Increasingly, Chinese currency policy is about much more than simply maintaining a competitive exchange rate. Great powers have great currencies, and great currencies in turn help to build power. China is undeniably the biggest challenger to the dollar-led system.67 The PRC is becoming a great power, and the internationalization of the renminbi is an important part of a grand strategy to accomplish this rise.68 Nevertheless, fears of the RMB “replacing” the dollar are overblown. As experts such as Sebastian Mallaby and Olin Wethington argue, the narrative about the rise of the renminbi is mostly wrong. As they see it, “the global rise of China’s currency will be slower than commonly predicted, and the yuan is more likely to assume a place among secondary reserve currencies … than it is to displace the dollar as the dominant one. Nor is it even clear that China wants the yuan to replace the dollar.… China’s uncertain effort to internationalize its currency has exposed the profound struggles that lie behind the country’s larger push to transform its economic model.”69
But given its growing footprint, the RMB hardly needs to replace the dollar to reap real geopolitical benefits for China. If historical precedents around the rise of the dollar, the deutsche mark, and the yen all serve, then the internationalization of the renminbi will likely occur steadily as China’s economic size grows, as other countries have increasing confidence in the currency, and as China’s own financial markets deepen.70
For some experts, these changes cannot come too soon. Today’s world, say economists such as Fred Bergsten, is one where emerging markets are growing faster than the United States, deepening their financial markets in ways that demand central bank holdings far above what the United States can sustainably provide.71 Were the RMB to become a reserve currency, China could serve as a provider of this insurance, not just a demander. Launching the RMB as a reserve currency would also require China to liberalize its financial sector and undergo a slew of reforms that are fundamentally in America’s national interest.
But the geopolitical implications surrounding reserve currency status for the RMB are less straightforward. The rising status of the RMB indicates that China is gaining regional influence through financial channels, activity that is much less well studied and understood than China’s impact through traditional economic means.72 Were the RMB to become a global reserve currency, its dominance would be largely concentrated in Asia (though more than fifty central banks from around the world have indicated that they plan to invest part of their foreign currency reserves in the renminbi).73 This would give China substantial leverage—from the perspective of monetary policy as well as foreign policy—over countries in Asia in particular, potentially counteracting efforts by Asian countries to reduce their economic dependence on China.74 According to a 2014 report from the Bank of International Settlements, changes in RMB/USD rates have a significant impact on other Asian currency movements against the dollar.75 Looking beyond the region, with an estimated 60 percent of China’s foreign exchange reserves in U.S. dollars, China would no longer be nearly as susceptible to fluctuations in the value of the dollar and changes in U.S. economic policies.76 An internationally recognized RMB also would create ample opportunity for China to play a larger role in influencing international financial institutions, such as the IMF and the World Bank. In what many heralded as the RMB’s symbolic graduation into the ranks of the world’s elite currencies, the IMF announced in December 2015 it would begin including the RMB in its market basket of currencies (which currently includes the dollar, yen, pound, and the euro) that together comprise an accounting unit known as the IMF’s “special drawing right.” The move required the IMF to certify that the RMB satisfied a two-pronged test for inclusion—that it was both “widely used” and “freely usable.” While China had long met the first criterion—the RMB already widely used to settle trade between countries—the “freely usable” question was more fraught and the reason the IMF’s move did not come much sooner (for some, the IMF’s decision came without sufficient progress by Beijing, as nation-wide caps still limit the amount of RMB-denominated debt foreigners can hold).77
By removing itself from the dollar system and becoming less reliant on low-yield government bonds from developed markets, Beijing will gain greater pricing power over global commodities markets, where China is already often the largest consumer.78 A reformed, rebalanced economy that rapidly expands its imports would also provide the Chinese government more leverage over other economies, especially as China pays for increasingly more of those imports in yuan.79 Renminbi internationalization would also be accompanied by growing Chinese FDI, some Chinese scholars predict, which in turn implies a need for China to protect its overseas assets.80 To adequately guard these new overseas assets, explains Chinese political economist Di Dongsheng, “Beijing will have to be capable of projecting power. Time and again in modern history hard power has followed where capital leads, flowing from advanced economies to developing nations regardless of the religion, culture, and ideology of the home country. Thus, China is likely to abandon its foreign policy orthodoxy of non-interference in order to protect its overseas investments.”81
China’s steady march toward internationalizing the RMB is already lending it new forms of influence, not just in Asia but more broadly as well.82 Even Taiwan is tempted with the opportunity to sign a RMB currency swap agreement, a move that would create yet another irreversible cross-strait linkage.83 A successful currency swap agreement will, in the words of the Central Bank of Taiwan’s deputy governor, Yang Ching-long, “not only contribute to Taiwan’s goal of becoming an offshore RMB market … but [it] will also facilitate China’s bid to internationalize its currency.”84
Even where these influences are more symbolic than real—many suggest that the world’s acceptance of the RMB as a global reserve currency would give China greater symbolic sway within the region—these beliefs can come to influence China’s foreign policy in ways that are difficult to predict. As Chinese analysts themselves describe the prospects, “China’s traditional dependence on the dollar-based system will gradually give way to more balanced relations as use of the renminbi spreads. Consequently, competition between the great powers will rise, even leading to a bipolar—or tripolar, alongside the eurozone—global political economic system in the coming decades.”85
Finally, a rising RMB may also come with costs for particular aspects of U.S. financial leverage, especially in the realm of sanctions. Certain financial sanctions—like those imposed on Iran’s central bank—are effective only because these entities deal in U.S. dollars. But the stakes change if countries begin to settle transactions in RMB or other currencies. According to reports from the Financial Times, Iran and China began settling oil transactions in RMB—which, while not freely convertible, allowed Iran to evade sanctions and use the funds on Chinese imports.86 Russian companies are hastening to switch contracts to renminbi and other currencies amid concerns that Western sanctions targeting Moscow for its incursion into Ukraine will freeze them out of the U.S. dollar market.87
If Beijing’s ability to translate reserve currency status into geopolitical heft remains largely on the horizon, another powerful monetary tool that is already fully incorporated into Beijing’s geoeconomic arsenal is the ability to impact another country’s borrowing costs. There are several concrete examples attesting to how the PRC’s ability to do this can confer geopolitical leverage—often when states are at their most vulnerable. China’s decision not to devalue its currency during the 1997–1998 Asian financial crisis earned Beijing gratitude across the region that lingers to this day. Another example is China’s desire for market economy status, a designation that served as a point of leverage during China’s negotiations to join the WTO prior to 2001.88 Market economy status would give leverage to Chinese companies that are accused of dumping—a term used when export products are priced below their real production cost. Over the last decade, Chinese companies have been investigated for dumping products from solar panels to bedroom furniture and
televisions.89 At various points during the eurozone crisis, the Chinese have rather explicitly set the EU’s granting of market economy status to China as the condition for any capital injection.90 It is a depreciating asset—Beijing argues the status should expire in 2016 by the terms of its WTO entry—but if the Europeans unilaterally move to recognize China as a market economy without U.S. agreement, one could expect a serious transatlantic row that would weaken U.S.-European geopolitical cooperation, at least in the short term.
But the most well-known example of Chinese leverage in this regard is of course Chinese purchases of U.S. debt since 2001. The most often cited contingency is that China could undertake a large and sudden sell-off of its substantial holdings of U.S. Treasuries. Chinese officials have suggested that its holdings of U.S. debt could be used in regard to economic and political disputes with the United States (most notably in 2010, when PLA military officials took to Xinhua, China’s leading news agency, to publicly urge Beijing to “dump some U.S. bonds” to punish the United States for its decision to follow through on an arms sale to Taiwan).91
Fortunately, Chinese PLA officers do not set the country’s monetary policy. And as many observers have noted, any significant sell-off of U.S. debt would carry substantial costs for China, which would see the value of its remaining Treasuries depreciate as a result. This self-inflicted depreciation, combined with the fact that U.S. bond markets are the world’s deepest, most liquid pool of marketable securities, together relieve Beijing’s holdings of much of their coercive value (indeed, in a rare point of agreement between economists and foreign policy strategists, most in both groups seem persuaded that, far from a source of strength, China’s holdings are on balance a liability for Beijing).92 As one Chinese banker explained less than a year after Lehman Brothers declared bankruptcy: “Except for U.S. Treasuries, what can you hold? U.S. Treasuries are the safe haven. For everyone, including China, it is the only option. We hate you guys. Once you start issuing $1 trillion to $2 trillion [of bonds], we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do.”93
This is probably true. At the same time, any balanced assessment should contend with at least four considerations. First, as Yale Law School professor David Singh Grewal put it in a 2009 essay on the subject, perhaps “the issue is not really about economics.”94 One could well imagine cases with stakes great enough for Beijing to accept the economic losses: almost certainly Taiwan would qualify, but rising tensions around territorial disputes, especially in the South and East China seas, suggest there may well be other flash points worth probing here in terms of the stakes they hold for some in Beijing. Most recently, there have been semi-official calls for the use of force to assert China’s maritime claims against the Philippines, a U.S. ally, as well as Vietnam. One notable example was an unsigned fall 2011 editorial in Global Times, a voice of the Chinese government (known for its often nationalist editorial stance): “The South China Sea, as well as other sensitive sea areas, will have a higher risk of serious clashes. If these countries don’t want to change their ways with China, they will need to prepare for the sounds of cannons. We need to be ready for that, as it may be the only way for the disputes in the sea to be resolved.”95
Questions about Beijing’s economic pain tolerance seem especially pertinent when considering that the “mutual assured destruction” argument outlined above rests on assumptions of economic rationality. Such assumptions should be considered carefully, though, as China’s very accumulation of these reserves is not economically rational, at least not as economists define the term. Indeed, for all the international ire surrounding China’s currency policies, no country loses from China’s exchange rate policies more than China itself: according to estimates by the Bank of Canada, the cost to China from delayed adjustment of the RMB is around 12 percent of its GDP (these same estimates place the costs to the United States of China’s currency policy at around 6 percent of U.S. GDP).96
At a minimum, the prospect of any significant reduction in China’s Treasury holdings should be viewed against the cost of other relevant policy alternatives for Beijing, especially the use of force. And compared to risking military conflict with the United States or one of its allies, the cost to China of suddenly and substantially reducing its holdings of U.S. Treasuries may not seem all that irrational.
This touches on a related point: it is easy to underestimate the considerable domestic pressure Beijing faces in holding such substantial and growing sums of U.S. debt. China’s reserve managers fell under strong public censure for their ownership of GSE debt during the financing crisis and still face continued criticism for underwriting U.S. consumption. In short, while the risk of any sudden reduction in Chinese holdings of U.S. debt is currently remote, it is also poorly understood. And Beijing, already having proven itself a price-insensitive buyer of Treasuries, could react as a price-insensitive seller if confronted with sufficiently profound geopolitical contingencies vis-à-vis the United States.
Moreover, any investor with sufficient market share could shift its holdings from one type of dollar-denominated instrument to another. A significant holder could choose to divest all agency mortgage-backed securities (e.g., Fannie Mae and Freddie Mac) it owns, for instance, or could sell longer-term Treasuries and reinvest the proceeds in short-term instruments, steepening the yield curve. Such shifts in portfolio holdings could further stunt the U.S. housing market or cause a sudden shift in the yield curve (thus tightening financial conditions and undermining much of what the Fed has done through its asset purchases)—all without affecting the overall value of the exchange rate, and thus the value of China’s dollar holdings.
Further, for sovereigns with enough share of a given market, the simple prospect of such action, or indeed even a move simply to purchase fewer securities in the future, may be enough to disrupt markets. For example, “if Sino-American relations deteriorate over economic or international political issues,” explains Cornell’s Jonathan Kirshner, “it is likely that U.S. macroeconomic stability will be ruffled by China shuffling its dollar cards, even if it never folds them.”97 In May 2009, Beijing for the first time aired public concerns about the viability of U.S. debt, and followed this with a relative downsizing in its purchases of long-term U.S. Treasuries.98 The result was a marked steepening of the yield curve as rates rose on longer-term U.S. bonds.99 While China quickly resumed and even accelerated its purchases of longer-term Treasuries, Beijing’s point seemed to register clearly on markets.
Finally, while central banks can and should offset these shifts—as the Fed did during 2008–2009 (structural limitations prevented the European Central Bank from doing the same)—any disruption, however temporary, could prove costly. Beyond a spike in U.S. borrowing costs, temporary disquiet in U.S. bond markets could deepen doubts about the dollar’s continued ability to anchor the world’s monetary system and, by extension, about the U.S. role as lead manager of the global economy. Further, the Fed’s room for maneuver is neither infinite—some economists have suggested that foreign sovereign purchases of U.S. government debt, especially by countries with already huge reserve stockpiles constrained the Fed’s ability to contain the bubble prior to 2007 (and Federal Reserve chairman Ben Bernanke has publicly offered similar sentiments)—nor politically easy.100
National policies governing energy and commodities. China’s appetite for energy and resources is a powerful driver of geoeconomics in the post–Cold War era.101 Much of this is structural. With nearly “1.4 billion mouths and a growing appetite for nationalism to feed,” China has little choice but to pursue geoeconomic strategies that support its geopolitical objectives abroad and prioritize the legitimacy of the Communist Party at home.102
At the same time, though, perhaps counterintuitively, the sheer size of China’s resource appetites also functions as a form of geoeconomic leverage.103 China’s negotiating clout is seen, for example, in Beijing’s ability to win equity stakes in its gas contracts—n
ot just in contracts with Central Asian suppliers (Turkmenistan is one example) but in those with Russia as well.104 It is also seen in the way that a shrinking U.S. energy appetite in certain regions, West Africa for instance, can mean a wholesale shift in the foreign policies of countries such as Chad and Angola; as these producer countries reorient their energy sales eastward toward Asia, their capital flows and geopolitical relationships inevitably follow.105
Structural determinants aside, there are some cases where China has forthrightly pursued or hinted at pursuing energy and commodities policies on geopolitical motivations—examples noted earlier include export bans on rare earths as a means of registering dissatisfaction with policies around the South and East China Seas, or the 2012 comments by China National Offshore Oil Corporation chairman Wang Yilin characterizing China’s deepwater rigs as “mobile national territory and a strategic weapon.”106 One such glimpse into the dual-use nature of these rigs came in May 2014 when, amid escalations in the South China Sea, China parked its first deepwater rig in what one press report described as “one of the most sensitive spots possible, about 17 miles off a speck of an island claimed by both China and Vietnam.”107 As press reports described the rig’s arrival: “Few believe that energy discoveries were the primary reason for the arrival of rig HD-981, which is owned by China National Offshore Oil Corporation, or CNOOC, the state-run energy giant.”108 As Holly Morrow, a fellow in the Geopolitics of Energy program at Harvard’s Kennedy School of Government, put it, “CNOOC is a business but also a political actor.… It’s never about energy completely, it’s about sovereignty.”109
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