Comment on “China as Number One: How about the Renminbi?”

Abstract

Ito (2010) addresses a number of important issues, but there are some critical points that I wish to raise. My first comment is that the paper needs to elaborate more on the internationalization of the renminbi (RMB). With China's growing size in the world economy, the view that the RMB will become the key currency in Asia and is on the way to become a new international reserve currency over the long run is widely shared. But what are the critical preconditions for the RMB to acquire reserve currency status? Will China transition smoothly to accomplish those preconditions? What would make Asian neighbor countries accept regional hegemony of the RMB in regional trade and financial transactions? Moreover, the question of using the RMB as a regional key reserve currency is directly linked to the future of the US dollar. A number of recent studies have analyzed these issues in detail (see Lee, 2010 for instance). My second comment relates to the gross domestic product (GDP) growth projections. Ito predicts the timing when China overtakes the USA in GDP. I agree that nominal GDP in US dollars should be used to measure market size. But the paper's prediction that “China as number one before 2027 seems to be certainty” is clearly subject to several critical assumptions. The simulation result is dependent on the estimated real GDP growth rate and real exchange rate appreciation. Lee (2010) assumes a simulation scenario in which China follows a low growth path with a 6% real GDP growth rate and a real exchange rate appreciation rate of 3.4%,1,2 and the USA maintains GDP growth at its historical rate of 2.1% per year and an inflation rate at 2.5%. In this low growth scenario, China will not be able to overtake the USA by 2035. My third comment relates to the paper's interesting and provocative observation point that “By 2030, it is likely that the IMF headquarter will move to Shanghai or Beijing.” International Monetary Fund (IMF) quotas are based broadly on the country's relative size in the world economy. Initial quotas are assigned to new members based on the quotas of existing members of comparable economic size and characteristics. The IMF uses a quota formula to guide the assessment of a member's relative position. IMF (2010) states that “the newly agreed quota formula is a weighted average of GDP (weight of 50%), openness (30%), economic variability (15%), and international reserves (5%). The formula also includes a ‘compression factor’ that reduces the dispersion in calculated quota shares across members.” Based on this formula, the argument in Ito (2010) sounds reasonable. However, by ignoring important institutional and political constraints, it is unrealistic. The last quota change was implemented in 2008. General reviews of quotas and voting shares are done only every 5 years. Currently, China's quota is only 3.7% of the total, while the USA has 17.1%, and the EU has 32.4%. I do not think China will ever be able to change the quota assignment rules of the IMF significantly. Section 2c of the Articles of Agreement states that any change in quotas requires an 85% majority of the total voting power. China's voting power is only 3.65%, while the USA has 16.74%. I am certain that any member with a large voting power would not be willing to relinquish it in favor of any other member. This suggestion looks politically unviable. China's quota will increase significantly over time but it may not overtake the USA. My last comment relates to the basket currency regressions using Frankel and Wei (1994). Ito (2010) says that “The Chinese RMB has been floated against the USD, then we can test whether CHY has any impact on movements of other Asian currencies, by adding CHY as the fourth variable on the right-hand-side: In this equation, identifying the coefficient of RMB can be problematic. Note that the estimation result shows that CHY can be explained very well as being pegged to a basket of three major currencies (US dollar, euro, and yen). The estimated coefficient of CHY in this specification may not identify the influence of CHY (independently from the major currencies) on other Asian currencies.