Tuesday, 12 January 2016

Yuan as Reserve Currency less important than Economic and Political Reform

By Chris Harry

In theory, the addition of the RMB as a top-reserve currency would further diversify the world's exchange reserves. It also would draw China further into the world economy, which might also be a positive force for encouraging China to move toward a stable economic model based on greater transparency and not-so minor adjustments such as the rule of law. On the other hand, Chinese banks would have to sink and park huge sums of money as deposit insurance, which could further weaken its already fragile debt-to-GDP ratio imbalance.

The fact that China is a maverick economic player that relies on artificial growth that is willing to use any and all means to continue the growth bubble for the sake of social stability and the perpetuation of the party-state, also means that China could potentially become a hugely disruptive and destabilising force in the world economy.

Party interests will always remain paramount and unchecked under the current system, so only when China makes a fundamental political and economic shift, can we expect the Yuan to make a positive contribution to global economic stability. China will also need to follow international rules and regulations in order to make a positive contribution to international economic stability. Again, under the current system in place in China, we cannot expect that it is willing to follow international norms, practices and rules. 

The lack of a domestic rule of law clearly indicates China unwillingness to abide by international treaties and conventions. China's approach in the South China Sea shows a total disregard for the sovereignty of its own neighbours and is a breach of the treaties it signed and pledged to uphold. Xi's administration has been emboldened to further apply the no-rules bully approach toward domestic politics and foreign policy. At the same time, the domestic economy has been tanking ever since Xi took power.

The stock market debacle also shows a total lack of transparency and honesty in dealing with internal domestic issues. In the end, the government relied on a command-driven and heavy-handed approach to force a recovery of the stock market. In the process, billions of individual investors' earnings evaporated along with crucial monetary reserves to support China's state retirement funds. 

Beijing took a huge gamble by creating a false bull market in order to orchestrate state-led insider trading, so as to prop up Zombie SOEs that are bleeding out huge losses daily and are kept alive by state-controlled banks that can barely handle the pressure of giving out free money to keep these SOEs afloat.

When China gets its political and economic house in order, then we might expect the RMB to play a positive role in the world economy.