RMB Bloc Ascending

These are interesting times. We are seeing the ascendance of a Chinese RMB Bloc, displacing the once-omnipotent US Dollar. This change has been engendered by China’s increased trade with the East Asian region since its trade liberalization since the 1980s. In particular, China’s share of East Asia’s manufacturing trade has grown from 2% in 1990 to 22% currently. As China liberalizes its financial and currency markets, which it is rapidly doing, the RMB’s appeal will grow exponentially. A reference currency is one which exhibits significant co-movement with other currencies. By this definition the RMB is a reference currency for many other currencies already, yet may also one day supplant the USD as the world’s reserve currency.

A country’s rise to economic hegemony is typically accompanied by its currency becoming a major reference currency. Enter China. Currently, average co-movement of East Asian currencies is 40% higher for the RMB than the USD. In recent East Asian currency history from June 2005 to June 2008, 6 currencies followed the USD more closely than the RMB and EUR whilst 3 currencies followed the RMB more closely and one currency followed the EUR more closely. Fast-forward to June 2010 and the EUR does not have any followers anymore, whilst the RMB has gained an additional four currencies whilst the USD has lost three currencies. June 2010 also coincided with the resumption of RMB floating, which prompted the increase in the number of currencies tracking it as a reference point.

7 out of 10 countries in East Asia are constituents of the RMB bloc because their currencies track the RMB more closely than the USD. This means that they are inclined to follow the RMB’s appreciations and depreciations. So when the RMB moves by 1%, these East Asian currencies move in the same direction by 0.55%, whereas when the USD moves 1% these currencies move in the same direction by 0.35% on average. These countries are South Korea, Thailand, Singapore, Malaysia, Indonesia, and Taiwan. As an example, the Thai Baht and the RMB have appreciated by similar amounts against the USD since 2009. Why do these countries find it more advantageous to ensure their currencies track the RMB more closely than the USD? Because countries that are closely intertwined with the Chinese market in terms of exports or imports and particularly those with supply chains centered on China find it beneficial to maintain a stable exchange rate against the RMB. However, three economies still follow the USD more closely. These are Hong Kong, Vietnam and Mongolia. Yet Hong Kong is now the largest offshore depositor of the RMB and more RMB is flowing through Hong Kong than HKD. Additionally, the advent of the ASEAN free trade community from 2015 will bring more integrated trade with China, whilst Mongolia’s trade with China will soar once their massive gold, coal and copper mines are fully operational in a few years.

 

Even outside East Asia, many currencies are following the RMB closely due to China’s trade dominance. These currencies include the Indian Rupee, Chilean Peso, South African Rand, Turkish Lura, and Israeli Shekel. The global financial crisis has exacerbated European and American economic difficulties and allowed the RMB to eclipse them in some parts of the world as a reference currency. In some ways, the renminbi has displaced the euro as the second most dominant global reference currency in the sense that there are more currencies outside East Asia that track the renminbi most closely compared with currencies outside Europe and the Middle East that track the euro. The movement to make China the world’s most popular reference currency is being spurred by China’s status as the world’s largest exporter, the world’s largest net creditor, and the world’s largest economy in purchasing power parity terms (by some measures). Given suitable financial sector liberalization measures instigated by the Chinese government, a global RMB bloc and its ascension to reserve currency status could be fact by 2025.