Eswar S. Prasad - Gaining Currency: The Rise of the Renminbi

Eswar S. Prasad

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Library of Congress Cataloging-in-Publication Data

Names: Prasad, Eswar, author.

Title: Gaining currency : the rise of the renminbi / Eswar S. Prasad.

Description: New York, NY : Oxford University Press, [2017] | Includes bibliographical references.

Identifiers: LCCN 2016017263| ISBN 9780190631055 (hardcover) | ISBN 9780190631079 (epub)

Subjects: LCSH: Renminbi. | Foreign exchangeChina. | FinanceChina. | ChinaEconomic policy2000

Classification: LCC HG1285 .P73 2017 | DDC 332.4/50951dc23 LC record available at https://lccn.loc.gov/2016017263

To Basia

My Muse, my love, my true friend

Zawsze i na zawsze

I have only to beg that readers, who have been unaccustomed to see Chinese matters treated from a rational point of view, will believe that I am no Mandarin worshipper, and that I am quite alive to the great faults of the Chinese nation and Government. Their civilisation, like our own, has been in great part a failure, though perhaps not such a saddening one as ours, for it has not had such fine material to work upon; but we must at least understand it and treat of it as it really exists, if we would avail ourselves of its experience It is desirable that we should know [the Chinese] system as it really is, and not as it has been fancifully representeda subject of ridicule to amuse the passing hour, or a subject of abuse to justify dubious aggressions.

The Ever-Victorious Army: A History of The Chinese Campaign Under Lt.-Col. C.G. Gordon and of the Suppression of the Tai-Ping Rebellion, .

Chinas economy is now the second largest in the world. In 2015, its annual gross domestic product (GDP) was $11 trillion, accounting for 15 percent of world GDP, placing it second only to the United States, which has a GDP of $18 trillion. China is also an important player in international trade, accounting for 12 percent of global trade in goods. Chinas impact on the world economy is even greater when measured along other dimensions. The country holds about 30 percent of global foreign exchange reserves and has accounted for one-third of global GDP growth since the financial crisis. China is big (

Figure P.1 China and the world (share of world total, in percent). All data are for 2015. Gross domestic product is in market prices. Trade refers to merchandise trade (only goods). Chinas share of world trade in goods and services is 11 percent. Foreign exchange reserves data begin in 1989.

Sources: International Monetary Fund, Peoples Bank of China, and World Trade Organization.

Despite Chinas economic might, the international stature of its currency, the renminbi (RMB), does not quite match that of its economy. Among the currencies of the worlds six largest economies, the RMB is only now beginning to emerge as a factor in the global economy. The othersthe U.S. dollar, the euro (which covers two of the six largest economiesGermany and France), the Japanese yen, and the British pound sterlingall have well-established roles in global finance.

In recent years the Chinese government has taken a number of steps to elevate the RMB into this group of elite currencies by increasing its international use. The RMBs adoption in global markets is constrained, however, since the Chinese economy has neither a fully market-determined exchange rate nor an open capital account that allows for free cross-border capital flows. Nevertheless, given Chinas sheer size and its rising shares of global GDP and trade, the governments steps are rapidly gaining traction.

This book takes stock of Chinas progress in promoting the RMB as a major currency in international financial markets. While the currency has made remarkable progress in a relatively short period, it is far from assured that it will continue along the same impressive trajectory it has followed for the past few years. To be sure, the RMB will become a significant player even if its rise to prominence levels off, yet its full potential may remain unrealized unless the Chinese government undertakes a broad range of reforms.

Although China has used money in some form for more than two thousand years and was actually the first country to use paper money, the RMB came into being only in 1949. provides a brief history of the evolution of Chinese paper currency, beginning with the Tang dynasty in the seventh century AD and tracing it to the present, following many twists and turns along the way. Even the tale of how present-day RMB notes came to look as they do reveals a colorful history.

There is a great deal of hyperbole surrounding the RMB, with some commentators arguing at the extreme that its displacement of the dollar as the dominant international currency is imminent. Such popular prognostications tend to conflate distinct elements of a currencys role in international finance. unpacks three related but distinct aspects of the RMBs role in the global monetary system. First, capital account convertibility reflects the extent to which China restricts inflows and outflows of financial capital that are intermediated through transactions involving the RMB and foreign currencies. A fully open capital account has no restrictions on cross-border capital flows. The second aspect, internationalization, involves the use of the RMB in denominating and settling cross-border trade and financial transactionsthat is, its use as an international medium of exchange. The third aspect is whether the RMB serves as a reserve currency, which is one that is held by foreign central banks as protection against balance of payments crises.

The remainder of the book evaluates these three elements within a unified conceptual framework and analyzes their implications along two dimensions: first, by reference to the balance and sustainability of Chinas own economic development; and second, by reference to the associated implications for the international monetary system, including the possible impact on the U.S. dollar and other existing reserve currencies.

documents the evolution of Chinas capital account openness in terms of official policy changes to restrictions on capital flows as well as the actual levels of foreign investment in China and the countrys own investment abroad. Why and how China has opened up its capital account is a story of some intrigue in itself.