Elements of the Global Financial System, Possibilities of Internationalizing Renminbi - Literature review Example

THE GLOBAL FINANCIAL SYSTEM by Student’s Name Code + Course Name Professor’s Name University Name City, State Date Table of Contents Introduction 3 Elements of the Global Financial System 3 Currency Internationalization 4 Good and the bad with Currency Internationalization 5 Possibilities of Internationalizing Renminbi (RMB) 5 What Influence will Renminbi Internalization have on Australia? 7 Conclusion 7 References 8 Introduction According to the World Economic Forum (2015) fiscal stability and sustainable growth of the global economy, calls for joint efforts among policy makers and the different actors within the financial sector. For this reason, the forum notes that the institutional framework of the financial systems has had to be integrated further, with time, so as to fully account for the growing influence exhibited by rising market economies. On the other hand, the new entrants as well as the traditional players in financial services sector have had to engage systematically so as to come up with a fair system that is acceptable at the global level (Bowles & Wang, 2011). In so doing, the international framework, seeks to provide a rare platform that connects households to public institutions, corporates and service providers within the financial sector. As a result, the access to a wide range of affordable, quality financial services and products that cushion customers from potential risks and facilitates investments and savings has grown significantly. In a bigger picture and in the long run, a comprehensive financial inclusivity is widely seen as one way to guarantee job creation through effective and efficient capital allocation. So, what are the key elements making up the current global financial system? Elements of the Global Financial System According to Frankel (2012) a number of new forces are slowly but surely taking over the global financial system. These forces can be placed into five main categories. At the top of these forces is the unit of the emerging markets that occupies an increasingly significant role in the collective international financial system. The author observes that, globally, the total financial assets across the world are projected to hit US$ 900 Trillion which will be a whopping 50% from the year 2010. However, he explains, a 25% of the enlarged total will be contributed by the developing economies only whereas the capital footprint of China alone is expected to attain US$ 125 Trillion. Secondly, technology comes up as another significant force that is expected to play a major role in shifting the boundaries of the world’s financial systems (Ryan, 2012). This is because, technology will pave way for new entrants into the policy-making stage to fill the voids left behind by the incumbents who characterize the existing domains. This force will provide solutions for automated investments, new payment platforms as well as inject capital into the global economy. It is these new developments that will alter the overall landscape of the financial services and probably transform the existing risk management systems. Thirdly, regulatory and monetary policies are also likely to be reviewed to not only boost economic growth but also guarantee soundness and safety of the world financial systems (World Economic Forum, 2015). Robust prudential measures like capital adequacy and improved liquidity standards will render the interest rates in the developed markets highly accommodative. Consequently, this will force the policy makers and the industry at large to assess the influence of their decisions on the delivery of key financial services. In the same vein, loss of trust in the current financial services is also likely to bequeath a financial crisis of global scales. According to the World Economic Forum (2015) poor corporate governance, weak internal controls coupled with unethical activities practiced by some of the market players are already being felt across the world’s financial systems. Notably, negative public sentiments have already been elicited by large fines imposed and cyclic legal battles witnessed among some financial players. In the long run, the declining trust, by the society will be extremely costly and concerted efforts to check against this possibility need to be implemented as a matter of urgency. The fifth factor that is already influencing the global financial systems is financial inclusion. Wright et al., (2014) argue that an approximated 2 billion adults, world over, are missing the benefits of financial inclusion. Being a critical pillar in the quest for economic growth and poverty reduction, this component remains key for not only businesses but national governments as well. Further, the digitization of a number of financial services – payments, credit access, savings and insurance – has already had immense impact in the lives of the financially included in the last few years. However, to accelerate the progress made, far-reaching cross-sector collaborations will come in handy especially when compounded with consistent innovations (Jackson, 2015). In sum, the future of the global financial system will ride on these five components. Currency Internationalization Fundamentally, an international currency is one that is used outside its home country. According to McCauley (2011) the study of currency internationalization mainly focuses on holdings for the reserve currency. The author gives three reasons for this: First of all, the annual data for all the relevant currencies is available for a period spanning more than 45 years; secondly it is pegged on the ability of the United States to finance its deficits with regard to the current accounts and the third reason is the complex interrelationship between the different roles, statistically and causally, played by an international currency. As a matter of fact, the international currency status has less direct economic implications when compared to the corresponding impact on the exchange rates. Good and the bad with Currency Internationalization There are a number of positive results for a country having international currency (Bowles & Wang, 2011). To begin with, there is the aspect of convenience enjoyed by the respective country’s citizens when borrowing, importing or exporting thereby minimizing transactional risks and foreign exchange risks. Secondly, the pair observes that, international currency status translates to more business for the host country as it means less firm connections between the bank’s nationality and the currency in which the transaction is conducted. Thirdly, is seigniorage – the countries that hold a foreign currency have to give up real services as well as goods so as to add value to the international currency on use. This enables the host countries to run up enormous debts denominated in own currency and at low interest rates. Finally, with the status, there is definitely prestige and political power. On the other hand, there are disadvantages in owing an international currency as well (Thorbecke & Mason, 2008). One of these limitations is the fluctuation caused by currency demand especially in scenarios of increased mobility of capital. Moreover, many central banks fear the possible volatility of their respective money stocks. With these comes the burden of responsibility where monetary authorities in leading international currency risk being pressured to take into account the world market resultant effects. Possibilities of Internationalizing Renminbi (RMB) No doubt that the emerging possibility that renminbi could soon join the league of international currencies has elicited too much excitement, observes Ryan (2012). However, McCauley (2011) cautions that there is need to carefully interrogate the myriad factors that come into play while arriving at such a decision. In this scenario, the best precedents would be the dollar (1913-1945), the rise of Deutsche mark (1973-1990) and finally the emergence of the yen (1984-1991). It’s worth noting that the fundamental determinants for a currency to acquire international status is the confidence it oozes, size of the economy and the depth exhibited by the financial markets. It is a generally accepted view that once the three basic factors are adequately taken care of then the internationalization of the given currency can be realized pretty fast. That is why the latest observation, that the RMB could challenge the position occupied by the dollar in a span of one decade aroused a lot interest among economic analysts. In spite of the optimism expressed by the proponents for the elevation of the status of renminbi, the currency has not yet met the third criteria i.e. depth of the financial markets (Wright et al., 2014). In principle, the advocates argue, the Chinese government could easily create a provision for the required depth by way of accepting to have an open capital account. This would see its control over domestic credit allocation decline considerably and consequently result in flexible exchange rates. Frankrel (2012) observes that though the government of china has been actively encouraging offshore currency use since 2010, very little has been done to meet the prescribed requirements. Probably, this could be explained from the fact that any such attempts, would have indeed deviated from historical precedents. This is because throughout the twentieth century, the period during which three currencies were internationalized, it was the popular interest in the imagined prestige in having the country’s currency in international listings that served as the major driving force. In most cases, businessmen fear that the currency internationalization process has a major negative bearing on the export competitiveness. Given this state of affairs, it would be understandable the reason as to why the Republic of China remains non-committal to quickly opening up its domestic financial markets and consequently allowing its currency to appreciate (Thorbecke & Mason, 2008). Although it may take considerably long to open up the Chinese financial markets, a number of economic intellectuals are well in agreement that there are real chances that the Chinese Renminbi will replace the US Dollar by the year 2020 (Jackson, 2015). This is further buoyed by the current situation where the Chinese currency has already met some of the threshold requirements for currency internationalization. Moreover, this is also backed up by the fact that the Chinese economy, in terms of size, is expected to surpass that of the US in the next five years. In addition, China is slowly but surely edging out the US with regard to claiming the enviable position of the world’s largest exporter. Consequently, Renminbi is expected to attain the level of an international currency in the next few years and even cement its position as one of the multiple reserve currencies. What Influence will Renminbi Internalization have on Australia? Fundamentally, the internationalization of Renminbi, would result in the currency’s appreciation (Frankel, 2012). Such an eventuality would reduce the price competitiveness of the exports from China. Consequently, the neighboring economies, including Australia, would rush to fill in the gap and maximize their exports to the Chinese economic partners. Secondly, it would be a major deterrent for the government of Australia to borrow from China even at the lowest interest rates. This is because of the possible exposure to a currency expected to appreciate. As a result, Australia would keep the imports from China under control as noted by McCauley (2011). Thirdly, China’s monetary and credit control may be compromised forcing the Chinese firms to borrow away from their mother country. Australian banks would be direct beneficiaries of such a possibility as this would present a golden opportunity to challenge the very predominance of banks domiciled in China. Conclusion Internationally, the use of the Chinese RMB continues to increase supported by favorable policy initiatives initiated by the Chinese government over the last few years. This presents a complex relationship especially when it comes to the country’s capital controls. While the RMB use by the Australian entities is also on an upward trend, considerable scope still remains on the possible prospects for the future growth. All in all, going by the current growth rates, the Chinese economy would most likely challenge that of the US in the next few years. In the same vein, the Chinese Renminbi, would effectively dislodge the US dollar from its privileged position in the global economy. In the long run, it also follows that the RMB would significantly appreciate against the dollar. References Bowles, P. & Wang, B., 2011. Renminbi Internationalization: A Journey to Where? Santa Barbara Bristol, England Frankel, J., 2012. Internationalization of the RMB and Historical Precedents. Kennedy School of Government, Harvard University, 79 JFK St., Cambridge MA 02138-5801, USA Hatzvi, E., Nixon, W., & Wright, M., 2014. The Offshore Renminbi Market and Australia. Reserve Bank of Australia Jackson, J.K., 2015. China's Currency Devaluation. Federal Reserve Bank McCauley, R., 2011. Renminbi Internationalisation and China’s Financial Development. BIS Quarterly Review, Beijing Ryan, J., 2012. China, the Eurozone and Global Reserve Currencies. Center for Economic Policy Analysis, University of Venice, Italy Thorbecke, W., & Mason, G., 2008. How Would an Appreciation of the RMB and Other East Asian Currencies Affect China’s Exports? George Mason University, Fairfax, VA 22030, U.S. World Economic Forum, 2015. The Global Financial System: Policy Recommendations for the Future. World Economic Forum 91–93 route de la Capite CH-1223 Geneva Switzerland Read More