photo by faungg's photos on Flickr
Last fall, the International Monetary Fund announced it would add China’s yuan to its basket of reserve currencies, in a victory of optimism and politics over common sense.
As I observed at the time, adding the yuan to the list of currencies included in the IMF’s Special Drawing Rights alongside the dollar, the euro, the yen and the pound seemed to be based solely on fear of running afoul of China’s economic and political clout. The decision certainly was not based on evidence of a free flow of capital or a transparent underlying economy. Even basic economic statistics remain state secrets in China, and Beijing is happy to close or manipulate the markets when it deems such action necessary.
Two months ago, however, the yuan took its place in the SDR. In a statement, the People’s Bank of China said the currency’s inclusion was “an affirmation of the success of China’s economic development and results of the reform and opening up of the financial sector.”
Yet it only took a handful of weeks before China became alarmed at the fact that multinational companies expect an international currency to flow relatively freely – even if that means more leaves the country than enters it.
The Wall Street Journal recently reported that China’s foreign-exchange regulator has instructed banks to massively scale back how much money businesses can move out of China into other branches of their operations. Until recently, big companies could “sweep” large quantities – up to $50 million worth of yuan or dollars – into or out of China without much effort. Beijing has slammed on the brakes, however, and sweeps are now capped at $5 million.
“Sweeping” arrived in Shanghai in 2013, as part of an experimental free-trade zone. Before the advent of sweeping, companies that wanted to move money generated in China elsewhere had to navigate a burdensome amount of documentation, as well as pay extra taxes. The free-trade zone was part of China’s effort to prove to the IMF that the yuan was a credible global currency after its rejection from the SDR basket in 2010.
The idea of the zone, at least on paper, was to test out financial reforms designed to open up the economy before introducing them across China. Instead, the government has now prioritized stabilizing the flow of capital. The local branch of China’s central bank recently announced new systems to monitor currency outflows in the free-trade zone to make sure they are balanced by inflows. The free-trade zone had gotten a little too free.
Multinational firms are now sharing the pain of domestic companies, which were China’s first target in the effort to keep capital from flowing too rapidly in what Beijing views as the wrong direction. In November, new rules (which are ostensibly temporary) subjected many overseas deals to reviews of “strict control,” the Journal reported. Authorities have also instituted measures to limit individual investment overseas. Beijing clearly sees where the yuan are flowing, and does not care for it; one senior government adviser said that overseas acquisitions by Chinse companies may serve as cover for working around capital controls.
It’s no fun to say “I told you so,” but it is hard to draw any other conclusion. The yuan is now an international reserve currency, but no sensible economist or businessperson can view it as anything like a “safe haven” today. Not only is Beijing making it increasingly difficult for multinationals to move capital in and (mostly) out of the country, any real data about the economy remains inaccessible to most third-party observers. Meanwhile, the yuan’s value hit an eight-year low last month after the U.S. presidential election.
As Eswar Prasad, a Cornell University economist, observed in the Journal, China still lacks an independent central bank, a trusted rule of law and a transparent government constrained by anything like the checks and balances present in the governments of other SDR basket currencies. “China has made abundantly clear it’s not going to have any of these,” he added. So, for now, China secured the status boost that comes with the IMF’s recognition, but the trust of rational central bankers will remain out of the country’s reach for the foreseeable future.
Without a reasonably open political system, stable and transparent financial institutions and independent courts that are willing to enforce contracts, China cannot be considered a developed nation, no matter how large its overall economy grows or how advanced its technology becomes. Regardless of how big China gets, its money cannot function as a stable store of value or a reliable medium of exchange, because those two fundamental purposes of currency are secondary to the overriding purpose of Chinese government: preserving its own power.