Project Syndicate - The Irresistible Rise of the Renminbi: [T]he United States’ own history suggests that the process can be completed more quickly than is sometimes supposed. As late as 1914, the dollar played absolutely no international role. No central bank held its foreign reserves in dollars. No one issued foreign bonds in dollars. Instead, they all went to London, allowing British banks to underwrite their transactions and conducting their business in sterling. Even US importers and exporters requiring trade credits obtained them in London rather than New York and did their business in sterling rather than dollars.
That London rather than New York still dominated in 1914, when the US economy was already more than twice the size of Britain’s, reflected the latter’s head start as an industrial power, an exporter, and a foreign investor. This is a reminder that incumbency is a considerable advantage in the competition for reserve-currency status.
But this situation also reflected the fact that the US lacked the market infrastructure needed for the dollar to play an international role. In particular, the US lacked a liquid market in trade acceptances, the instrument used to finance imports and exports. And it lacked a a central bank to backstop that market.
This changed in 1914 with the creation of the Federal Reserve System. One of the new central bank’s first actions was to encourage the development of a market in trade acceptances. It did so by using repurchase agrements to buy for its own account the majority of trade acceptances issued in New York. This ensured that spreads were low and prices were stable.
As a result of this official support, private investors gained confidence in the new instrument. And, with their growing participation, the market in trade acceptances became more liquid.
New York surpassed London as a source of trade finance by the mid-1920’s. At this point, the Fed could curtail its intervention and give the market over to private investors. And where private investors led, central banks followed. In the second half of the 1920’s they held more of their reserves in dollars than sterling. Thus, it took barely a decade, from a standing start, for the new international currency to overtake the incumbent.
Chinese officials have targeted 2020 as the date by which both Beijing and Shanghai should become leading international financial centers, with deep and liquid financial markets open to the rest of the world. By implication, that is the date by which they want to see the renminbi become a leading international currency.
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