[NSP Research Report] Internationalization of the Renminbi and South Korea's Financial Diplomacy: Incompatibility and Strategic Choices

Abstract

This paper discusses the internationalization of the Chinese Renminbi, which poses the greatest challenge to the existing international monetary order, and the policy direction of South Korea's financial diplomacy in response. For South Korea, the issue of Renminbi internationalization is not limited to exchange rate policies related to ensuring the stability of trade and investment. This is because the internationalization of the Renminbi and its potential to replace the dollar possess explosive power that could fundamentally alter the US-China relationship, the most significant variable in South Korean diplomacy. To this end, this paper utilizes the theory of financial statecraft to analyze the policy choices for South Korea's financial diplomacy in response to Renminbi internationalization and to suggest a policy direction. The paper is based on Cohen (1993)'s study on the incompatibility of policy objectives in financial diplomacy faced by each country, and supplements it with Armijo and Katada (2014)'s research, which theorizes the financial diplomacy strategies of emerging and middle powers like South Korea, not great powers, to present policy choices for South Korea's financial diplomacy concerning the Renminbi. Indeed, considerable policy proposals for South Korea's financial diplomacy regarding Renminbi internationalization have already been presented, primarily by economists. Existing policy proposals tend to focus on the 'utilization of Renminbi internationalization,' leaning towards economic costs and benefits. However, a multidimensional analysis is required, considering that the policy objectives of financial diplomacy are not limited to economic considerations but also include securing monetary policy autonomy and engaging in global governance diplomacy. Therefore, this paper applies the theory of financial statecraft to approach the validity of previously proposed policies from political, economic, and diplomatic perspectives. In other words, this paper does not selectively present the superiority of any particular policy; rather, it discusses the trade-offs that may accompany the selection of a policy, rather than evaluating the validity of a specific policy. Through this, the paper aims to provide a systematic and comprehensive list of policies for responding to Renminbi internationalization.

From the Main Text

For South Korea, the issue of Renminbi internationalization is not limited to exchange rate policies related to ensuring the stability of trade and investment. This is because the internationalization of the Renminbi and its potential to replace the dollar possess explosive power that could fundamentally alter the US-China relationship, the most significant variable in South Korean diplomacy. The political, military, and economic influence and leadership that the United States projects globally cannot be separated from the dollar's dominant position in the international monetary system. For instance, if the international monetary system shifts from a dollar-centric system to a multi-currency system where the Renminbi, Euro, and others compete with the dollar, the US may experience a weakening of its political leadership as its unilateral policy actions face constraints in forums for policy coordination such as the G7, G20, IMF, and World Bank. A multi-currency system could also result in a reduced scope for the exercise of US macroeconomic autonomy, as the US would no longer be able to consider currency issuance without concerns about inflation and exchange rates due to the multi-currency system. Furthermore, a multi-currency system could weaken US military power, as it would lead to a reduction in the US's borrowing capacity, thereby constraining US military expenditures.

Will China continue to aggressively promote the internationalization of the Renminbi and challenge the dollar system for hegemony in the international monetary system? Considering the background discussed earlier for China's promotion of Renminbi internationalization, China's objective is at least for the Renminbi to compete with the dollar. However, setting aside whether China and the Renminbi can meet all the requirements of an international reserve currency, there are voices of concern within China itself about the hasty internationalization of the Renminbi. This is because the internationalization or reserve currency status of the Renminbi does not solely benefit China.

The competition for reserve currency status between the Renminbi and the dollar is expected to be the most significant and paramount issue in international politics over the next 10-15 years. As discussed in the introduction of this paper, the outcome of this reserve currency competition could fundamentally alter the US-China relationship, and consequently, the international order encompassing politics, economics, military affairs, and security could be realigned. In the history of modern international politics, there has been no hegemonic power that did not possess an international reserve currency (or dominate the international monetary order). In this context, as long as China does not abandon its 'Chinese Dream' of establishing itself as a superpower in the international community, its policy of Renminbi internationalization is expected to continue in various forms.

What policy mix will South Korea choose? The most crucial external condition for selecting a policy mix is how the unfolding of Renminbi internationalization will affect each element, or the entirety, of the incompatible objectives: exchange rate stabilization, monetary policy autonomy, and capital liberalization. Internal conditions can be seen as South Korea's macroeconomic trends, the international competitiveness of its financial industry and domestic financial infrastructure, and the overall direction of the government's monetary and financial policies. Due to the absence of a policy mix that can simultaneously satisfy all three policy objectives mentioned above because of their incompatibility, setting priorities among them is expected to be the core of South Korea's financial diplomacy in response to Renminbi internationalization. Micro-level policy linkage strategies, considering the sequence among the three policies, could also be designed in a forward-looking manner.

Author

Professor of Political Science and International Relations at Korea University. He received his Ph.D. in International Politics from the University of Southern California, after majoring in East Asian Studies at the University of Kansas. His main research areas include international political economy, constructivism, East Asian regional cooperation and financial regionalism, and the multilateral trade order. His books and edited volumes include "Complex Transformation and South Korea's Strategy in the East Asian Regional Order" (2014, co-edited), "Plurality of Methodologies in International Politics" (2014, co-edited), and "China’s Rise and Regional Integration in East Asia: Hegemony or Community?" (2014, co-authored).