China's renminbi as world reserve currency?

Reported in USA Today, Money section...(7th Oct, 2014)

Main point:

China is making moves to become part, technically or fundamentally, of the world's reserve currencies as a member of the IMF's Special Drawing Right department. As the world's second largest economy, the Chinese government does have a point - as more and more international trade is denominated in yuan, the argument is that such a large currency provider should be part of the mainstream. Indeed, the UK government has recently issued renminbi denominated bonds with the Bank of England holding proceeds. Over the next decade, we should expect increasing renminbi flows through the commercial and central banks similar to the flows we get from the Euro and Sterling.

Secondary point:

It also makes sense in many respects from a Sino-political point of view. If China pushes for world reserve currency status, the USA would finally be sidelined economically and politically: the American century will have ended and the Chinese would begin. Much has been discussed about China's economic and political growth over the past two decades. Some worried about a single party, undemocratic state gathering so much wealth and power, others content to see a more even balance of power emanating around the world.

Commentary.

Whatever the political implications - which are always difficult to assess while they are proceeding - the economic implications are at once obvious but at another glimpse less obvious.

A large currency joining the international markets makes sense. It will be touted as providing greater stability and a political economic balance to global financial markets: an Asian counter balance to the mighty dollar-euro axis. Culturally, the Chinese government will have to accept more transparency in its dealings (especially gold flows), and that in its turn will give the renminbi greater kudos and accordingly help China attract more foreign investment and allow its banks to flourish around the world too.

Nice story. But the downside - and not something to concern central bankers or international banks who are more likely to welcome another club member - is less obvious. Or it will be to the mainstream media.

China prints money. Just like the other members of the club. It creates money and hence 'value' out of thin air. The Bank of China is as inflationist as all the other central banks (inflationism = the policy of devaluing a currency). The renminbi is a paper currency. And that mean that the BofC has no brake on what it can print.

Ironically, the Chinese were the first to place with paper currency a thousand years ago. They banned it because of its powerful and detrimental economic effects. Wise move. Now some of that wisdom has been forgotten - probably by high flying Chinese economists indoctrinated in western monetary economics at our top universities!

Another big inflater on the bloc is likely to unleash more global inflation - world price indices would tick up and an up and the poor of the world will wonder quietly why their lives are getting harder and why famine and poverty are never curtailed. Political theorists will create complex theories on why the South is being exploited by a West-East partnership. And wars will break out in areas of high poverty and unemployment and disaffection.

On the other hand, gold bugs are aware that China has imported tonnes of the stuff over the past decade - China could take a golden opportunity to attach the renminbi to gold and profit massively by becoming the ultimate world currency (gold never left that spot - it has only been politicians dreaming that the gold standard ended). Now that would be something!

(Is it so far fetched? James Rickard's in his excellent Currency Wars elaborates on the thesis).