The Renminbi and the Role of the Dollar: Greenback vs Redback

The last post talked about currency manipulation and the renminbi, but what about the idea of the renminbi as a challenger to the dollar's role as global reserves currency. In other words, is the redback (as the renminbi is sometimes called) a threat to the greenback's global dominance.

The Economist gave the standard arguments (albeit in the kind of depth somewhat unique to the Economist) one normally hears back in 2011. Specifically, that being the issuer of the world's reserve currency was a boon to the US (often called the exorbitant privilege) and that China was fed up with relying on the dollar. However, it also discussed the traditional counter-argument that being the issuer of the reserve currency is a curse because it puts a nation in the Triffen dilemma. That is, it encourages the issuer to put more money in circulation, which in turn undermines confidence in its currency. (Of course, the Triffen dilemma applied to the Bretton Woods System in which the US had to maintain a fixed exchange rate with gold while everyone else was able to adjust the value of their currency to the dollar, but I'll let that slide.)

Barry Eichenberger laid out the in-depth argument for the demise of the dollar as the reserve currency in "Why the Dollar's Reign Is Near an End" He argues that the US dollar's role as reserve currency is founded on 3 pillars: the depth of US dollar securities in the market, the fact the dollar is the world's safe haven, and the lack of viable alternatives. However, the rise of the Euro and the Yuan will provide rivals for the dollar while economic crises and rising debt in the US will undermine the perception of dollar as a safe haven. This will lead to multiple reserve currencies being adopted instead of reliance upon the dollar alone.

Michael Pettis disagreed with the view that the RMB could play the role of reserve currency. His original blog post was lost when it was hacked by Business Insider summarized his argument. First, unless China starts running a current account deficit, there will be no way for the world to acquire renminbi. Second, people are suspicious of China's financial system which is in need of significant liberalization and reform. Third, major countries such as Russia, India, South Korea, and Vietnam are also suspicious of China for political and security reasons. Finally, Pettis argues that the international trade in RMB is overstated as most of the trade is in the form of swaps between the People's Bank of China (PBoC) and other central banks as opposed to private financial transactions.

Pettis also argued that having the dollar as reserve currency represents an Exorbitant Burden in a Foreign Policy article. He argues that having the dollar as reserve currency contributes to the US current account deficit and that the US would be better off if another reserve currency was in place. Pettis argues that developing the IMF;s Special Drawing Rights (SDRs) into a truly international currency would be the best alternative.