This one number explains how China is taking over the world

December 3, 2013

Financial powerhouse? Just maybe. (CATHERINE HENRIETTE/AFP/Getty Images))

An announcement Tuesday by the obscure-sounding Society for Worldwide Interbank Financial Telecommunication, better known as SWIFT, may not get much ink. China's currency, it reported, was used in 8.66 percent of global trade finance transactions in October, the group said. It's now the No. 2 most widely used currency for trade finance, supplanting the euro.

But that is a lot more important than it might sound. It gives an important window into how the global economy is changing--and why America's long reign of economic dominance is at risk.

Let's back up. Suppose you're a textile manufacturer in Malaysia, and you want to sell your goods all across Asia and beyond. You sell those goods on credit, letting buyers pay you later for goods shipped today. But what currency should that credit be extended in? You might prefer it be denominated in Malaysian ringgit. Your buyers would prefer their home currencies--the Indonesian rupiah, the Thai baht, whatever. So you settle on something neutral--a currency that is viewed as having stable value and which each party can easily convert funds into and out of.

For decades, that has meant you finance this trade in dollars, and only dollars. This is one important piece of America's role as issuer of the "global reserve currency," a result of the dollar functioning as the bedrock of the global financial system.

But the SWIFT data show that the renminbi, China's currency (also known as yuan), is fast becoming the dollar's major competition for dominance in global trade. It held only a distant second place in October, to be sure. the dollar accounted for more than 81 percent of global trade finance, to less than 9 percent for renminbi. But the speed with which China's currency has gained market share as a tool for international trade is astonishing. In January 2012, it accounted for less than 2 percent of trade finance, behind the dollar, euro, and yen. One can easily imagine the renminbi being the dominant currency for financing trade within Asia within a few years.

RMBChart

It is no accident. The Chinese government has long sought a role as a financial power to match its economic might. It has sought to establish Shanghai as a financial capital on par with London or New York. Internal advocates of reform, particularly at the People's Bank of China, have used this nationalistic goal to push for the changes that China will need to undertake if it to achieve those goals: Allowing a more free flow of capital in and out of China, backing away from its aggressive interventions to depress the value of the currency, and encouraging the development of modern bond markets.

Encouraging the use of yuan in trade finance has been perhaps the most successful aspect of China's financial rise to date. In the new SWIFT report, quite logically China itself and Hong Kong (a special administrative region of China which has its own currency) account for the vast majority of the renminbi-denominated trade finance, 58 and 21 percent respectively. But China is making inroads beyond its own borders, with Singapore, Germany, and Australia counting for much of the remainder.

And the PBOC has established linkages with a range of foreign central banks, first in Asia and now in Europe, that will help ensure that banks around the world can get access to renmimbi when they need it. These "swap lines," including one agreed to in October with the European Central Bank, should help give businesses confidence that they can finance trade with renmimbi without the fear that there will be a sudden freeze-up in money markets that mean they can't convert their funds.

A German exporter, for example, can have confidence that if his bank has trouble getting access to yuan for whatever reason, the ECB can get access to the currency through the PBOC and then extend emergency loans to European banks.

There is an interesting parallel: This is exactly the tool that the U.S. Federal Reserve used during the 2008 crisis to help flood the global financial system with dollars at a time banks were hoarding them. At the peak, in December 2008, the Fed's liquidity swap lines amounted to $580 billion with 14 foreign central banks. The Fed was the lender of last resort to the world; the fact that it would do such a thing is part of the reason the dollar is the global reserve currency.

So China is taking concerted measures to make renminbi a more useful currency for global commerce, and it is starting to pay off in its usage for trade finance. Should America care? Does this matter for the United State's financial future?

The dollar's status as reserve currency creates an "exorbitant privilege," as it has been called, insulating the United States from many of the vicissitudes of global financial flows and making long-term U.S. interest rates lower than they would be otherwise. It also has some costs, most notably keeping the value of the dollar higher than it would otherwise be on global currency markets, which makes U.S. exporters a bit less competitive.

On one level, the rise of China as a financial giant could be good for the world. There's no obvious reason that when a Malaysian company and an Indonesian company do business, they should use the currency of a country that is 9,000 miles away and speaks a different language. And for China, leadership in the financial sphere could help speed along a process of maturing as a leader on the world stage. If China becomes Asia's banker, it might be too busy making money to be a geopolitical threat.

In the meantime, put China's rise in trade finance on a long list of ways that the United States can't count on being the only global hegemon around forever.

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