Back in 2013, I argued that some powerful structural shifts were unfolding behind the G3 currencies and the emerging markets, giving rise to some distinctive trends that were conducive to the rise the renminbi. These trends have continued to unfold. They include the weakening of the US dollar’s global influence, the uncertainty of the euro and the structural decline of the yen. Meanwhile, even with a largely closed capital account, the global market influence of the renminbi has increased substantially.
The failure of the G3 currencies
Recent economic development suggests that the basic functions of money (as a unit of account, a medium of exchange and a store of value) of the G3 currencies might have been eroded. Firstly, while the US dollar always dominates as a unit of account, the outlook for this dominance is likely to change, underscoring the weakening trend of the US dollar’s influence.
Of the five most actively-used international payments currencies in the S.W.I.F.T. system – US dollar, euro, pound sterling, yen and renminbi – only the renminbi stands out as the one that will most likely experience growing international usage in the coming years. Being a new component currency of the Special Drawing Rights (effective in October 2016) and with Beijing continuing the liberalisation of the country’s capital account, the renminbi will become a growing part of the global financial infrastructure. Notably, China’s creation of the Asian Infrastructure Investment Bank, the Silk Road Fund, the New Development Banks and the usage of its domestic policy banks for international lending are all instrumental in boosting the role of the renminbi under the Belt and Road (BAR)2 plan that spans from China to Asia and Europe.
Secondly, most of the world’s major currencies are failing to serve as a store of value by not being able to deliver stable positive return both in nominal and real terms. Since the currency war in 2010, global currency market volatility has risen sharply. The Swiss franc and the Japanese yen have become negative yielding currencies since 2015. The euro, the Swedish krona and the Danish krone also do not provide any reasonable stable non-zero returns. The Canadian, Australian, Kiwi dollars, Norwegian krone, Brazilian real and South African rand have been stuck with volatile downward trends that are influenced by commodity prices.
Although the US dollar and the pound sterling are still providing the store of value function, could the renminbi emerge as an alternative over time in a world of financial instability? The dollar and the sterling have been more volatile, and providing lower yields, than the Chinese renminbi. Granted, there are structural problems behind the renminbi and it is not fully convertible on the capital account yet. But who else do not have structural problems?
China differs from most other countries in that it has a stronger resolve to reform. It is, arguably, the biggest country in the world implementing the largest amount of structural reforms. Beijing’s ambition to make the renminbi a global reserve currency is compatible with its incentive to keep the renminbi strong and stable over time, despite all the short-term noises about devaluation.
 “The Renminbi Rises: Myths, Hypes and Realities of the RMB Internationalisation and Reforms in the Post-Crisis World”, Chapter 1, Chi Lo, Palgrave Macmillan 2013.Download to read more