete mechanization” of the armed forces before 2020. Coming back to the present article, an addition to this long-term goal was made recently on March 25, 2009, when China’s State Council added the target of building up Shanghai as an “international financial and shipping center” by 2020. LU Qianjin, the author of the present article, is arguing that RMB internationalization is crucial for reaching this target. The fact that this article was republished in the “Theory” section of the CPC Central Committee’s online newspaper People’s Net shows that it is being taken seriously in China and therefore deserves, in my opinion, to be presented to the West.

Even though China only recently began its pilot program of allowing some cross-border settlement in RMB on April 8, 2009, LU Qianjin sees great long-term potential in internationalizing the RMB. He believes that exporting the RMB around the world could have numerous positive effects on China’s economy. For example, he believes that it would help decrease China’s trade account and capital account surpluses, which he maintains would be good as long as foreign debt remains low and as long as the net result is an increase in the “inflow of real resources from abroad”. Exactly how this would be possible is unclear to me.

Additionally, he believes that a decrease in the trade and capital account surpluses would lead to changes in the balance sheet of the PBC (People’s Bank of China, China’s central bank). This is because the PBC currently has to massively expand the RMB monetary base in order to balance out it’s huge inflow of US dollars, which results from China’s surpluses. Of course, Western economists would likely argue that both China’s surpluses and the PBC’s need to expand its monetary base stem from the undervaluation of the RMB. According to LU Qianjin, if exporting the RMB pushes down the surpluses, presumably because foreign importers could pay in RMB instead of US dollars, the PBC’s expansion of the monetary base will no longer be necessary. This would, in turn, lead to a slower expansion of the entire money supply and thus relieve inflation.

LU Qianjin also argues that RMB internationalization would help fix the US-China consumption imbalance because the surplus reduction would force China’s economy to rely more on internal demand for economic growth, thus changing China’s export and investment driven economic model. In addition, he believes that exporting the RMB will necessitate “marketization reforms”, meaning financial market liberalization, to avoid the potential harm that speculators could cause with arbitrage bets. If exchange rates, interest rates, and asset prices were no longer set or managed by the Chinese authorities, it would be less likely that speculators could take advantage of inefficiencies to make profits.

Finally, LU Qianjin proposes building up a mature government bond market in China to offer foreign investors a place to invest their RMB. This he believes is essential for dealing with the future problem of “RMB capital backflow”. It appears that he envisions the RMB following the path of the US dollar to become a globally important currency that can be used to purchase commodities worldwide and for international trade. He proposes giving China’s state-owned banks the incentive to go abroad and set up branches to “serve the internationalization of the RMB” by allowing foreigners to open up RMB accounts in their own countries. This may partly explain Bank of China’s decision to open a private banking branch in Geneva in November 2008. LU Qianjin also believes that the PBC should eventually rely on RMB government bond transactions to control the money supply and thereby “regulate and control the macroeconomy”. He thus suggests that China eventually follow the example of the Federal Reserve and other Western central banks. The implications of such a change would be radical because it means the PBC would attempt to back the RMB with RMB government bonds, instead of with US government bonds. Among other things, this would mean that the US government would have to either find other major buyers of its debt or eventually spend less money.

It is unclear to me whether the future monetary path envisioned by LU Qianjin is likely to be adopted by the CPC. While I certainly believe the CPC would like China’s currency to play a more important role internationally, I don’t understand why they would allow their surpluses to shrink, which have until now given them so much political and economic leverage. Also, I don’t know if it is even possible for the PBC to back the RMB with RMB government bonds. It is true that the US Federal Reserve has US dollar bonds on the assets side of its balance sheet, however, it also still officially has 8133 metric tons of gold, which, if marked to market, would cover almost one third of the 800 billion US dollars in world-wide circulation (which was also the size of the entire US dollar monetary base until it was recently tripled by the Fed’s purchase of toxic assets). Some economists argue that the US dollar was only able to become the world’s dominant currency because it was backed by gold and redeemable to all until 1933 and to other central banks until 1971. While no longer redeemable, the Federal Reserve’s gold still backs a significant portion of its monetary base. It is debatable whether China could create an international currency backed to a large extent by its own debt without first going through the stage of having an internationally trusted, redeemable, gold-backed, or asset-backed currency. The one thing we can be fairly certain of, however, is that China’s leaders have grand and long-term plans for the future of their currency and that at least some of them are taking LU Qianjin’s opinions into consideration.