From a ‘people’s currency’ to a global currency

By Rashmin Lokubandara

A less well-known fact about China is that it invented the first paper or fiat currency in the 7th century.

As per the Financial Times lexicon, a fiat currency has “no intrinsic value in themselves and not convertible into gold or silver, but made legal tender by fiat (order) of the government”. The key word here is “by legal tender by fiat (order) of the government”, though China did have the obvious advantage of having invented printing first. 

The paper money of the 13th century Yuan Dynasty (no pun intended) was backed both by the ruler’s reputation and the threat of execution for any subject who refused to accept it as legal tender. 

The modern day currency of China is called the “Renminbi” and loosely translates into English as the “people’s currency”, keeping well with the official communist ideology of the country. More importantly, the threat of execution for those who refuse to accept the “people’s currency” as legal tender is absent. The latter day progeny of the first fiat currency rules not by terror but by the reputation of its issuer.

And what a reputation China has: despite hairsplitting on the accuracy of data on the Chinese economy, China has established itself an undeniably central role in the global economy – first as the low cost factory to the world and now as its second act, the transition to an economy driven by domestic consumption. 

When the economist Jim O’Neill coined the term BRICS in the early 2000s, he estimated that it would at least be the end of 2015 before China overtakes Japan. However by 2018, China’s economy is already two-and-a-half times larger than Japan’s, five times the size of India and larger than the entire Eurozone. 

The $ 1.5 trillion expansion (in nominal terms) of the Chinese economy in 2017 alone is sufficient to create an economy the size of Korea and is equivalent to three times the size of the Swedish economy. Another interesting metric is that the Chinese consumer, making up 40% of the Chinese GDP, has added $ 2.9 trillion to the world economy since 2010. The entire output of the UK in nominal terms was only $ 2.56 trillion in 2017.

Notwithstanding these positive developments, the “go to currency” for the drug dealer and gun smuggler in movies and the large global investor during jittery times is the USD and US Treasuries. When will the “people’s currency” take its rightful place in the global financial stage? 

The main reason for the renminbi’s continued weakness in international finance is that, despite progress it remains a half-baked international currency due to its inconvertibility outside designated offshore markets. As a result, its weight in international investors’ portfolios is miniscule. However Chinese foreign policy is clearly directing its energies on this. 

Despite the absence of mortal threats unlike during the Yuan dynasty, China already settles a quarter of its exports in renminbi, and has established renminbi clearing banks and swap lines abroad, including in New York. South Korea, Poland and Hungary have issued renminbi-denominated sovereign debt and Sri Lanka too plans to follow suit. Even the venerable Bundesbank has announced plans to include renminbi in its currency reserves. 

In 2016, the International Monetary Fund agreed to include it among the major currencies that make up the value of the IMF’s international reserve asset, the Special Drawing Right.

The progress of the “people’s currency” is still in its nascent stage but has a long way to go to be a contender for the reserve currency of the world, the USD. For the renminbi to become a true global currency, it needs the support of deep, liquid financial markets, which may take decades to develop, even if the Chinese economy continues to grow without interruption. 

[The writer, CFA, BSc (Hons), is a member of CFA Society Sri Lanka. He works as a Senior Dealer – FX and Rates Trading at a leading international bank in Sri Lanka.]