by Quinn Tai Barrie-Watts
edited by Jamie Miura
Scholars have predicted and observed the rise of China’s currency as an international medium of exchange for the past decade. The Renminbi (RMB) or yuan, which is the unit of account, gained official international currency status in 2015 when the International Monetary Fund (IMF) included the RMB in what the organization calls its Special Drawing Rights (SDR) basket.[i] The SDR is reserved for national currencies that are widely used in international monetary transactions.[ii] As previously put forth by Daniel McDowell and David A. Steinberg, this paper will support their argument that China will not surpass the United States as a key currency issuer, despite having similar economic and military strength to the United States and past key currency issuers such as Great Britain. First, the term “key currency” will be defined in accordance to Susan Strange’s conceptualization. Next, China’s economic situation and systemic position will be compared to that of Great Britain in the 1800s, focusing on their strong economies, their linkages to international trade and investment, and their military capacities. Comparisons will also be made between China and the United States in more recent times, highlighting their military spending and other economic characteristics such as Gross Domestic Product (GDP). Lastly, the challenges China faces in building confidence in the RMB will be presented, using political economy theories such as capital control, the distribution of power, and Robert Keohane’s hegemonic stability theory.
KEY CURRENCY AND THE WORLD POWERS
According to Strange’s “key currency” theory, the international economy lacks a “world currency” but needs an international medium of exchange.[iii] National currencies are arrayed hierarchically in terms of their value and confidence state actors have in them, with the key currencies being the most attractive to other countries. Key currency issuers have many advantages over other countries.[iv] For example, they gain bargaining power because other states become reliant on their services. Furthermore, key currency issuers can run deficits in their balance of payments in the short run.[v] However, the Chinese government faces a long road ahead to obtain the benefits the United States currently hold. In 2017, the US dollar made up 60% of the world’s current reserves, with the Euro a distant second at 20%.[vi] The RMB may have a chance at unseating the US dollar if the Chinese government continues to grow the country’s economy, and if they continue to act as a strong revisionist state by participating in and reforming existing international institutions.[vii]
To become a key currency issuer, a state needs to be strongly linked to the international economy. For example, Great Britain had a booming economy in the nineteenth century despite its lack of domestic resources.[viii] The country’s economy developed because its domestic actors became highly engaged in overseas trade, which was facilitated by its favourable geographic location.[ix] China, too, has developed strong trade relations with countries around the world. In fact, Shanghai recently surpassed the Netherlands’ Rotterdam as the world’s busiest port.[x] Furthermore, starting in the 1980s, the Chinese government began developing relations with African countries. Under the government of Deng Xiaoping, China experienced rapid economic growth. The enrichment of the population led to the expansion of the bourgeoisie, which in turn resulted in an increased need for energy resources such as oil and raw materials.[xi] To meet this need, the Chinese government turned to the African continent for these resources, and further diversified the business deals by pursuing ventures in infrastructure, manufacturing, telecommunications, and agriculture.[xii] Additionally, Xi Jinping’s government launched the ambitious Belt and Road Initiative (BRI) in 2013, a network of infrastructures that would facilitate trade between China and Europe via the Middle East and Africa.[xiii] The BRI may allow the Chinese government to gain a monopoly on the global trade system, as having a large economy with a stronghold in international markets facilitates the building of extensive networks. Therefore, this increases the likelihood that foreigners will want to hold assets in that country’s currency and use their currency in the market.8 The BRI should enhance the RMB’s recognition and usage by China’s trading partners, and possibly propel the RMB past the US dollar as top key currency issuer.
In addition to having a strong economy, a key currency issuer must have a strong military. Great Britain, indeed, was endowed with limited land but a large population. Following the Napoleonic Wars at the beginning of the nineteenth century, Great Britain emerged with a powerful navy.[xiv] Combined with the dawn of the Industrial Revolution, the country developed key economic and military advantages over other European states, which allowed Great Britain to rise to global dominance.[xv] Today, China’s factor endowments are arguably better than Great Britain’s at that time, as they currently have the largest population in the world, and vast amounts of land. China has also built a strong military in recent years. According to the realist tradition, “states which possess a substantial share of global military capabilities receive a credibility boost which can lead to increased international confidence, and thus investment, in its currency.”[xvi] In fact, over the past decade, China’s military spending has increased by an average of about 10% and its military budget now ranks second in the world, with the United States claiming the top spot.[xvii] The spending gap between China and United States remains quite large, though the Chinese government has narrowed the it quite significantly in the past few years.
Nonetheless, China has a fierce competitor in the United States, as the US dollar has maintained its value around the world. However, China has surpassed the United States in severable economic arenas. The GDP gap between China and the United States has decreased over the past two decades, and China has already surpassed the United States as the world’s largest economy in terms of purchasing power parity (PPP).[xviii] In 2012, China surpassed the United States as the world’s largest trading country, accounting for 26% of the world’s trade, a rise of over 10% in the past decade.[xix] China’s increased linkage to the international community through trade will most probably encourage partners to conduct business using the RMB. In fact, about a quarter of China’s trade in 2015 was conducted in RMB and, in 2013, it became the second most used currency in international trade.[xx] As China continues to become a strong trading partner, it is logical that foreign countries will eventually want to hold RMB in their reserves. In doing so, countries will be able to facilitate business deals with China.
THE CHALLENGES TO UNSEATING THE GLOBAL HEGEMON
The RMB is certainly an eligible candidate to surpass the US dollar, but it faces many challenges according to political economy theories. The first challenge China’s RMB faces in its journey to surpassing the US dollar can be understood through the “capital control” theory. A state can choose to have no capital controls, in which money can easily move in and out of its borders. States can also put capital controls in place, thus preventing money from flowing out of its borders and preventing domestic citizens from purchasing foreign assets and foreigners from investing domestically. While the United States has removed capital controls, China has not. This limitation on the flow of capital coming in and out of the country ultimately limits China’s full integration into the world economy. China’s military capacities may increase the state’s credibility and international confidence, but with the government keeping their capital within its borders, the RMB cannot grow in confidence if foreigners cannot use the currency. Although China is highly engaged in international trade, the government needs to allow money to flow in and out of its borders in order for the RMB to become attractive to foreign investors.
Moreover, even though China is a key player in international trade and has a powerful military, the government will face challenges in toppling the US dollar because of today’s distribution of power. Great Britain enjoyed almost one hundred years as a key currency issuer and global hegemon when the pound was pegged to gold, but this reserve system was too difficult to maintain during World War I. In fact, during the interwar period, the country attempted to reinstate the gold standard regime, but its attempts failed because other countries had taken advantage of the floating exchange rates to fuel their economies during the war.[xxi] Moreover, Great Britain had strong competition from the United States, whom it shared almost equal power and influence with during the interwar period up until the beginning of the Bretton Woods regime in 1944.[xxii] The rise of the United States and its dollar vis-à-vis Great Britain and the pound resulted in a bipolar world. The Bretton Woods regime ushered in a new era led by the United States.[xxiii] Since then, the United States has been able to retain its position of global dominance, even when the Bretton Woods regime ended. However, the likelihood of China taking the reigns from the United States as the top key currency issuer is not likely to happen anytime soon, especially with the country’s recent economic stagnation.[xxiv] Nevertheless, the world has arguably returned to a state of bipolarity, with China and the United States on both poles.
In order to the surpass the US dollar, the Chinese government should successfully pursue hegemonic stability. According to institutionalist Robert Keohane, the “hegemonic stability” theory refers to a hegemon that establishes a regime to provide stability and cooperation mechanisms in the international system. The regime allows other states to collaborate with one another under the guidance of the leader state.[xxv] A hegemon leads by making or changing rules in the international system. China is attempting to provide cooperation through the BRI, and by making its currency attractive through devaluations. However, the government needs to turn its attention to making the RMB more attractive internationally by increasing its confidence and removing its capital controls. For example, Great Britain’s booming economy in the 1800s allowed the country to become an influential state actor in the international system. The government repealed a tariff on wheat (known as the Corn Laws), opened up its borders to free trade, and chose to peg its currency to gold to increase its confidence. Upon implementation of these measures, other countries began following suit gradually, opening up their borders to trade and fixing their own currencies to gold accordingly. In order to foster the RMB’s position as a key currency, China may have to implement a regime similar to the Gold Standard or Bretton Woods, which would allow the Chinese government to dictate exchange rates and encourage the international community to comply without excessive coercion. The ability of China to implement such as a regime may be far down the road, but the attainment of international medium of exchange status and the creation of the BRI is a step in the right direction.
In conclusion, Xi Jinping and his government have successfully made the RMB a key currency, though the RMB is far from unseating the US dollar as the top key currency. Given contemporary China’s similarities with Great Britain in terms of its economic position when the latter country was rising in the global system, it seems the RMB may eventually become more valuable than the US dollar. More recently, China has also surpassed or is second to the United States in a number of key economy arenas. However, international relations theories predict that China must attain a certain political position in the eyes of the international community in order for the RMB to surpass the US dollar. Furthermore, the United States is a strong opponent for China to compete with. For the RMB to surpass the US dollar, the Chinese government would need to increase confidence in the RMB, and then establish an international monetary regime that the international community would be willing to accept. Moreover, the Chinese government must be willing to remove its capital controls. The RMB may eventually surpass the US dollar, but the likelihood of this occurring in the near future is slim because China would need to make certain economic decisions and play political catch-up to its rapid economic growth and expansion.
Quinn Tai Barrie-Watts recently graduated in May 2019 with a degree in Honours Political Science and a Minor in East Asian Language and Literature. She was adopted from China at 14 months old, a fact that inspired her to pursue a minor in the East Asian Studies Department. Quinn has a wide variety of academic interests in political economy, international law, human rights and the provision of healthcare. She will be pursuing a Master of Arts in Political Economy in the fall at the University of Ottawa.
[i] Daniel McDowell and David A. Steinberg, “Systemic Strengths, Domestic Deficiencies: The Renminbi’s Future as a Reserve Currency,” Journal of Contemporary China 26, no. 108 (2017): 802, https://doi.org/10.1080/10670564.2017.1337292.
[ii] McDowell and Steinberg, “Systemic Strengths,” 801.
[iii] Susan Strange, Sterling and British Policy: A Political Study of an International Currency in Decline (London: Oxford University Press, 1971).
[iv] Mark Brawley, Power, Money and Trade: Decisions that Shape Global Economic Relations (Toronto, Ontario: University of Toronto Press, 2005), 3082. Kindle Edition.
[v] Brawley, Power, Money, 3082.
[vi] Daniel McDowell and David A. Steinberg, “Systemic Strengths, Domestic Deficiencies: The Renminbi’s Future as a Reserve Currency,” Journal of Contemporary China 26, no. 108 (2017): 802, https://doi.org/10.1080/10670564.2017.1337292.
[vii] Qin Yaqing, “International Society as a Process: Institutions, Identities, and China’s Peaceful Rise,” The Chinese Journal of International Politics 3, no. 2 (July 1, 2010): 137, https://doi-org.proxy3.library.mcgill.ca/10.1093/cjip/poq007.
[viii] Paul Knox et al., Human Geography: Places and Regions in a Global Context, fourth canadian edition ed. (Toronto: Pearson-Prentice Hall, 2013), 69.
[ix] Knox et al., Human Geography, 69.
[x] Knox et al., Human Geography, 69.
[xi] Eleanor Albert, “China in Africa,” Council on Foreign Relations, last modified July 12, 2017, accessed September 18, 2018, https://www.cfr.org/backgrounder/china-africa.
[xii] Albert, “China in Africa,” Council on Foreign Relations.
[xiii] Planet China,” The Economist, July/August 2018, 13.
[xiv] Knox et al., Human Geography, 69.
[xv] Knox et al., Human Geography, 69.
[xvi] McDowell and Steinberg, “Systemic Strengths,” 804.
[xvii] McDowell and Steinberg, “Systemic Strengths,” 805
[xviii] McDowell and Steinberg, “Systemic Strengths,” 803.
[xix] McDowell and Steinberg, “Systemic Strengths,” 803
[xx] McDowell and Steinberg, “Systemic Strengths,” 804.
[xxi] Brawley, Power, Money, 4953.
[xxii] Brawley, Power, Money, 5464.
[xxiii] Brawley, Power, Money, 5459.
[xxiv] Christopher Balding, “What’s Causing China’s Economic Slowdown,” Foreign Affairs, last modified March 11, 2019, https://www.foreignaffairs.com/articles/china/2019-03-11/whats-causing-chinas-economic-slowdown.
[xxv] Robert Keohane, “Hegemony in the World Political Economy,” in After Hegemony: Cooperation and Discord in the World Political Economy (Princeton, NJ: Princeton University Press, 1984), 33.
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“Planet China.” The Economist, July-Aug. 2018, p. 7.
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