All of a sudden, the renminbi is being touted as the next big international currency. Just in the last year or two, the Chinese currency has begun to internationalise along a number of dimensions. A renminbi bond market has grown rapidly in Hong Kong, and one in renminbi bank deposits. Some of China’s international trade is now invoiced in the currency. Foreign central banks have been able to hold renminbi since August 2010, with Malaysia going first.
It used to be thought that international currency status was subject to much inertia (e.g. Krugman 1984, Goldberg 2010). There was said to have been a long lag between the date when the US economy passed the UK economy with respect to size (1872, by the criterion of GNP) and the time when the dollar passed the pound (1946, by the criterion of shares in central banks’ holdings of reserves).
The “new view,” represented in particular on this site by Eichengreen (2011) and Eichengreen and Flandreau (2010), is that the lag was in fact rather short. It took until the First World War for the dollar to fulfil the criteria of an international currency. Furthermore, the date when the dollar is said to have come to rival the pound in importance has now been moved up to the mid-1920s.
In recent research (Frankel 2011), I argue that the first point is right. If trade is the measure of size, the US first caught up with the UK during the First World War. The US did not even have a permanent central bank until 1913. The other important criteria came soon thereafter: creditor status for the country; the perceived prospects for the currency to remain strong in value; and deep, liquid, open financial markets. (I have discussed the criteria in earlier papers. Chinn and Frankel 2007 evaluate them econometrically and give further references.) The second point seems a matter of whether or not we want to distinguish between the concept of “coming to rival” / “catching up with” the pound (1920s) versus the phenomenon of definitively “pulling ahead” / “displacing” the pound (1945). Under either interpretation, the dollar’s initial rise as an international currency was indeed rapid, once the conditions were in place.
The current renminbi phenomenon differs from the historical circumstances of the rise of the three earlier currencies in that the Chinese government is actively promoting the international use of its currency. This was something that neither Germany nor Japan, nor even the US, did – at least not at first. In all three cases, exporters, who stood to lose competitiveness if international demand for the currency were to rise, were much stronger than the financial sector, which might have supported internationalisation. We might expect the same fears of a stronger currency and its effects on manufacturing exports to dominate the calculations in China.
In the case of the mark and yen after 1973, internationalisation came despite the reluctance of the German and Japanese governments. In the case of the United States after 1914, a tiny elite promoted internationalisation of the dollar despite the indifference or hostility to such a project in the nation at large. These individuals, led by Benjamin Strong, the first president of the New York Fed, were the same ones who had conspired in 1910 to establish the Federal Reserve in the first place.
Interesting history. First, the gap between economy size and currency internationalization is found shorter than previously thought; second, China is unique in that its government is promoting it; third, exporters and financial sectors have opposite views on currency appreciation due to global demand for the currency.