Despite China's ambitions, renminbi in no position to topple dollar

People’s Bank of China Governor Pan Gongsheng on Wednesday made a strong pitch for a multipolar international monetary system and warned against excessive reliance on a single currency. The message clearly is to shift away from the dollar-denominated global financial system. China has been consistently trying to project the renminbi (RMB) as an international currency. Six foreign banks announced on Wednesday that they would use China’s Cross-Border Interbank Payment System, an alternative to the SWIFT (Society for Worldwide Interbank Financial Telecommunication) payment system. In principle, there is merit in the argument that the world should not rely on one currency or one payment system to settle cross-border payments. Given the state of American politics and policy, such views may gain traction. For instance, European Central Bank President Christine Lagarde recently remarked that the dominant role of the dollar was no longer certain. 

 

The Donald Trump administration is pushing the United States (US) into uncharted territory in so many ways that it’s difficult to gauge where and how things will eventually settle. President Trump, for instance, has decided to change the way the US trades with the world. In his book, a trade deficit with any country is bad, and tariffs are the best way to deal with it. With his July 9 deadline for trade deals fast approaching, it is not clear how many trading partners the US will have an agreement with. Nonetheless, what is clear is that tariffs will be much higher, and the US will have done significant damage to the rules-based trading system. The uncertainty is hurting the real economy. 

 

The Federal Reserve, for instance, decided to keep the policy rate unchanged on Wednesday, mainly because of tariff-related uncertainty. The Federal Reserve’s new economic projections showed that it now expects the inflation rate to be 3 per cent in 2025, as against the March projection of 2.7 per cent. Further, it expects gross domestic product to grow 1.4 per cent in the current year, compared to the March projection of 1.7 per cent. The prospect of falling growth and rising inflation puts a central bank in a difficult spot. The administration’s position on trade is not the only problem. The complete disregard for institutions can do enormous damage. Mr Trump, for example, called Federal Reserve Chairman Jerome Powell “a stupid person” before the policy decision was announced. Financial markets don’t like central banks being pressured by governments. Furthermore, the US is on an uncertain fiscal path with debt stock expected to rise substantially in the coming years.

 

The current US position certainly doesn’t inspire confidence, and it would get reflected over time in trade and capital flows. However, this would not automatically boost the RMB’s chances. Since China is a trade powerhouse and the world’s second-largest economy, some bilateral and regional trade may move to RMB-based systems. There are at least two fundamental hurdles for the RMB in its path to becoming an international currency. The RMB itself has been pegged to the dollar for decades, which has been enabled by tight capital controls. China is unlikely to give up capital controls in the foreseeable future. For wide international usage, a currency needs to be freely traded. Second, China runs a massive current-account surplus, which means there won’t be enough RMBs in the rest of the world to be traded.  Therefore, while there are concerns about the US and the dollar, the RMB is not in a position to fill the gap. Nevertheless, the global monetary system might become more fragmented in the coming years, resulting in higher costs and increased uncertainty.