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China’s Next Move And Triumph: Reserve Status For The Yuan

220px-Terracotta_pmorganChina is gaining increasing prestige and influence in the world by carefully working within Western established institutions, when it is to their advantage and going around them when it does not support the Chinese drive towards great power status. China has been largely successful in garnering enough world wide support in the establishment of the Asian Infrastructure Investment Bank, over the objections of the Japan and the United States. Now the Chinese are working to make the yuan also known as the renminbi (the people’s currency) a global reserve currency for trade and investment.

Once again China is finding the United States trying to block an initiative, that will add to the power of China. The rise of the yuan will allow the Chinese their place in the global economy, that is commensurate with their growing wealth and industrial strength. China with a GDP (Gross Domestic Product) of $9,240.27 trillion USD (United States Dollar) is the world’s 2nd largest economy. The United States in comparison, has a GDP of $17,701 trillion USD.  In Purchasing Power Parity, China already has the largest economy in the world.Graph_of_Major_Developing_Economies_by_Real_GDP_per_capita_at_PPP_1990-2013

As was the case the last time one great power was surpassed by another, one needs to return to the 20th century. Although the United States had surpassed the economy of Britain in 1872, the British were able to maintain their international dominance for another generation.

The victory the British Empire had achieved during the Napoleonic Wars and ratified by the Congress of Vienna in 1815, would last a full century. The decisive event was World War I. It was on the battlefields of France, locked in a desperate struggle with Imperial Germany, that Britain bankrupted its economy.

The British Empire

The British Empire

Following the end of war the British were able to hold onto the Empire, but the pound sterling gradually gave way to the American dollar. In the end economic reality always wins. The United States was creating enormously large companies, that now had a global reach. Britain which had been the workshop of the world, was now overtaken by mass production in manufacturing and industry.

The British were also able to maintain their preeminence in international affairs, but only because the United States did not challenge the world order at the time. The Americans were not yet ready to assume the position of the leading power in the world. World War II would change this paradigm. This time in order to achieve victory, the British would virtually destroy their economy and with it the Empire. It was only then that the United States became the superpower of the 20th century.

The creation of the United Nations, NATO (North Atlantic Treaty Organization) and numerous other military treaties and alliances, soon allowed American power to be projected around the globe. The large military industrial complex of the United States made it all possible. It was American economic power, that allowed the United States to bend much of the rest of the world to its will.

Mt. Washington Hotel In New Hampshire Site Of The Bretton Woods Conference

Mt. Washington Hotel In New Hampshire Site Of The Bretton Woods Conference

Bretton Woods held near the end of the war and the numerous financial institutions that would spring forth from this conference, would cement American commercial and monetary dominance. The IMF (International Monetary Fund) and the World Bank are just two examples of American engineered financial ascendancy. It allowed the Americans the ability to offer the dollar, as the first world reserve currency. This gave the United States a tremendous advantage and would help allow the United States to become the preeminent economic power for the rest of the century.

In the 21st century, exactly a hundred years after the beginning of the end for British supremacy, the world is once again at a juncture where an ascendant country is ready to acquire the tools necessary to reach great power status. When Germany attempted to challenge Britain at the end of the 19th and the beginning of the 20th century, it turned a European War into World War I. The British decided to use military force, to prevent German economic and military dominance of the European continent. Whereas the American threat to British security was potential and far away, the German menace was on the door step of the home islands of the British Empire.

German Soldiers On The Way To The Front In 1914. A Message On The Freight Car Spells Out "Trip To Paris"; Early In The War, All Sides Expected The Conflict To Be A Short One.

German Soldiers On The Way To The Front In 1914. A Message On The Freight Car Spells Out “Trip To Paris”; Early In The War, All Sides Expected The Conflict To Be A Short One.

In retrospect, perhaps the strategy of Prime Minister Lord Asquith did not serve British interests in the long run after all. In not taking a more activist policy in European affairs earlier and neither being very accommodating to rising German aspirations, war was perhaps inevitable.

The addition of British military strength did deny a quick German military victory, but also ensured a long struggle. This was because the opposing sides were almost evenly matched. Slowly and painfully the Germans began to win, first in the east and would only be denied victory in the west, by the arrival of American troops. It would tip the balance of power towards the British side, but at a great cost. The British were practically financially insolvent at the end of the war.

Now the contest is between China and the United States. One would hope the struggle will remain in the economic and financial arena, but there is always the chance of a miscalculation. The increasing aggressiveness of the Chinese in the South China Sea for instance, has made this all too evident. The Americans are partly culpable in the Chinese economic rise. Running huge trade and fiscal deficits over the course of decades with China, allowed the country its current financial clout.ForbiddenCity_MaoZedongPortrait_(pixinn.net)

China is attempting to persuade the IMF to make the yuan a reserve currency. This would put it in an elite group that consists only of the American dollar, the Japanese yen and the Euro. It would be the first step in a drive to topple the United States Dollar, from being the lone world reserve currency. Of course the United States is opposing the Chinese effort. Unfortunately for the Americans, key allies are once again supporting China, mainly Western Europe led by the Germans.

The attitude in Europe and even in Australia is that allowing the Chinese yuan reserve status, would help accelerate the reforms necessary, to liberalize the partially closed financial markets within China. This would help facilitate trade and open up China to greater Western investment and market penetration. It will in turn, intensify the need for the central banks of leading countries, to acquire additional yuan in their transactions and reserves.

Graph Comparing The 2013 Nominal GDPs Of Major Economies In US$ billions, According To IMF Data

Graph Comparing The 2013 Nominal GDPs Of Major Economies
In US$ billions, According To IMF Data

The elevation in the financial power of China will come at an ideal time for the country, in it’s quest to challenge the economic and political hegemony of the United States. The Americans for their part, understand the threat and insist in order for the yuan to become a reserve currency, China must totally overhaul their economic system.

The United States is demanding a far more open financial system from China. This would include interest rate liberalization and an exchange rate based on market forces. There would also need to be greater international oversight.

Knowing that the Chinese communist leadership will be unlikely to accede to the sweeping American demands, is one way to torpedo the effort. In spite of the American and once again Japanese objections, the Chinese government is moving forward on some reforms. For example, beginning in May of this year, the Chinese government is having their banking system provide bank deposit insurance for customers.

The Shanghai Stock Exchange Building In Shanghai's Lujiazui Financial District. Shanghai Has The 25th-Largest City GDP In The World,  Totaling $304 USD Billion.

The Shanghai Stock Exchange Building In Shanghai’s Lujiazui Financial District. Shanghai Has The 25th-Largest City GDP In The World, Totaling $304 USD Billion.

For the Chinese yuan to be considered for reserve status according to IMF rules, it must be freely usable. Of course, the rules are flexible enough that the executive board could rule either way. Therefore, the way the Chinese government carefully manages the value of the yuan, does not necessarily disqualify it for consideration. A decision by the IMF will be made later this year.

China has certainly helped its case by using the yuan in more international trade transactions. These have increased dramatically over the past few years from almost nothing in 2009 to near 25% in 2014. At the same time working to the Chinese disadvantage, is the present government controls on the flow of capital in and out of China. This may well be the deal breaker for the officials at the IMF.

Regardless of the immediate outcome, it is no longer a matter of if, it is a matter of when the yuan will reach reserve status. The Managing Director of the IMF has even stated so. The United States cannot forestall the inevitable shift in power forever. History shows that eventually, the economic and financial strength of a country must be accommodated in international affairs, one way or another. The only other alternative would lead to war. It will be the same for China. Given the growing strength of the country, it is unlikely that great power status is very far off. China will be the world’s next superpower in this century, it is just a question of how soon.

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