speri.comment: the political economy blog

Global currency shifts and the City of London

The internationalisation of the renminbi reinforces some of the peculiarities of British development

Jeremy Green, Lecturer in International Political Economy, University of Cambridge, SPERI Honorary Research Fellow

Jeremy GreenFor the US dollar the global financial crisis of 2007-8 represented something of a paradox.  On the one hand, it revealed the vulnerability of the huge US debt market and deep instabilities within an American growth model beset by staggering imbalances.  These factors point towards a long-term weakening of the dollar’s international standing.  On the other hand, the crisis demonstrated the enduring strength of the dollar.  Global investors fled to US safe-haven assets, while the Fed’s global lender-of-last-resort actions helped ease a liquidity crisis in foreign markets.

This paradoxical character of the dollar’s current status underpins divisions over its expected future trajectory:  ‘dollar optimists’ and ‘dollar pessimists’ expect widely divergent outcomes for the future of the greenback within the international monetary order.  However, the dollar’s future does not depend exclusively on the fundamentals of the American economy.  Equally important is the question of its relative standing vis-à-vis potential competitor currencies, and here the evolution of the Chinese currency, the renminbi (RMB), is particularly significant.

Chinese elites responded to the travails of the American economy, and the subsequent depreciation of the dollar, in a way that will have profoundly significant implications for the future of the global political economy.  In the build-up to the G20 London summit in March 2009, Chinese Central Bank Governor Zho Xiaochuan called for a reform of the international monetary system and an increased role for alternatives to the dollar.  This was a crucial symbolic moment: it represented the first public announcement that Chinese elites have begun to question their reliance upon the dollar and look for alternative strategies to reduce their dollar-dependency.  Given China’ status as the world’s second largest economy and high rate of growth it still enjoys, its views on international currency politics will only become more influential.

China’s concerns pre-date the crisis and reflect the longer-term growth of Sino-American interdependence.  China’s hugely impressive export-led growth over many decades has been extraordinarily dependent upon the American export market, leading Chinese governments to hold vast trade surpluses in the form of dollar-denominated assets.  That exposure to dollar-assets makes China extremely vulnerable to fluctuations in the dollar’s value and has prompted concerns in China about breaking this dependency.  One solution is to promote the internationalisation of the renminbi as a regional and, ultimately, international trade, accounting and reserve currency.

Steps to liberalise the RMB and promote its international use are already well under way: China has established large currency swap arrangements with a number of economies; signed agreements with Russia and Brazil to encourage trade settlements in each other’s currencies (thus bypassing the dollar); and promoted the holding of bank deposits and bond issuances (so-called ‘Dim Sum’ bonds) in Hong Kong.  By 2020, Chinese officials want Shanghai to become an international financial centre.

More recently, China has turned its attention towards the major European financial centres, a key step towards promoting the RMB beyond its East Asian homeland, and has found willing partners for this project in the current British government and the City of London.

That appetite partly reflects the peculiarities of British development.  Ever since the demise of sterling during the post-war decades, the City has relied upon an incorporation of business and services denominated in foreign currencies to maintain its supremacy as a global financial centre.  It did so with the development of the London ‘Eurodollar’ market from the 1960s, tapping successfully into the vast pool of offshore dollars to maintain London’s international standing.  As a consequence, British development is now characterised by a special sensitivity to, and status as a barometer for, shifts within the international monetary order.  By the same token, the actions and strategy of the City and related British government agencies represent a unique lens through which to view the global currency system.

The City’s recent and growing embrace of China’s strategy to internationalise the RMB is thus very important, both for Britain and the wider global economy.  

Earlier this year the Bank of England appointed one of China’s largest banks as the Chinese currency clearing bank in London. This is part of a wider Anglo-Chinese strategy to make London a hub for Chinese currency dealing, which began with a currency swap agreement between the Bank of England and the People’s Bank of China in 2013.  George Osborne has suggested that ‘the emergence of China’s currency as one of the world’s leading currencies will be the next huge change’ in the financial world.  In 2013, China opened up its markets to British-based investors and allowed London-based asset managers to invest directly in Chinese RMB -denominated stocks and shares.  As a result of this agreement, London-based asset managers are the only ones within the West able to invest directly in this manner.

It’s no surprise that the Bank of England and the British government are so keen to embrace the internationalisation of the RMB.  The Bank is expecting a precipitous increase in global RMB transactions over the immediate future, calculating that China’s gross international investment position could increase from around 5% to 30% of world GDP by 2025.   Chinese capital flows are therefore likely to expand exponentially, with the British economy ‘likely to be relatively more affected than most due to its large and open financial system and existing strong financial linkages to China’.  London already accounts for an impressive 62% of RMB payments outside of China, securing an important ‘first-mover’ advantage over New York, which faces the problem that an embrace of the RMB would represent an uncomfortable domestic acknowledgement of the dollar’s changing fortunes.  Yet there are already signs that the RMB’s internationalisation is challenging the dollar’s status within its home market.

What are the broader implications of these dynamics?  Although City traders and bankers look set to benefit from huge earnings dividends as Westward RMB internationalisation, routed through the City, continues apace, the implications for Britain as a whole are more troubling.  The embrace of the RMB represents a continuation of the City’s longstanding role as a nodal point for global financial flows, which in turn means the continuation of a disproportionately large financial sector relative to GDP and ongoing exposure to the systemic risk associated with the increasingly unstable ebb and flow of global finance.  Additionally, it suggests that a reorientation of major business activities within the City towards promoting domestic reindustrialisation and regional development is extremely unlikely.  The City and key state agencies prefer to look outwards to the wider world, rather than inwards towards the rest of Britain.

The global consequences are less clear.  Britain’s embrace of the RMB and its rapid internationalisation show that major changes are underfoot which threaten to undermine American power by weakening global dollar-dependency.  But an era of Chinese currency dominance that echoes the dollar’s post-war role looks unlikely.  Instead, we are probably moving towards a multi-currency system in which several major international currencies, including the RMB, play large roles. 

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