Renminbi Not Ready For Prime Time

The meme of the month seems to be the toppling of the almighty dollar in favor of China’s renminbi or possibly some yet to be invented world currency administered by Lord knows whom.

No less a notable than Nouriel Roubini has predicted this turn of events. Recall that the Chinese started all of this several months ago when they proposed a move away from the dollar. They have since kept that drumbeat going though in a somewhat more muted fashion.

Today the Financial Times reports Brazil and China are in talks to pay for goods purchased from each other in their respective currencies. The Times treats all of this as major news and offers this analysis of its implications:

Economists have argued that while the SDR plan is unfeasible now, bilateral deals between Beijing and its trading partners could act as pieces in a jigsaw designed to promote wider international use of the renminbi.

Any move to make the renminbi more acceptable for international trade, or to help establish it as a regional reserve currency in Asia, could enhance China’s political clout around the world.

Now before we get too far ahead of ourselves here with all this talk of reserve currencies and such, let’s remember a couple of things.

First, real reserve currencies are generally freely convertible and not subject to capital controls by the issuing country. Those countries that have reserve currencies also tend to have few restrictions on foreign investment in their country. Neither of these attributes apply to China. Brazil may indeed build up a large store of renminbi but I wish it good luck in doing much with it if it runs out of things to buy from China. 

Second, and this one is very important, reserve currencies become such not because they are freely convertible but because people expect that the economy that backs them will be around to make good on the implicit promise that their paper has value for the long term. What causes people to believe that? Aside from a strong economy, it’s democratic government, the dominance of the rule of law and a stable society. Ask yourself if any of those attributes are typical of China at this point in time.

Before the renminbi it was the euro that was going to vie with the dollar for reserve currency status and before that it was the yen. It is likely that before the dollar does share the stage with some other currency that a few more candidates will have come and gone. 

There is less than meets the eye in the deal between Brazil and China.

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