China, already an economic power in East Asia, is poised for another great leap forward after Beijing announced plans this week to liberalize trade of its currency, the yuan.
The decision could, in the long term, spell the demise of the U.S. dollar as the preferred reserve currency of international commerce and trade, a favored position enjoyed by the U.S. since the end of World War II.
The Chinese State Council revealed it would propose plans this year to allow freer flow of the yuan, after a meeting led by Premier Li Keqiang on Wednesday. The announcement underlines Li Keqiang’s commitment to furthering China’s financial liberalization.
“It’s a positive sign that the new government under Li Keqiang is trying to boost growth by reform instead of launching fiscal stimulus,” Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong, told Bloomberg. It shows that the “reform ideas promoted by Zhou Xiaochuan have received endorsement from the cabinet,” he said.
Easing the flow of the Chinese yuan will bring the Chinese economy one step closer to what economists call “full convertibility,” meaning free exchange in the global market. The U.S. dollar, British pound sterling and the euro are among the most freely-traded currencies worldwide with values determined by basic supply-and-demand market principles.
For years, the Chinese government kept a tight control on the yuan, in order to tip the balance of payments in favor of its burgeoning export-driven economy. This led to a bevy of complaints from the U.S., China’s primary trade partner. With a trade imbalance of nearly $39 billion, Congress and the Obama administration have long accused China of being a currency manipulator.
Liberalizing trade of the yuan is not necessary good news for the U.S. economy. Chinese liberalization is part of a broader trend of creating new economic institutions run by countries in the developing world. These new economic arrangements may not replace the World Bank and International Monetary Fund, but economists posit that they are likely to shift the balance of power away from once-ubiquitous Western financial institutions.
New economic institutions in the developing world
Toward this end, leaders of Brazil, Russia, India, China and South Africa — known by the acronym “BRICS” — introduced plans for a new development bank in March, that could offer the same services as the World Bank and International Monetary Fund (IMF), set up during Bretton Woods.
The Bretton Woods conference of 1944 brought together 730 delegates from all 44 Allied nations in an attempt to rebuild post-World War II Europe. Attendees established an international exchange rate by tying its currency to the U.S. dollar. Delegates also gave the IMF power to bridge temporary imbalances of payments. The historic meeting helped pave the way for decades of U.S. economic dominance in the global economy.
With combined foreign-currency reserves of $4.4 trillion and 43 percent of the world’s population, BRICS nations have the power to fundamentally change this dynamic going forward.
“The deepest rationale for the BRICS is almost certainly the creation of new Bretton Woods-type institutions that are inclined toward the developing world,” Martyn Davies, chief executive officer of Johannesburg-based Frontier Advisory, told Bloomberg. “There’s a shift in power from the traditional to the emerging world. There is a lot of geopolitical concern about this shift in the western world.”