The new China International Payments System (CIPS), which is set to debut before the end of 2015, has been described as a “worldwide payments superhighway for the yuan.” What the creation of such a system means in the short-term is that the Chinese currency (officially known as the renminbi) has the potential to become a truly international, convertible currency and a more attractive currency for conducting international trade and finance. What it means in the long-term is that America’s long reign of economic dominance is at risk.
Ever since the end of World War II, the dollar has been the bedrock of the international financial system. The rise of a competitor currency to challenge the dollar seems almost impossible. While the euro and the yen have emerged as possible options for supplanting the dollar, they have never had the global clout of the U.S. dollar. China’s plans for the internationalization of the renminbi, though, are a different matter entirely. Given the size and heft of China’s economy, it only makes sense that China is creating a global payments system to make it easier for people to trade, invest and conduct transactions using the renminbi.
One way to measure how important the Chinese currency has become worldwide is to look at the percentage of international trade finance deals that are conducted using the renminbi. On a global basis, the renminbi accounts for nearly 9 percent of all trade finance deals worldwide, the second largest behind only the dollar. Moreover, as of January 2015, the renminbi is now the fifth most used payments currency in the world, trailing only the dollar, the euro, the pound sterling, and the yen. According to Wim Raymaekers, Head of Banking Markets at SWIFT, this is “an important milestone” that confirms the transition of the renminbi from an “emerging” to a “business as usual” payment currency.
One area where the launch of the new Chinese payments system could really have an impact is in the global energy markets. As a result of the so-called “petrodollar system” established between the U.S. and Middle East oil producers, oil exports are priced and transacted in dollars. Now imagine the price of oil being quoted in Chinese yuan and not U.S. dollars. What if Saudi oil exporters decide they want yuan and not dollars for their oil? That means anyone buying or selling oil in commodity markets has to have a yuan bank account in addition to a dollar bank account. Given the voracious energy demands of China’s growing economy, it’s easy to see why a global payments system facilitating these trades makes sense.
Right now, of course, the renminbi does not pose a direct threat to the dollar. While 41 percent of all global payments involve the dollar, only 2 percent involve the renminbi. But think ahead a few years. If the Chinese economy continues to grow, if plans continue to internationalize the renminbi, and if gridlock in Washington continues, it’s at least theoretically plausible that the renminbi could eventually supplant the dollar as the reserve currency of choice around the world. Especially since the investment theme of “de-dollarization” has started to be picked up globally.
If the renminbi ever replaces the dollar, there are going to be effects felt from Wall Street to Main Street. For one, foreign investors won’t need to hold as many dollars since they’ll be conducting transactions in yuan instead. That means they will have fewer dollars to invest in dollar-denominated U.S. government debt — the same debt that is the key to financing massive U.S. budget deficits. To keep foreign investors investing in this dollar-denominated debt, the U.S. government would have to jack up interest rates. Moreover, if all the dollars held globally ever make their way back to the United States, that influx of dollars could lead to crushing domestic inflation and a whole host of uncomfortable economic consequences.
Of course, building the CIPS is just the next logical step in the internationalization of the renminbi. Things won’t change overnight — or perhaps ever. However, keep in mind that China has hatched a number of other plans to transform the international financial system. With the rise of the BRICS, for example, China is looking for alternatives to a Western-dominated international financial system. Last year, the Chinese helped to launch a new BRICS Development Bank based in Shanghai as a competitor to the World Bank and International Monetary Fund. Anyone want to guess whether this bank in the future will be making loans in dollars or yuan?
The internationalization of the renminbi is easier said than done. You don’t just wave your hands and your currency becomes the world’s primary reserve currency. You have to build trust. The Brookings Institution, for example, has recently highlighted five big political challenges facing the internationalization of the renminbi. One big drawback, of course, is the fear of “capital controls” imposed by the Chinese government. In layman’s terms, you may shift your money into renminbi and not be able to get your money out when and how you need it. That understandably spooks anyone thinking of dumping dollars for yuan.
It’s only in the past decade that the Chinese have launched an aggressive drive to internationalize the renminbi. There’s still a lot to be done, but the creation of CIPS appears to be the next logical step in changing how the world thinks about the renminbi. If the Chinese economy is indeed taking over the world, it will need a currency that is also capable of taking over the world.