A False Fear of China

A recent article about how U.S. companies have increased their use of Chinese yuan has engendered renewed fears of China. In particular, the announcement has raised concerns that the yuan might soon displace the dollar as the world's premier currency for international trade and banking, what economists refer to as the global reserve currency. This is not the first time such anxieties have emerged. But, as in previous instances, today's fears are a distraction and far from grounded in reality. Whatever Beijing implies in its public statements, it neither wants its yuan to replace the dollar, nor could it, even if China's leadership wanted.

Beijing's rhetoric would seem to claim special status for the yuan already. Government spokesmen have promoted trading arrangements that bypass the dollar. They have frequently criticized Washington's budget deficits as inappropriate for the government that issues the world's reserve currency. China's leaders on more than one occasion have advocated diversification away from the dollar at international gatherings such as the G-20, the group of the world's twenty largest trading nations. But if such complaints and positions are sincere on an aspirational level, the elevation of the yuan is not yet practical.

For one, it would threaten China's prosperity. For years, China has promoted exports as a means to growth by keeping the yuan cheap to the dollar and the euro and so giving its products attractive prices in global markets. Because international status for the yuan, much less reserve currency status, would prompt nations and businesses to hold it in amounts far beyond the needs for trade, it would tend to push up the yuan's value and thwart this strategy. China cannot have it both ways. It will continue to opt for exports and growth.

Beijing would, of course, like to reorient its economy away from exports. As far back as 2005 a government paper acknowledged the limits of export-led growth and advocated that China rely more on domestic sources, particularly consumer spending. But this sort of transformation is far from easy and can only go slowly. Even now, the scholarly research estimates that some 30 percent of the country's jobs depend directly or indirectly on exports, which account for an even greater percentage of its jobs growth. For the foreseeable future, then, China will remain export dependent and unable to tolerate the rise in the yuan associated with reserve status.

If China's ongoing export strategy alone stands in the way of the yuan's internationalization, one other thing will make Beijing balk. For a currency to achieve such status, its home country must offer broad, liquid financial markets where the whole world can trade freely, both the currency and an array of financial instruments where domestic and foreign holders can place their yuan. Presently, China offers none of this. Instead, China's financial markets are thin, rudimentary, and far from open to the world. In part, Beijing has resisted making the adjustment because open, fluid markets interfere with government control of the foreign exchange value of the yuan. They also interfere with Beijing's still strong desire to control the flow of financial capital in China, something it can do much more effectively now through the complete dominance state-owned banks.

There is every reason to expect that at some distant future date the yuan will challenge the dollar. But that time will wait until China has re-oriented its economy and no longer needs exports as a primary engine of growth. It will also wait until Beijing feels confident enough to relinquish the control it currently seeks in closed, narrow financial markets. When that time arrives, the yuan and the dollar may share the reserve role for an extended time, as the dollar and Britain's pound sterling did for decades in the middle of the last century. But all this is a long way off. In the interim, concern about the yuan supplanting the dollar is a distraction from real life. To be sure, much about the U.S. economy raises questions about the dollar's qualifications as the world's reserve currency. But right now, not much else has the credentials to replace it, the yuan in particular.