The Rise of the Renminbi as International Currency: Historical Precedents

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 internationalize along a number of dimensions. RMB bank desposits are now available in Hong Kong. A RMB bond market has grown rapidly there as well, with the issuers including major multinationals such as McDonald’s. Some of China’s international trade is now invoiced in the currency. Foreign central banks have been able to hold RMB since August 2010, with Malaysia going first.

Some are now claiming that the renminbi could overtake the dollar for the number one slot in the international currency rankings within a decade (especially Subramanian 2011a, p.19; 2011b). The basis of this prediction is, first, the likelihood that the Chinese economy will surpass the US economy in size and, second, the historical precedent when the dollar overtook the pound sterling as the number one international currency during the period after World War I.

It used to be thought that international currency status was subject to much inertia (e.g., Krugman, 1984). There was said to have been a long lag between the date when the US economy had passed the UK economy with respect to size (1872, by the criterion of GNP) and the time when the dollar had passed the pound (1946, by the criterion of shares in central banks’ holdings of reserves).

The “new view,” represented in particular by Eichengreen (2011) and Eichengreen and Flandreau (2010), is that the lag was in fact rather short. It took until World War I for the dollar to fulfill the criteria of an international currency. Furthermore, the date when the dollar is said to have challenged the pound in importance has now been moved up to the mid-1920s. The first point is right. If trade is the measure of size, the US first caught up with the UK during World War I. 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 one wants 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.