East Asia Institute (EAI) Panel on China 2009, No. 2

4+α or ACU, Discussion on the Chinese Yuan as an Anchor Currency

The G20 London Summit marked a new chapter in global cooperation by agreeing on six points2) for world economic recovery and the establishment of a new international financial order. Particularly noteworthy around the time of the London Summit was the significant shift in leadership guiding the world economy. The voice of emerging economies, including China, has grown relatively louder in the policy decision-making structure of the world economy, which was previously led by the United States and G7 countries. The expansion from the existing G7 to G20 itself attests to this change. In other words, a consensus has been formed that the cooperation of emerging economies is absolutely necessary to overcome the global economic crisis. Among these, China's rise is the most prominent change, especially as China, which ignited the 'discussion on the Yuan as an anchor currency' by raising the issue of the 'dollar's anchor currency system' before the summit, stepped forward to fulfill its role (有所作爲: to do what needs to be done) by pledging to contribute $40 billion to the IMF with its foreign exchange reserves of $2 trillion.

However, the issue of the Chinese Yuan as an anchor currency, which emerged as a matter of utmost concern alongside measures to overcome the global economic crisis at the summit, was not adopted as an official agenda item due to opposition from developed countries such as the United States and Europe, thus thwarting China's initial attempt to change the dollar system. China also settled for advocating for the use of SDR (Special Drawing Rights) as a supranational reserve currency to replace the dollar. However, since the SDR also has a low probability of replacing the dollar, the embers of a currency war between the dollar and the Yuan over the reserve currency remain. Nevertheless, at this G20 Summit, although China's attempt to make the Yuan an official reserve currency failed, it secured the practical benefit of an early adjustment of IMF voting rights, thereby laying the groundwork for establishing the Yuan's status as a reserve currency.

In any case, it is true that the global economic crisis has raised serious questions about the status of the dollar. Unlike in the 1980s, when the dollar was threatened by the United States' massive fiscal and trade deficits, and the crisis was overcome through a significant appreciation of the Yen in the Plaza Accord of September 1985, this time China has no intention of significantly appreciating the Yuan as the US wishes, and the US is facing an unprecedented situation where even its 'Big Three' automotive companies, its cash cow industries, are on the verge of bankruptcy.

Considering the historical context where Britain emerged as an economic power in the 20th century through the Industrial Revolution from the 18th century onwards, and the United States through manufacturing after World War II, it is perhaps a natural outcome that China, with its annual trade surplus of approximately $300 billion as the world's factory in the 21st century, is emerging as the economic hegemon of the 21st century, following Britain and the United States. Therefore, the challenge of the Yuan to the dollar's status as a reserve currency has long been anticipated. The discussion on the Yuan as a reserve currency was triggered by the media's public disclosure of statements made by Zhou Xiaochuan, Governor of the People's Bank of China, at a press conference during the National People's Congress in March regarding the 'possibility of settling foreign trade in Yuan'4), and by Zhu Yuchen, General Manager of the China Financial Futures Exchange, regarding the possibility of the Yuan becoming a reserve currency5). However, China, which is on the verge of becoming a G2 beyond G3 with the world's largest manufacturing base, had already permitted Yuan settlements for foreign trade between Guangdong Province and the Yangtze River Delta, Hong Kong, and Macau, as well as between Guangxi Zhuang Autonomous Region and Yunnan Province and the ten ASEAN countries in December of last year.6) Furthermore, by permitting Yuan settlements for foreign trade in five cities including Shanghai, Guangzhou, Shenzhen, Zhuhai, and Dongguan in April of this year7), it is actively expanding the scope of the Yuan. Additionally, by signing currency swap agreements worth 650 billion Yuan with six countries including South Korea, Hong Kong, Malaysia, Belarus, Indonesia, and Argentina8), it is not hesitating to undertake behind-the-scenes work to establish the Renminbi as a reserve currency.

However, the possibility of the Yuan replacing the dollar is likely to remain slim for a considerable period. While the status of the US economy has indeed declined significantly, the dollar remains the most powerful international currency as the world's largest economy, accounting for 25% of the global economy. Moreover, with most countries, including Japan, Europe, China, and South Korea, relying on trade surpluses with the US as a major driver of economic growth, and with the US possessing purchasing power as the world's largest consumer market (outlet) that sustains production and consumption despite an annual trade deficit of $800 billion, it is currently unimaginable for the dollar to lose its reserve currency status. Therefore, it is unlikely that the dollar's reserve currency status will change significantly for some time to come. However, it would be more appropriate to understand the main purpose of China's challenge to the dollar as an effort to strengthen China's international standing and as a long-term strategy for preparing for the possibility of the Yuan becoming a reserve currency, which is still very remote.

Firstly, at the G20 Summit, China secured an agreement to complete the IMF voting power adjustment, originally scheduled for 2013, by January 2011, two years ahead of schedule, thereby creating an opportunity to elevate the status of the Yuan in the long term. In particular, if the voting rights are adjusted, China could expand its share through additional contributions to the IMF, while potentially benefiting from a reduction in the US share. Indeed, at the IMF meeting in Singapore in September 2006, the voting rights of emerging economies such as China (+0.88%p), South Korea (+0.61%p), Turkey (+0.15%p), and Mexico (+0.27%p) were increased, while the shares of the United States and the United Kingdom decreased by -0.29%p and -0.64%p, respectively. Furthermore, with the voting rights adjustment, China has proposed the '4+α' system, where the Yuan would participate in the SDR basket currency, which currently consists of four currencies: the dollar (42.2%), the euro (36.3%), the yen (12.4%), and the pound (9.1%). This would allow China to simultaneously consider establishing a de facto reserve currency status within the current system where the burden of SDR contributions is shared among these four currencies. Meanwhile, from China's perspective, which is well aware that making the Yuan a reserve currency in the short term is difficult, this discussion on the Yuan as a reserve currency has at least laid a long-term foundation to challenge the dollar's status, and it may have secured a relative competitive advantage over the Japanese yen in discussions concerning the Asian Monetary Fund (AMF)10) and an Asian Currency Unit (ACU), which are receiving renewed attention as realistic alternatives for making the Yuan a reserve currency.

It is clear that China has indeed emerged as a G2 alongside the United States on the world economic stage, taking advantage of the global economic crisis. However, the discussion on the Yuan as a reserve currency, given that its convertibility has not yet been fully achieved, is premature. Furthermore, the challenge of overcoming the 'trust and inertia associated with the dollar in the international community' remains the biggest hurdle for it to be recognized as a reserve currency. More importantly, China must possess the corresponding responsibilities and obligations in the international community. Just as an individual has personal integrity, national prestige in the international community, perceived as 'Dollar = America,' 'America = Freedom and Justice,' is based on the trust in that country and its currency. China is clearly emerging as a G2. However, in economic terms, Japan is clearly the G2 after the United States. Yet, Japan's national prestige in the international community falls far short of its economic size, which is the current reality. Is this not precisely the lesson that China should learn from Japan as a cautionary tale (反面敎師) in the international community?