China is following a recipe of what it takes to become a dominant currency, but currently the yuan remains far behind the US dollar in international financial transactions unrelated to trade, according to prominent Indian-American economist Gita Gopinath.
Gopinath, who would become the first woman chief economist of the International Monetary Fund (IMF) in January, is currently the John Zwaanstra Professor of International Studies and Economics at the prestigious Harvard University.
“China is following a market recipe of what it takes to become a dominant currency,” Gopinath said in response to a question at the 19th Jacques Polak Annual Research Conference on ‘International Spillovers and Cooperation’ organised by the IMF here.
China is trying to convince its trading partners invoicing in renminbi, the official Chinese currency, but it does not have the financial institutions as is the case with the US dollar, she said, adding that it has to be both trade and finance.
So, if one does not have financial institutions, free capital flows, free exchange rate mobility and free convertibility, it would be difficult for it to become a dominant currency, she said.
In her research presentation ‘Banking, Trade, and the Making of a Dominant Currency’, Gopinath said that China is now one of the largest economies in the world, and the biggest exporter, it appears that Beijing is making tremendous effort to internationalise the renminbi.
Similar to the US interventions in the early 20th century, they have proceeded by encouraging the use of the renminbi in international trade transactions. Following this push, between 2010 and 2015, the renminbi’s share as a settlement currency in China’s trade has gone from zero per cent in 2010 to 25 per cent in 2015.
Also, renminbi has now surpassed the euro as the second most widely-used currency in global trade finance, Gopinath said.
But renminbi currently remains far behind other major currencies in international financial transactions unrelated to trade, she said.
Outlook for US dollar
Giving an insight into her research, Gopinath said in the medium term, the self-reinforcing mechanisms in her model might lead one to predict that the US dollar’s dominance would continue largely undisturbed, and that the renminbi would have a hard time gaining much traction in international banking and finance.
“However, in the longer run, if the gap between Chinese and the US shares in the world exports widens far enough, we could eventually get to a point where a renminbi-dominant equilibrium becomes inevitable,” she said in her paper, adding that at this point, the US dollar’s share in global trade and finance could potentially decline quite sharply.
While the US dollar continues to be the dominant currency and there is no visible challenge to it, Gopinath warned that in the longer run, if the gap between the US and one of the other economies widens far enough, the US dollar may potentially fall on the world stage to a very substantial extent, much as the British pound sterling did in the early part of the 20th century.