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CHINA’S RENMINBI IS ALREADY A DOMINANT GLOBAL CURRENCY: New evidence of the emerging ‘tripolar’ monetary system

  • Published Date: December 2014

China’s renminbi has become a key driver of currency movements in Asia since the mid-2000s and especially since the global financial crisis. For example, when the Chinese authorities make official statements about their exchange rate and reserve policy, the currencies of other emerging Asian economies react in a way that is very similar to the market reaction of the renminbi.

These are among the findings of research by Marcel Fratzscher and Arnaud Mehl, published in the December 2014 issue of the Economic Journal. Their results suggest that the international monetary system is on the verge of becoming ‘tripolar’ – with the US dollar, the euro and the renminbi all playing a role as anchor currencies.

The financial crisis has brought reform of the international monetary system back to the forefront of global policy discussions. Some G20 leaders question the configuration of the current US dollar-based system. Other observers expect a multipolar system to emerge as a corollary of the rise of Asia as the global economy’s powerhouse. According to this view, the Chinese renminbi may emerge as a global currency alongside the euro, while the US dollar would lose its dominant status.

The new study assesses the extent to which a tripolar international monetary system has already emerged. The authors test what they call the ‘China’s dominance hypothesis’ – that is, whether the renminbi is already a dominant currency in Asia, exerting a large influence on exchange rate policies in the region, as much as China exerts a large influence on its neighbours through the well-known Asian production chain.

Today’s debate is remarkably reminiscent of an older one in Europe in the 1980s on the ‘German dominance hypothesis’. The international monetary system was dollar-dominated then too. The European currencies were linked to each other under the European Monetary System. But the system was markedly asymmetric de facto, with the deutsche mark playing a dominant role.

There are important similarities with Asia’s situation now. Emerging Asian economies peg their currencies to the US dollar, de jure. They are highly dependent on China, de facto. They have an incentive to maintain the stability of their currency relative to the renminbi because of the Asian production chain. China’s exchange rate and monetary policy are hence likely to exert a significant – if not dominant – influence on exchange rate and monetary policies in the rest of the continent.

The new research tries to gauge how strong this influence is, hence the analogy with the German dominance hypothesis. But the China’s dominance hypothesis is not as easily testable as its German analogue. China’s managed peg to the dollar creates an identification problem. Co-movements in short-term interest rates or in money aggregates are uninformative; China’s financial markets remain heavily regulated.

The researchers use a global factor model of exchange rates and a complementary event study to overcome these challenges. They show that the renminbi has become a key driver of currency movements in Asia since the mid-2000s, especially since the global financial crisis, in line with the China's dominance hypothesis. This suggests that the international monetary system is already on the verge of becoming tripolar, at least as far as the role of anchor currencies is concerned.

Specifically, the study’s three-factor model of exchange rates includes a US dollar factor, a euro factor and a regional currency factor. It is estimated on a sample of 48 currencies.

The researchers identify a statistically significant regional factor in emerging Asia’s exchange rate dynamics, stronger than in any other regions. They show that this factor has grown markedly in magnitude since the onset of China’s exchange rate reforms in 2005. They show that it is driven mainly by the renminbi, especially since the outbreak of the global financial crisis (although there is also evidence of bi-directional causality). This suggests that policy-makers in the region have paid growing attention to regional currency developments since the mid-2000s, and particularly to the renminbi.

The researchers’ event study analyses how shocks to China’s foreign exchange regime affect exchange rates in Asia and globally. It uses the market reaction to the official statements of Chinese authorities on exchange rate and reserve policy.

The results show that the response of emerging Asian currencies to these statements is very similar to that of the renminbi, unlike those of most other currencies in the sample. This again is supportive of the China’s dominance hypothesis.

ENDS

Notes for editors: ‘China’s Dominance Hypothesis and the Emergence of a Tripolar Global Currency System’ by Marcel Fratzscher and Arnaud Mehl is published in the December 2014 issue of the Economic Journal.

Marcel Fratzscher is at DIW Berlin. Arnaud Mehl is at the European Central Bank.

For further information: contact Romesh Vaitilingam on +44-7768-661095 (email: romesh@vaitilingam.com; Twitter: @econromesh); or Arnaud Mehl via email: arnaud.mehl@ecb.int