Below is a very good video from the FT which outlines the growth of the Chinese currency – the Renminbi (RMB). It includes some excellent graphics including the value of the currency against the US$ from 2005 – 2015 (see graphic below)
- 1948 – RMB was put into circulation by the Communist party
- 1997 – RMB was pegged to the US$
- 2005 – Peg was removed
- 2009 – China allowed approved companies to settle trade payments with non-Chinese customers using the RMB
- 2015 – 20% of China foreign trade is settled in RMB compared to 3% in 2010
- 2015 – RMB the 5th most traded currency although it is a long way behind US$ and €
The Chinese authorities want to have the RMB included in the basket of currencies that make up the IMF’s special drawing rights. This would mean an official endorsement of the RMB as a reserve currency. However one of the conditions of the IMF of being a reserve currency is that it must be freely tradable. Although the Chinese government is reducing its interventionist approach it is not yet ready to give market forces complete free rein over its exchange rate.
The US Treasury officials are not happy about the recent depreciation of the Chinese renminbi after a period of appreciation from 2010. Chinese authorities want to avoid the influx of ‘hot money’ into the economy and therefore the central bank has been keen to trick speculators who are getting used to a steady appreciation. This can put doubt in the minds of foreign exchange dealers who can take the hint and sell renminbi which in turn depreciates the currency further. Nevertheless the depreciation of the renminbi is greater than you think once you consider inflation.
How do they set the renminbi exchange rate?
Each day at 9.15am Bejing time the Peoples Bank of China – the Central Bank – in conjunction with the State Administration for Foreign Exchange (SAFE) issues a circular to all the banks in China stating the reference rate for the US dollar against the renminbi. However authorities are now experimenting with allowing the renminbi to move within a daily limit either side of a benchmark set by the central bank.
How does inflation affect the value of the currency?
What has little exposure in the media is the impact of relative rates of inflation in different countries when working out if a currency has depreciated and appreciated. The depreciation of the renminbi is actually greater than what you think. Figures that are widely used to show the level of depreciation are stated in nominal terms and does not account for the difference levels of inflation in both countries – in this instance the US and China. When you consider the real value you find that between December 2013 to April 2014 the renminbi actually fell 3.2% rather than 2.8% – see table below. However if you consider the period June 2010 through to November 2013 the renminbi actually appreciated 18.5% in real terms as against 12% in nominal terms. Inflation makes a difference because if there is higher inflation in the US than in China in takes more renminbi to buy the same number of goods so the renminbi is worth less. The opposite applies if the inflation rate is higher in China.
The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.
There has been much talk of the Chinese currency the Renminbi becoming the reserve currency of the world. If you were to look at the trading volumes you would think that they are not far off the mark. However the growth has been so large in the last few years mainly because it has come from such a low base. But the following points put it in perspective:
* The Renminbi is the 7th most used currency according to SWIFT a global transfer system
* The Renminbi accounts for only 1.4% of global payments – US dollar is 42.5%
* When you look at assets open to international buyers there are just $0.3 trillion of Chinese assets available compared to $56 trillion of American – this is one reason why the US dollar is liked as a global currency.
For the Renminbi to become a more dominant it has to become global. An easy way for this to happen is for China to run trade deficits as this will add to the global holdings of Renminbi on a daily basis. However China has traditional run surpluses which means that more foreign currency is coming into the economy. On the other hand the USA has run trade deficits which in effect adds to the global holdings of US$. However even if China did run deficits what could the holders of Renminbi do with it? China could open the Capital Account of the Balance of Payments which would encourage investment. There is still a long way to go before the Renminbi becomes the reserve currency.