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Global Economy Rebalancing: One Step Closer

Moorad Choudhry|Treasurer, Corporate Banking Division, RBS
Wednesday, 18 Apr 2012 | 4:12 AM ET

We’re discussing the Chinese renminbi so we may as well begin with the oft-quoted Chinese proverb: a journey of a thousand miles begins with but a single step.

Chinese yuan coins on China's flag
Datacraft | Getty Images
Chinese yuan coins on China's flag

The end point of that 1000-mile journey will see a more balanced economy and two, possibly three reserve currencies for the world to trade and invest in. By any yardstick this will be a good thing. It will also force some measure of budget discipline on future US governments.

When I say “balanced”, I mean an adjustment to the equation whereby budget deficits in the West are partly financed by investments from the Asia-Pacific and oil-exporting surplus reserve countries, and which was a major cause of the 2007-2008 financial crash, and there is increased domestic consumption in these same surplus countries.

The one step closer I refer to is the announcement from the People’s Bank of China this weekend that it was widening the trading range in which the yuan could fluctuate against the US dollar, from 0.5 percent to 1 percent. Just like the first step on that 1000-mile journey, this is a signal that we are on the road to a fully convertible and tradable Chinese currency, and one whose exchange rate against other currencies will be set by the market.

The market-set foreign exchange rate for the yuan will be considerably higher than its pegged rate today, and this would be viewed as a negative development by the Chinese authorities because it will hurt their export performance. But at some point soon the Chinese economy will be mature enough to withstand this, and its productivity and competitiveness levels are sufficiently robust to ensure that export volumes will remain strong.

But this is not just a case of a currency becoming tradable. The size and influence of the Chinese economy is such that the yuan will also become a “Eurocurrency”, with debt raised in offshore locations denominated in yuan and used as the key medium of exchange. This can free the way to price certain commodities in yuan rather than dollars, which will also help to rebalance the global economy onto a more stable footing.

In the debate that has raged about the causes of the financial crash and how to minimise the impact of the next crash, it is often forgotten that liquidity was cheap during 2002-2007 not only because US dollar interest rates were low, but also because the surplus foreign exchange reserves of the exporting nations was invested in Western banks.

These funds had to be lent out, and this partly explains the ready availability of funds and the eagerness of banks to expand their corporate, sub-prime and structured finance lending. Reducing this imbalance, with greater domestic consumption in Asia-Pacific countries and currency reserves being held in yuan (or euros, once the EU gets its act together) rather than dollars, will reduce instability in the global economy.

Every move to make the yuan a freely tradable currency should be met with hearty cheers from international investors.

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The author is Professor Moorad Choudhry, Treasurer, Corporate Banking Division, Royal Bank of Scotland.

"The views expressed in this article are an expression of the author’s personal views only and do not necessarily reflect the views or policies of The Royal Bank of Scotland Group plc, its subsidiaries or affiliated companies, or its Board of Directors. RBS does not guarantee the accuracy of the data included in this article and accepts no responsibility for any consequence of their use. This article does not constitute an offer or a solicitation of an offer with respect to any particular investment."

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