Regional role for China’s yuan

by Mamoru Ishida

It is likely that a renminbi (RMB) area emerges in East Asia.

When RMB was pegged to the dollar, most of ASEAN currencies were also pegged to the dollar. That was because a large part of their trade was denominat- ed in dollar. Since China shifted to a managed floating in 2005, RMB has been appreciating vis-a-vis the dollar, followed by major ASEAN currencies and Korean Won. As a result, they are now trading in effect as if in a single bloc. Martin Hohensee, Deutsche Bank’s head of fixed income and credit research, sees the economic case for monetary union in Asia.

What we see now is a move toward an RMB area. In a serious dollar crisis, these currencies may move to a more formal joint floating, as Europe did in the dollar crisis in 1972. Would China then attempt to fix it as RMB area, or consider it as an interim stage in the process toward an Asian currency regime for the entire region? Chinese economists seem to be divided on the issue.

One school proposes a strategy to make RMB a key currency in East Asia.

Yao Zhizhong, Institute of World Economics and Politics, says that while ASEAN economies are under such strong Chinese competitive pressure that they require stable exchange rates with RMB, ASEAN currencies are not a major concern for China. RMB is favorably positioned in Asia. A precondition for RMB to be a key currency in Asia is stability. If ASEAN currencies are stable to the stable RMB, they will be stable to each other, making other exchange rate arrangements superfluous. The yen failed to be accepted as Asia’s key currency because it fluctuated too much and too often to the detriment of Asian economies. Yao says in future Asia the yen would be like what British pound is today in Europe.

RMB is now being used in China’s trades with neighboring countries in a limited manner. Li Jing, Capital University of Economics and Business, emphasizes that it is a spontaneous process chosen by the real economy, not by the government’s encouragement. She expects China’s structural trade deficits with ASEAN countries to lead to an increased supply of RMB to ASEAN for a wider use.

An RMB area with RMB as its key currency would divide East Asia into an RMB area and a yen area possibly comprising yen alone. Exchange rate fluctuations between the yen and the RMB area currencies would put Japanese companies at great disadvantage. Japan’s growth strategy based upon integrating Japanese economy with growing Asian economies would be in jeopardy. China is required to create 10 million new jobs annually in order to prevent social instability. Obviously Japan and China need exchange rate stability in the whole of Asia. Geopolitical implications of divided currency areas in East Asia would be even more far-reaching.

The other school calls for exchange rate cooperation in Asia. A typical example is an East Asian exchange rate mechanism advocated by Dr. Yu Yongding, former member of Monetary Policy Committee of the People’s Bank of China.

Professor Li Xiao of Jilin University says that because the RMB alone is unable to secure stability under the current dollar standard, China should seek stability by cooperating with Asian countries including Japan. His view reflects the European Union’s successful experience of the ECU (European currency unit), which resulted in the euro. The first stage in Asia will be to start regional exchange-rate coordination by means of the ACU (Asian currency unit) as guideline. It could be realized, if there was a political will. The second stage will be for each country to peg its currency to the ACU. But economic structures and development levels are so diverse in Asia that there are no economical and political conditions for the second stage at the moment. The third stage of Asian common currency is an ideal belonging to a remote future.

Both the RMB area school and the Asian exchange rate cooperation school present long-term visions. Judging from moves in the markets, inaction is likely to lead to emergence of an RMB area. However, there are circumstances that favor Asian exchange rate cooperation. First of all, exchange-rate stability in the whole region is in the common interests of all nations including China and Japan.

Second, ASEAN plus Japan, China and South Korea have successfully cooperated in creating and consolidating the Chiang Mai Initiative, a framework of emergency credit facilities, and have agreed to studying the ACU. This fact logically points to exchange rate cooperation. I would add, however, that exchange rate cooperation, which limits economic policy sovereignty, is more difficult to implement than emergency credit facilities.

To use ACU as guidelines for exchange rate coordination is within possibility. A proposal by Hajime Shinohara, Institute for International Monetary Affairs, that a research institute annexed to Chiang Mai Initiative be established to facilitate studies of Asian financial cooperations could also be realized, should China and Japan agree.

Japan has played a leading role in providing financial aid to crisis-stricken Asian countries, creating the Chiang Mai Initiative and proposing the ACU. Japanese policymakers are expected to keep leading Asian currency cooperation and, simultaneously, to use diplomacy to encourage China to choose Asian currency cooperation. If China uses her newly acquired economic and political power to promote Asian currency cooperation instead of establishing an RMB area, she will certainly be respected by the whole international community. ASEAN countries, which hate hegemony either by China or Japan, would welcome China and Japan’s cooperation in creating a stable exchange rate regime in Asia.

But there is a risk in this scenario. Nationalism giving rise to conflict between Japan and China could arise, making cooperation impossible. Political leaders of the two countries are responsible for preventing such xenophobic nationalism.

Mamoru Ishida is an adviser to Itochu Corp.