The problem with today's currency system is that it depends on the flawed and badly managed dollar. World trade and the global economy all depend largely on the greenback, which has all the stability of a drunk on a unicycle. The dollar is based on the highly indebted and profligate economy of the United States, whose dysfunctional political system is playing chicken with the prospect of default.
It shouldn't be this way. The world's currency system was devised at the end of World War II to have a double base: the U.S. dollar and the British pound. As the role of the pound declined, the deutschmark and yen seemed likely to replace it but never quite succeeded.
A decade ago, the euro looked to be the dollar's new partner, being based on an economy of roughly similar size to that of the United States'. But the euro itself, with its recurrent crises in Greece, Ireland and Portugal, has also failed to make the grade as the dollar's equal. Roughly two-thirds of the world's currency reserves are in dollars and only around one-quarter in euros.
China's renminbi is the international version of the yuan. Beijing's insistence on state control means it isn't a currency that can be bought and sold and traded on international markets like the dollar, pound and euro. But very smart banks, like HSBC and Deutsche Bank, have each suggested recently that the renminbi will be traded within five years.
That may well happen and that could bring some advantages for China's long-squeezed consumers, whose pay packets would be able to buy more foreign goods and whose companies could borrow more easily on international markets. But it would certainly reduce the level of government control over the economy, since the rules of international supply and demand rather than just Beijing's policy decisions would affect China's interest rates.
Indeed, back in 1993, China said it planned to make its currency convertible by the end of the decade but then came the Asian crash of 1997-98 when whole countries were sandbagged as hot money flooded out faster than it had flooded in, provoking currency crises and onerous rescues by the International Monetary Fund.
For Beijing, that was an awful warning and the convertibility plans were shelved. And China resolved to keep its exchange rate artificially low to encourage exports and use the resulting hoard of dollars as an insurance against any currency crisis squeezing Beijing's policy prerogatives. Three trillion dollars later, China is sitting on a hoard of foreign assets that has itself become a global problem.
Moreover, China's main customers in the United States and Europe are increasingly frustrated at China's exchange rate policy and so are Chinese workers who have been pushing for hefty pay rises to share in the wealth their country has created. Beijing, which dreads the idea of poverty or policy reducing the readiness of foreign buyers to import its goods, has allowed the renminbi to appreciate modestly by about 6 percent against the dollar over the past year.
There could be a middle way. The head of China's central bank, Zhou Xiaochang, chose the occasion of the Group of 20 summit in the crisis atmosphere of March 2009 to suggest a "super-sovereign reserve currency managed by a global institution" to replace the current international monetary system. The IMF's notional currency, the Special Drawing Rights could become such a new global currency. But it would have to be based on a basket "of all major economies."
That would require a very far-reaching international agreement and would be seen as a bruising defeat for American prestige. So China is taking another path, a form of convertibility by stealth, taking one step and one country at a time.
So far it has bilateral currency swap agreements worth well over $100 billion with South Korea, Malaysia, Belarus, Indonesia, Argentina, Iceland, Singapore, Hong Kong, New Zealand and Uzbekistan with Russia, Brazil and South Africa reportedly in talks.
China is also working on trade finance, licensing more than 67,000 exporters in 20 provinces to invoice in renminbi and is seeking to get importers to pay with renminbi. There is a problem here; those importers who do have renminbi to spend are hanging on them, expecting the currency to increase in value.
This approach means that China's currency won't be at the mercy of the dollar system, in which Beijing has understandably less than full confidence. But then few people can have much confidence in a currency system, which sees such bizarre gyrations as a euro worth 80 U.S. cents 10 years ago but worth $1.50 this month, even as the euro staggers from crisis to crisis.
So far this year, on a basket of trade-weighted currencies, the dollar is down 6.5 percent, the euro is up 3.2 percent and the yen is down 5.5 percent.
How long China will hold back from full convertibility of the renminbi is unknown. Beijing sets a high priority on maintaining control of strategic matters like its currency. But the impact on world markets would be dramatic if and when it happens.
Most observers have focused on China's official holding of $3 trillion in foreign assets. But the personal savings of China's 1.3 billion people currently amount to 75 trillion yuan and, were they convertible, they would be valued at $11.6 trillion. Add in the $3 trillion of China's official holdings and China's total savings are the equivalent of the U.S. gross national product. They could buy very nearly all the stocks on the New York stock exchange.