Renminbi : The Internationalization of China's Currency 9781844643998, 9781844643172

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RENMINBI RENMINBI RENMINBI

THE INTERNATIONALIZATION OF CHINA'S CURRENCY

THE INTERNATIONALIZATION OF CHINA'S CURRENCY

THE INTERNATIONALIZATION Author: Zhaodong SunOF CHINA'S CURRENCY

Translated by: Yong Xie Author: Zhaodong Sun Translated by: Yong Xie Author: Zhaodong Sun Translated by: Yong Xie

Renminbi: The Internationalization of China’s Currency Author: Zhaodong Sun

Translated by: Yong Xie

RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY Author：Sun Zhaodong Translated by：Yong Xie

RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY Copyright ©2009 by China Financial & Economic Publishing House No. A28 Fucheng Road, Beijing, China Author: Zhaodong Sun Translated by: Yong Xie All rights reserved. No production, copy or transmission of this publication may be made without written permission.

Contents

Contents

Preface / Introduction /

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Currency Internationalization in developed countries / 1 1. What is currency internationalization? / 3 2. The British Pound: rose from industrialization and colonies / 6 3. The US Dollar: Rising in the Game and Fight with the British Pound / 11 4. The Japanese Yen: reliant on the USD and anxious to make progress / 15 5. The Euro: a successful model as a regional currency / 20 6. Common Features of Monetary Internationalization / 23

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The Bumper Car Game between RMB and the Dollar in the Process of Internationalization / 29 1. Timely Help in the International Financial Crisis / 31 2. RMB- Golden Partner for the Dollar / 33 3. Healing the International Monetary System Together / 36

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Gradual Rise of the RMB on the International Stage / 39 1. RMB on the Path toward Free Exchange / 41 2. Testing of the RMB Settlement of Cross-border Trade / 48 3. Charm of Potential - the RMB and Regional Anchor Currency / 55 4. The RMB Internationalization - Go on Its own Path / 62 5. Strategies to Advance the RMB Internationalization / 69

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RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY

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Years of the RMB Test Run on the International Racing Track / 73 1. The RMB Overseas / 75 2. Different Lengths of the RMB 'Shadows' / 80 3. Currency Swap Agreements Frequently Signed by the PBOC / 100 4. Changes in the Exchange Rates of the RMB against Currencies in Major Countries / 93

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Why Should the RMB Internationalization Be Accelerated / 103 1. Seeking Opportunities among Risks / 105 2. The RMB Internationalization Accelerated by the Financial Crisis / 106 3. Monetary Demands of China at the Current Development Stage / 111 4. China's Foreign Exchange Reserve — Solid Backup for the RMB Internationalization / 115

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The Outlook and Effects of the RMB Internationalization / 121 1. Advantages of the RMB Internationalization / 123 2. Several Difficulties in the RMB Internationalization / 135 3. Risks in the RMB Internationalization / 137 4. How Far Away will the RMB Internationalization Be / 142

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The Development History of the International Monetary System / 145 1. Gold Standard Era / 147 2. The Gold Exchange Standard System / 153 3. Early Stage of the Dollar Standard System-the Bretton Woods System / 157 4. The Coming of the Dollar Standard Age - the Jamaica System / 161 5. The Problematic International Monetary System / 165 6. Direction of the International Monetary System Reform / 170

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Contents

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Super-Sovereign Currency / 179 1. Three Articles by Zhou Xiaochuan published in the spring of 2009 / 181 2. The Past and Present of the Super-sovereign Currency / 186 3. Is Super-sovereign Currency Realistic? / 194

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One World One Currency / 199 1. Periodic Evolvement of Traditional Currencies / 201 2. A New Era Connecting the Past with the Future / 205 3. The Conception of One Currency / 206 4. The Future International Currency / 208

Reference / 219 Postscript / 223

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Preface

Preface I would like to congratulate Mr. Sun Zhao Dong, my esteemed colleague and longtime friend, on the forthcoming publication of the English edition of Renminbi: The Internationalization of China’s Currency. Mr. Sun Zhao Dong’s deep academic research into the field of finance has spawned many achievements and several of his works have been highly praised in China. It is a great honour to be asked to write this preface, and I now do so with great pleasure. Today, China has become the world's second largest economy, but the use of the Renminbi (RMB) in the international arena is still far from the level appropriate for the world's second largest economy. From the history of the development of the Dollar and the Euro, it is evident that the level of the international acceptance of a country's currency is closely related to the country's economic strength. When a country's currency is widely used in the international community, it reflects the fruits of that country’s economic activity, and also confirms its economic strength. At the same time, it also reflects other nations’ confidence in the stability and liquidity of the country’s currency. The Chinese government is trying to develop the RMB into a global currency and promote its internationalization to become one of the world’s core currencies, alongside the U.S. Dollar and the Euro. In just 3 years since 2010 the global offshore RMB market has shown exponential growth; the trading volume of the RMB in the global foreign exchange market grew from 0.9% to 2.2% in 2013. Although the trading volume of the RMB is still relatively small compared to that of the Euro and U.S. Dollar, the extent of international RMB payments is climbing steadily. In order to become a truly global currency, the RMB must gain acceptance in the world’s major financial centres, particularly London, the birthplace of the Euro-Dollar. As a leading international financial centre, London has been closely following the rise of the RMB as a future new global currency. The Chinese government has actively promoted the internationalization of the RMB with the aim of gaining the support of the British government. In June 2013, The Bank of England signed a RMB 200 billion (£20 billion) currency swap agreement with The People’s Bank of China. This bilateral currency swap agreement will help London build an offshore RMB centre, and provide liquidity support for the development of London’s RMB market. In 1

RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY

October 2013, a dialogue was held by the British and Chinese governments in Beijing, specifically to discuss several measures and proposals on the further development of the offshore RMB market. After the joint efforts of China and the UK to promote development at all levels of society, London’s suite of offshore RMB products has been enlarging, and trading volumes have been continuing to rise rapidly. Taking foreign exchange trading for example, the average daily trading volumes between the RMB and other currencies were about $5 billion in 2013, up from about $2.5 billion in 2012. London accounts for 62 per cent of RMB trading conducted outside China and Hong Kong. These RMB products and services help investors effectively reduce the cost of international transactions, improve efficiency, ensure transaction security, and achieve the hedging and management of risk. These developments have garnered positive feedback from investors. Renminbi: The Internationalization of China’s Currency not only provides a detailed account of the development prospects of the RMB on its journey towards internationalization, it also describes the evolution of the international monetary system over the past century, covering the development of the U.S. Dollar, British Pound, Japanese Yen, Euro and so on. I hope this book will help more people understand the significance of the internationalization of the RMB in terms of its farreaching implications, not only for China, but also for the whole world.

Xilai Feng

London

2nd November, 2013

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Introduction

Introduction

Taking care of your future by paying attention to the RMB development

In an age when everyone talks about the economy, the RMB is deservedly eyecatching. Rich people pay attention to the RMB because they do not want to see their assets depreciated; the middle class pay attention because each round of financial crisis could make them less affluent; well-off family do so because they need to think about how to make money in order to become middle class; poor people do so because they not only need to feed themselves and keep themselves warm but also dream to be rich someday. Some smart foreigners also keep an eye on the RMB because they know that currencies come after commodities and the value of a currency is based on how many commodities the issuing country has. Since China joined the WTO in 2001, its GDP leaped from the sixth in the world to the third and with its rapidly developing economy, the RMB has been appreciating. Now the world needs the RMB and no matter for developed countries or developing countries the RMB is expected to join the international monetary system, play a bigger role, and especially contribute to the recovery of the world economy. It seems that only in such a context, the issue of the RMB internationalization is not only in research but also in practice. However, the attention the RMB has drawn derives from its intrinsic quality.

Charm from Power

From farming life characterized by plow and sow to modern white-collar profession featured by sitting in front of computers, from the two-inch long telescope invented by Galileo which is able to recognized rings of Satur to Keck Telescopes with a radius of 10 meters that can observe the space 12 billion light years away from the earth, from 1

RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY

delivering letters on a horseback to sending messages at a speed of light... from the ancient times till now, the human society has undergone tremendous changes. No matter how times may change and how the economic systems may shift, people need money to live in the society, which is not changed. There is a Chinese saying 'even a capable housewife cannot cook a meal without rice'. No matter how capable one is, without money he would not be able to live. Money means being able to buy necessities of life and without money one can afford no articles for daily use; money can also gain people better education opportunities which can help to promote social status as can be seen in the sentence 'A good scholar will make an official' in order to contribute to the society; money also means being able to realize your dream with necessary economic conditions. Only when we do not need to work for a living can we pursue a life we want. There is a vivid description about the importance of money in ancient Chinese: money can make a devil obedient. Nowadays the power of money is even stronger than any period in history. If you think about ordinary family life, the one that contribute more by making more money can stand straight because money is the most direct measurement of contribution. Also among countries, just look at which countries have more discourse power and which countries are in a weak position. The former US secretary of state Kissinger summarized that if you control the oil, you control all countries; if you control food, you control all the people; if you control currencies, you control the whole world. In spite of such a powerful influence of money, its power has been greatly weakened. Why is that? The reasons can be summarized into the following: economic globalization. Under such a background, when 100 yuan is printed by a printing company, it can fly to anywhere in the world and can even be visit more than two hundred countries. Due to the difficulty in predicting the area and speed of its circulation, no country can really control money, so the world economic situation is becoming more complicated. As we all know that there are more than two hundred kinds of currencies and every country has its own. Then why does money in some countries circulate around the world while in others can only circulate in a small area? How can some currencies travel across the oceans while others cannot? Is there a difference among currencies? Money is backed up by national strength and currencies from countries with strength are in higher demand and naturally become internationally recognized currencies. Therefore, such currencies are more powerful than others, which is a reflection of one 2

Introduction

sentence that charm comes from power and influence comes from charm.

From Pegged to the Dollar to Dependent on the Dollar

Now the US is undoubtedly the most powerful country in the world with its GDP of over RMB 97 trillion. Backed by the national strength of the US, the dollar also becomes powerful. By the end of 2008, the dollar issued by the US had amounted to RMB 56 trillion and the amount of US Treasury bond purchased by other countries had reached RMB 15 trillion. The total amount of foreign exchange reserve in the world amounted to RMB 45 trillion with the dollar of the highest percentage of 64.9% (RMB 29 trillion). Therefore, the dollar has become the No. 1 currency in the world and is also the most recognized currency. The dollar has becomes a favorite for developed countries and rich people. In the current international trade settlement, the proportion of the dollar exceeded 60%; in the foreign exchange trading, its proportion exceeded 40%. Overall, in spite of the serious financial crisis that happened in the US, the dollar remained the most widely accepted international currency. The US knows well that opportunity is only kept for people fully prepared. When the world economy is gradually globalized and the financial system is being integrated, currencies are also becoming global. The US, as a country highly developed economically and technically, took the lead in realizing the importance of currencies. Therefore, while developing its economic and technological strength, the US also devoted much effort to developing the dollar. In several decades, the dollar standard replaced the gold standard and gold exchange standard to become the leading currency standard in the world. Back to our main topic. Readers may be wonder why attention should be paid to the RMB since the dollar is so powerful. How does the RMB internationalization bear any relevance to me? According to personal experience of the author, maybe now you can still ignore the RMB but one day it will become one of your concerns because the RMB is no longer a toddler but an attractive young person that is confidently going to explore the world. Let us first take a look at the physical strength of the young person. The RMB is being used by one fifth of the population of the world. In 2009, the GDP of its country reached RMB 34 trillion, ranked the third in the world. The country issued around RMB 56 trillion while spent about RMB 14 trillion buying currencies of other countries in order to exchange them in need. 3

RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY

Without the centennial financial crisis, compared with the dollar, the RMB might still be an unnoticeable kid. Indeed, compared with the dollar born in the 1792, the RMB born in 1948 is younger, but with the eye-catching development since the foundation of the PRC sixty years ago especially since reform and opening up thirty years ago, China grew from a poor country to the third largest country in the world in terms of economic aggregate with an average two-digit growth and its currency also attracted more attention globally. Now more and more trade is settled in RMB especially after the financial crisis and more attention is being paid to the RMB, the currency of the most rapidly developing country in the world that has not depreciated for a long time. At the time of the international crisis, China is accumulating more capital, which can be used to save itself in crisis and can also help to save other countries including the US. Therefore, the world monetary system is now embracing a new force, that is, the RMB.

Primetime for the RMB Internationalization

From December 2008 to March 2009, the PBOC signed currency swap agreements with a total volume of RMB 650 billion with six countries and regions, namely South Korea, Hong Kong, Malaysia, the Republic of Belarus, Indonesia, and Argentina. In April 2009, the Chinese government decided to implement the RMB cross-border trade settlement piloting programs in four provinces and cities including Shanghai and Guangdong. On July 2nd 2009 after HSBC and Bank of East Asia issued the RMB bond consecutively in Hong Kong, six ministries including the PBOC published The RMB Cross-border Trade Settlement Piloting Rules as a guide. No matter in the global financial crisis or in the economic recession or in the next round of economy circle, if China wants to play a bigger role in the international economy and finance, the RMB has to be internationalized. However, the RMB internationalization had not really been on the Chinese government's agenda before the American mortgage crisis even though the topic was started in the 1990s. Generally speaking, only developed countries have strong will for currency internationalization and China is still a developing country with low per capita GDP and resources. The low-profile Chinese government, therefore, lacks strong will to internationalize its currency. In September 2009 when the US mortgage crisis became a global crisis, the Chinese government started to have a different attitude toward the RMB. More and more countries and governments have to admit such a fact that the RMB is gradually becoming international. Economic health and stable development have ensured the appreciation of the RMB which is being internationalized in great strides.

4

Introduction

It is not hard to predict that the Chinese government will continue to accelerate the RMB internationalization in a period to come. On the one hand, China will implement currency swaps with its neighboring countries (ASEAN countries including Thailand, the Philipines, and Vietnam as well as Taiwan province and Russia) on a larger scale; on the other hand, more cities in China will be approved to become pilot places for the RMB cross-border trade settlement, especially cities with close economic ties with the ASEAN countries like Kunming, Nanning, and financial centers. Currently, the biggest handicap for the RMB internationalization is that the Chinese capital market is still not mature, which limits the possibility for the Chinese government to fully open the capital account and make the RMB convertible. For China, regulations on the capital markets are the last line of defense against the international financial crisis. Before the financial market, institutions, investors and regulatory bodies are ready, China will not fully open its capital account, which means that the RMB internationalization is a long and gradual process. In summary, China has entered the deep-water zone of reform and opening up and it is time for adjusting the development strategy of advancing cautiously. In order for the currency development to catch up with economic development, we have to bear pains and promote the RMB internationalization. Readers will find one day that the RMB will have big influence on our daily life with only a small action as it is becoming more powerful in the international monetary system. Eventually, people around the world will also be influenced by the RMB development. This book starts from the currency internationalization process of developed countries to explore the purpose, role and significance of the RMB internationalization for the Chinese economy as well as the process and future trend of the RMB internationalization. The book also aims to reveal the impact such a process may have on the world, countries, enterprises, and individuals as well as how to prepare for its internationalization. This book also gives the prospects on the international monetary system in one century and put forward the expectation of 'One World One Currency'. I hope that this book will contribute to the advancement of the RMB internationalization and the financial development of China and the world as well as maximize the benefits enterprises and individuals can gain in such a process.

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Currency Internationalization in developed countries

1

Currency Internationalization in developed countries

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Currency Internationalization in developed countries

What is currency internationalization? Currency internationalization means that a currency is accepted by countries besides its issuing country as a medium of exchange, unit of account, and store of value. Currency internationalization is compared to the act of issuing IOUs. History has shown that the acceptance of an internationalized currency by other countries should be based on 'state credit' established through strong political, economic and military powers. Since the 1960s, this issue has attracted more and more attention with the internationalization of the Japanese Yen, European monetary integration, and the appearance of the Euro as an international currency.

Meaning of currency internationalization According to Robert Mundell, the father of the Euro, when a currency is circulating outside its legal circulation areas or when the fraction and multiple of a currency is imitated by other areas, it is internationalized. Some scholars think that trades between different currency areas, without international exchange media, can only be conducted in different currencies. If a dealer has a lot of transactions of different currencies to do, he has to hold a large amount of cash which will induce huge costs. Private dealers tend to transact in the most convenient currency in order to save carrying costs and to minimize the information uncertainties brought about

Robert Alexander Mundell Robert Alexander Mundell is a Nobel Prize-winning Canadian economist and a professor of economics at Columbia University and the Chinese University of Hong Kong. Mundell earned his BA in Economics at the University of British Columbia in Vancouver, Canada, and his MA at the University of Washington in Seattle. After studying at the University of British Columbia and at The London School of Economics in 1956,[3] he then attended the Massachusetts Institute of Technology (MIT), where he obtained his PhD in Economics in 1956. After completing his post-doctoral fellowship at the University of Chicago in 1957, he began teaching economics at Stanford University, and then at Paul H. Nitze School of Advanced International Studies in Johns Hopkins University during 1959-1961. In 1961, he went on to staff the International Monetary Fund. Since 1974 he has been a professor in the Economics department at Columbia University. He received the Nobel Memorial Prize in Economics in 1999 for his pioneering work in monetary dynamics and optimum currency areas. Mundell is known as the "father" of the euro, as he laid the groundwork for its introduction through this work and helped to start the movement known as supply-side economics. Mundell is also known for the Mundell-Fleming model and Mundell-Tobin effect. Mundell is best known in politics for his support of tax cuts and supply-side economics; however, in economics it is for his work on currency areas and international exchange rates that he was awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel by the Bank of Sweden.

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RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY

by exchange rate fluctuations. Robert Mundell also thinks that to be internationalized, a currency must win stable confidence which depends on the area of its circulation and transaction, the stability of the monetary policy, regulation, strength of the issuing country and consistent reversion value. In his opinion, a currency, as a public article, has inner scale and economy of scope which are measured by the width and depth of its market. The wider a currency circulated, the stronger it is able to fight against shocks. Triffin dilemma The Triffin dilemma or paradox (also called dilemma between confidence and liquidity) is the conflict of economic interests that arises between short-term domestic and long-term international objectives when a national currency also serves as a world reserve currency. The dilemma of choosing between these objectives was first identified in the 1960s by Belgian-American economist Robert Triffin. He pointed out that the country whose currency, being the global reserve currency, foreign nations wish to hold, must be willing to supply the world with an extra supply of its currency to fulfill world demand for these foreign exchange reserves, and thus cause a trade deficit. The use of a national currency, e.g., the U.S. dollar, as global reserve currency leads to tension between national and global monetary policy. This is reflected in fundamental imbalances in the balance of payments, specifically the current account: some goals require an overall flow of dollars out of the United States, while others require an overall flow of dollars into the United States. Specifically, the Triffin dilemma is usually cited to articulate the problems with the role of the U.S. dollar as the reserve currency under the Bretton Woods system.

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Impacts of currency internationalization Economists have analyzed the impacts on economic policies of currency internationalization. Take the US dollar as an example. The US dollar shoulders two responsibilities in the Bretton Woods System, guarantee of the dollar to be exchanged with gold according to the official price to maintain confidence in the dollar and providing liquidity. However, these two responsibilities are contradictory, the so-called Triffin Dilemma. The US dollar, as a key global currency, is not only facing the Triffin Dilemma but its international role has also reduced the country's ability to implement monetary policy. They have found that by using the bargaining mechanism to bring price into the monetary search model and analyzing the purchasing power, internationalized currencies have stronger purchasing power domestically than overseas and also are stronger than non-internationalized currencies in terms of purchasing in their home countries. In terms of the welfare effects, economists agree that the issuing country can finance its international deficit through the issuance of more currencies. With the expanded use of a currency internationally, earnings of its financial organizations will increase as the purchasing

1

Currency Internationalization in developed countries

of loans, investments, commodities, and services are conducted through these organizations. At the same time, the issuing country also gets revenue from seigniorage which is determined by various factors such as the degree of its monopoly. If an internationalized currency is in total monopoly, the issuing country will receive enormous amount of revenue; if it faces the competition of other acceptable currencies, the revenue will go down accordingly. For example, economist have done empirical tests on the net seigniorage revenue of the British pounds between 1965 and 1969 and found that the revenue was zero. The cost of an internationalized currency is represented in that under fixed exchange rate regime, preference shifts of foreigners may lead to a large flow of capital which will destroy the issuing country's ability to control base currency and affect domestic economic activities. Under floating exchange rate regime, such shifts will lead to dramatic changes of the exchange rate which may affect the ability to make domestic policies. For example, if we regard Japan as an issuing country and the other parts of East Asia as a foreign country, with the expanded use of the Japanese Yen, it will bring positive influences on the East Asian economy (measured by economic welfare) if a majority of Japanese enterprises choose PCP pricing and a majority of East Asian enterprises choose LCP pricing while the currency expansion of East Asia will have almost no influence on Japan. Therefore, with the expansion of Yen-denominated currencies and wider external influence of Japan's monetary policy, Japan will be required to take East Asia into consideration when implementing these policies.

Motive Power of Currency Internationalization Some motive powers of Currency Internationalization 5

RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY

can be found in research papers. Firstly, Currency Internationalization is a result of market choice whose conditions include political powerfulness and stability, economic scale, market share of international trade investment, development degree of the financial market, currency value stability and product differentiation. Secondly, the international status of a currency is closely related to the comprehensive competitiveness of the issuing country. Currency Internationalization will bring both revenues and costs to its issuing country. The higher a currency's international status, the more revenues and the fewer costs; with a lower status, the cost could exceed the revenue. Thirdly, after internationalization, a currency will face competition from other international currencies and to maintain, consolidate and enhance its international status, various conditions should be considered and more efforts need to be taken.

The British Pound: rose from industrialization and colonies From 1689 on, Britain and France started a one-century fight over political and economic prestige and colonies, which ended up in 1763 with the success of Britain. In 1689, compared with Britain, France appeared more powerful with a population four times of that of Britain, more powerful military forces, richer natural resources, fine harbors and naval bases. More importantly, France saw a consistent growth in its industrial production while Britain experienced a slowdown. Therefore, Britain started to face a competitive enemy-France. In the end, Britain was able to win the so-called "the second centennial war", which resulted from the success 6

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Currency Internationalization in developed countries

of the industrial revolution. At the same time, "the financial revolution" started from the 1690s was also a determinant factor. The 18th century witnessed an era of successful and progressive industrialization in Britain. With the completion of that, the productivity was enhanced and products enriched. When the over-produced products were not able to be sold domestically, the capitalist class started to search and explore overseas markets with commercial products and artilleries. Britain thus became an empire on which 'the sun never sets' in the global arena and gradually developed a unified world market. At that time, the empire on which 'the sun never sets' was powerful and looking down upon the rest of the world. A writer described demands from the global market for British products like this: in the American forests, trees were cut down by Birmingham axes; in the Australian prairies, sounds from Birmingham bells were heard constantly; in East and West India, sugarcane fields were taken care of by hoes. Britain's position as a major world financial country was also consolidated in the process of industrialization. In 1695, British Royal Exchange started to buy and sell public debt and stocks of the East India Company and Bank of England. After that, all kinds of transactions, which were operated in Amsterdam in the previously mighty power Netherlands, were done in London. In the second half of the 18th century, the capital market in London exceeded that in Amsterdam and consolidated its status in the international financing field. The prosperity of the London financial market expanded and deepened the government bond market with a bigger popularity from foreign investors on the British bonds and reduced financing costs. Compared with France, Britain was able to collect more funds with lower interest. Between 1752 and 1832, interest expenses paid

Isaac Newton Sir Isaac Newton PRS MP (25 December 1642 - 20 March 1727) was an English physicist and mathematician who is widely regarded as one of the most influential scientists of all time and as a key figure in the scientific revolution. His book Philosophi? Naturalis Principia Mathematica ("Mathematical Principles of Natural Philosophy"), first published in 1687, laid the foundations for most of classical mechanics. Newton also made seminal contributions to optics and shares credit with Gottfried Leibniz for the invention of the infinitesimal calculus. Newton moved to London to take up the post of warden of the Royal Mint in 1696, a position that he had obtained through the patronage of Charles Montagu, 1st Earl of Halifax, then Chancellor of the Exchequer. He took charge of England's great recoining, somewhat treading on the toes of Lord Lucas, Governor of the Tower (and securing the job of deputy comptroller of the temporary Chester branch for Edmond Halley). Newton became perhaps the best-known Master of the Mint upon the death of Thomas Neale in 1699, a position Newton held for the last 30 years of his life. These appointments were intended as sinecures, but Newton took them seriously, retiring from his Cambridge duties in 1701, and exercising his power to reform the currency and punish clippers and counterfeiters. As Master of the Mint in 1717 in the "Law of Queen Anne" Newton moved the Pound Sterling de facto from the silver standard to the gold standard by setting the bimetallic relationship between gold coins and the silver penny in favour of gold. This caused silver sterling coin to be melted and shipped out of Britain. Newton was made President of the Royal Society in 1703 and an associate of the French Académie des Sciences.

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RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY

for public debts by France were two times more than those by Britain. Lower interest burdens gave Britain an advantage to collect more money to build powerful navy and enhance its national strength. With the development of the British economy, the number of its colonies, the scale of international trade, inconveniences from commodity exchanges called for a unified exchange medium-a common currency. Therefore, gold with its natural advantages and inner value was accepted and started to circulate globally. In 1816, Britain made a 'Gold Standard Legal Act' and took the lead to implement a Gold Standard System. However, the British pound has been pegged to gold ever since 1717 when one ounce of gold was decided to be equal to 3 pounds 17 shillings and 10.5 pennies. Britain made the Gold Standard System into law in 1821 when Britain, with a large volume of gold reserve accumulated through heavy trade deficit and fast growing domestic productivity, became the world's trade and financial centre. Bank of England controlled foreign exchange and the international Gold Standard. With the overseas expansion of Britain, the British pound started to circulate in the UK, the British colonies, and around the world and became the only cash with an equal status of gold. Free exchange and free import and export under the international Gold Standard were closely related to the British pound. In its circulation, the pound became a replacement for gold and the international Gold Standard became 'GoldPound' Standard with the pound used as paper gold. The pound was the earliest and also most internationalized credit paper money with a distinctive character that it could be exchanged freely with gold, a position not attained by any other international currency. Because of this, only the pound could be named as real paper gold.

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Currency Internationalization in developed countries

With the establishment of the international Gold Standard system, Britain as the world's financial conqueror was consolidated and sustained a global financial system which ended in 1914. That system provided conveniences for the British economic expansion and Britain started to make an enormous amount of intangible credit revenue including commercial commissions, overseas remittances, and revenues from investments. In 1914, Britain's total overseas investment was more than any other country in the world, which accounted for 41.8% amongst all the overseas investments made by western countries. Britain also gained high profits from such investments. In such a process, Bank of England established in the British 'financial revolution' played a key role. The bank helped Britain to defeat France in various wars during the 18th century through government bonds. At the same time, it made significant contributions to the financial and economic stability during Britain's rising. In 1844, The Clause of Bank of England granted the bank the basic right of currency issuance, a decisive step towards making it the central bank. In 1872, Bank of England started to shoulder the responsibility of 'lender of the last resort' providing fund support to other banks at their most difficult times, consolidating its position as 'Bank of banks'. From then on, Bank of England was transformed into the 'issuing bank', 'Bank of banks', 'Bank of the government', making it the first real central bank in the world that exerted huge influence on the central banking system of other countries. With a highly effective public credit and currency system, a financial market of considerable scale, a Gold Standard system aimed at financial stability, and Britain's position as a big political and economic country, the British pound gradually became a globally acceptable currency and London rose to a world financial centre. 9

RENMINBI: THE INTERNATIONALIZATION OF CHINA'S CURRENCY

The internationalization of the pound is closely related to international trade which was the main cause and motivation of the pound going global as well as a key channel for the pound to circulate around the globe and enhance the depth of its internationalization. At the same time, in an era when the international economic and political order was not yet complete, Britain's colonies and tributaries were forced to use the pound, which represented another way of its internationalization. Therefore, in this sense, its internationalization was a bit forceful which signified another distinctive character. However, at the time when the almighty empire was at its peak, the sun already started to go down. Before the British became aware, the world was a totally different place where its competitors controlled new rules and brought intimidating challenges to the British Empire. The advantages of the empire on which 'the sun never sets' were disappearing and a new round of power shuffle thus began. Germany and America which underwent industrialization after Britain were catching up, with late-mover advantages. In the European economic depression between 1873 and 1896, the position of the pound already began to shake and when the First World War broke in 1914, the golf standard system was suspended. After the war, in order to mitigate the floating exchange rate risks and regulate the order of international trade, the international community decided to restore the golf standard system. In 1925, Britain took the lead in reusing the Gold Standard system. However, due to lack of gold, the restored system was distorted into Gold Bullion System. In the process of restoring the Gold Standard system, the overestimation of the British pound lead to difficulties in international balance and outflow of gold in Britain and the British economy received a deadly hit. In 1931, Bank of England was no longer able to promise the exchange between the pound 10

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and gold and thus announced the end of such a system which also marked the end of the pound's dominance of the world.

The US Dollar: Rising in the Game and Fight with the British Pound The US Dollar rose at the time of the pound's downfall and its dominance was closely related to the evolvement of the international currency system. After the Independence War, the newly built the United States of America started to issue paper 'Continental Bill'. On December 31st 1781, the 'Continental Bill' was replaced by bank note. In 1785, the US Congress decided to use 'dollar' as its currency and implement a system of Main and Fractional Currency in which one dollar equals 100 cents. That was when the US dollar was born. America originally consisted of 13 colonies and at the beginning of its foundation, the domestic market was not yet formed and the economic development was slow. In the mid-19th century, after the end of the Civil War and at the advancement of the government, a unified market was gradually established. Approximately after 1870, the GNP of the US and its productivity exceeded those of the western Europe and its economic power Gold and silver bimetallism In 1860, the annual growth rate of the US industrial output was 3 times that of the UK. In 1880, the US industrial output caught up with that of the UK and took the leading place of the world. Into the 20th century, one third of the world's products came from the US, making it the largest manufacturing country in the world. In the eve of WW Ⅰ , the British industrial output declined to 14% of the world's total

Federal Reserve System The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) is the central banking system of the United States. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907. Over time, the roles and responsibilities of the Federal Reserve System have expanded and its structure has evolved. Events such as the Great Depression were major factors leading to changes in the system. The Federal Reserve System has both private and public components, and was designed to serve the interests of both the general public and private bankers. The result is a structure that is considered unique among central banks. It is also unusual in that an entity outside of the central bank, namely the United States Department of the Treasury, creates the currency used. According to the Board of Governors, the Federal Reserve System "is considered an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms." The Federal Reserve System consists of a Board of Governors and twelve District Reserve Banks. The seven-member Board of Governors is a federal agency. It is charged with the overseeing of the District Reserve Banks and setting national monetary policy. It also supervises and regulates the U.S. banking system in general. Governors are appointed by the President of the United States and confirmed by the Senate for staggered 14-year terms. There are 12 Federal Reserve Banks located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. Each reserve Bank is responsible for member banks located in its district. The size of each district was set based upon the population distribution of the United States when the Federal Reserve Act was passed. Each regional Bank has a president, who is the chief executive officer of their Bank. Each regional Reserve Bank's president is nominated by their Bank's board of directors, but the nomination is contingent upon approval by the Board of Governors. Presidents serve five-year terms and may be reappointed.

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while that of the US rose to 38%. The US started to challenge the leading position of the UK at its downturn. In 1912, the US put forward the dollar policy in expanding its overseas interests and alleged that in dealing with international relations, the big stick policy was important but can not be used as a primary one. It was the most effective to use the dollar to replace guns and bullets in expanding the US influence on the world economy. The overseas investment for the US mainly concentrated in Latin America and thus the dollar policy was a continuation and development of the Monroe Doctrine in the 20th century.

Monroe Doctrine It is a U.S. foreign-policy statement first enunciated by Pres. James Monroe on Dec. 2 1823, declaring the Western Hemisphere off-limits to European colonization. Concerned that the European powers would attempt to restore Spain's former colonies, he declared, inter alia, that any attempt by a European power to control any nation in the Western Hemisphere would be viewed as a hostile act against the U.S. It was reiterated in 1845 and 1848 by Pres. James K. Polk to discourage Spain and Britain from establishing footholds in Oregon, California, or on Mexico's Yucatn Peninsula. In 1865 the U.S. massed troops on the Rio Grande to back up demands that France withdraw from Mexico. In 1904 Pres. Theodore Roosevelt added the Roosevelt Corollary, stating that in the event of flagrant wrongdoing by a Latin American state, the U.S. had the right to intervene in its internal affairs. As the U.S. became a world power, the Monroe Doctrine came to define the Western Hemisphere as a U.S. sphere of influence. Good Neighbor Policy.

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All the above mentioned may have paved the way for the US dominance and it was the two world wars that made the turnaround of the US and the dollar happen. The US has always been interested in wars outside its own country because it is an effective way to shift its domestic crisis and export its influence. Let's take a look at how the dollar rose in fight with the pound during the WWⅠ. After the WWⅠ, many countries were hit hard economically while the US did not suffer from any considerable loss but made a big fortune instead. Britain and the British pound were on the verge of losing their dominant position when the US seized the opportunity to strike against the British pound and strengthen the position of the dollar in the international arena. The US decided to implement the classical Gold Specie Standard, which proved effective. At that time, no other country was able to challenge the US in gold reserve and monetary stability and they could restore the Gold Specie Standard by resorting to forces. The pound was hit hard in the WWⅠ, which could be seen from the reactions of other countries. After the war, the dollar liquidity held by official institutions in

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Europe increased dramatically. Meanwhile, due to the instability of currencies in most European countries, foreign exchange regulation and underestimation of exchange rates, the dollar which was maintained at a fixed price in exchange for gold became more attractive. Therefore, the international community started to price more in dollar and private departments began to hold more dollar assets to reduce transaction risks. In the 1930s, some country alienated the pound and gathered around the dollar to form a dollar zone, becoming fans of the dollar. Britain was reluctant to recede from the historic stage. To maintain its international position, the pound started a serious battle with the dollar. Through heated domestic debate, Britain finally decided to restore the Gold Standard System from January 1st 1926 when one pound was equal to 4.8655 US dollars in which the pound was noticeably overestimated. Britain was not willing to reduce the gold price of the pound in order to protect the position of London as an international financial centre. Moreover, Britain implemented the Gold Bullion Standard while the US used the Gold Specie Standard, in which the dollar was more stable than the pound. The dollar also enjoyed a better international reputation and the pound was no longer what it used to be. Finally on September 21st 1931, Britain was forced to give up the Gold Bullion Standard and carry out foreign exchange management in which the pound was freely traded only within the pound zone, which marked the shift of its international currency position to the pound zone currency. After WWⅡ, international reserve of the pound experienced a sharp decrease due to concerns about the stability of Europe while the dollar became a more popular international reserve currency. Currency holders paid more attention to the stability of the dollar rather than exchanged it for gold. The dollar then became a 13

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safe international reserve asset. At the end of the war, the industrial output of the US accounted for half of the world's total and its foreign trade volume was over one third of the world's total. At the same time, its foreign investment volume increased dramatically and the gold reserve grew from 14.51 billion US dollars in 1938 to 20.08 billion in 1945, accounting for 58% of the capitalist world. With extraordinary economic powers, the US became the largest creditor nation, creating necessary conditions for the dollar's dominant position. Then the US was not able to hold its ambition and became increasingly wanting to control the world. In the 1940s, the US actively planned to create an international currency system centering round the dollar to change the chaotic situation of the global currency system. In 1943, the US and Britain put forward the White Plan and the Keynes Plan respectively. After hot debates, Britain had to give up its own plan facing its powerful competitor, which brought the Bretton Woods System into being. The US took the most key step in the internationalization of its currency. In 1944, the International Gold Exchange System was established with the dollar taking the central position, which marked the shift of economic dominance from the declining Britain to the prospering US. It also paved the way for the highest degree of internationalization of the dollar both legally and systematically. At the same time, the economic restoration after the two world wars provided huge room for its internationalization. Even when the Bretton Woods System collapsed and the Jamaica System was established, the influence of the dollar was still there. Up till now, in the global financial crisis caused by the mortgage crisis, the dollar, though was hit, is still the most important currency in the world. The US now has the most advanced and developed stock markets, including the largest stock exchanges 14

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--- the Nasdaq stock exchange and the New York stock exchange, as well as the world's largest financial derivatives markets. In 2006, Chicago Mercantile Exchange (CME) and Chicago Board of Trade (CBOT) were combined into the new Chicago Mercantile Exchange (CME) whose market capitalization exceeded that of the New York Stock Exchange.

The Japanese Yen: reliant on the USD and anxious to make progress There were ups and downs in the process of the Yen internationalization. After the WW Ⅱ , as a defeated country, Japan was on the verge of collapsing economically. Hyperinflation caused by the economic policies made by the supreme commander of the allied powers almost completely destroyed the Japanese economy. As the saying goes, opportunity comes when one is most desperate. Such a chance occurred in October 1948 when the National Security Commission passed the 13-2 Act making up their mind to help Japan to accelerate its steps in economic recovery. In fact, in 1945 before Japan signed the unconditional instrument of surrender, the US planned to establish a base in Asia to contain the development of the socialist camp which was expanding fast during the upgrading of the Cold War. Therefore, in the process of the Tokyo Judgment, the US already made a plan to work with Japan and support its postwar construction, which was demonstrated in the 'Dodge Route'. In February 1949, President Trumen asked Joseph

Inflation The overall general upward price movement of goods and services in an economy (often caused by a increase in the supply of money), usually as measured by the Consumer Price Index and the Producer Price Index. Over time, as the cost of goods and services increase, the value of a dollar is going to fall because a person won't be able to purchase as much with that dollar as he/ she previously could.

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The First Oil Crisis The 1973 oil crisis started in October 1973, when the members of Organization of Arab Petroleum Exporting Countries or the OAPEC (consisting of the Arab members of OPEC, plus Egypt, Syria and Tunisia) proclaimed an oil embargo. That year, Egypt and Syria, with the support of other Arab nations, launched a surprise attack on Israel on the holiest day of the Jewish calendar. Israel went on full nuclear alert, loading warheads into planes and long-range missiles. The United States chose to re-supply Israel with arms and in response, OAPEC decided to retaliate against the United States, announcing an oil embargo. It lasted until March 1974. With the Arab nations' actions seen as initiating the oil embargo and the longterm possibility of high oil prices, disrupted supply, and recession, a strong rift was created within NATO. Additionally, some European nations and Japan sought to disassociate themselves from the U.S. policy in the Middle East. T h e e ff e c t s o f t h e e m b a r g o w e r e immediate. OPEC forced the oil companies to increase payments drastically. The price of oil quadrupled by 1974 to nearly US$12 per barrel. As a result, the US GDP dropped by 4.7%, that of Europe dropped by 2.5% and that of Japan dropped by 7%.

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Dodge, the Detroit banker, to serve as an economic and fiscal advisor to MacArthur in the new economic plan for Japan. On February 1st, the US sent the Dodge delegation to Japan whose main mission was to help MacArthur to implement the nine principles of stabilizing the economy. Dodge was the fiscal advisor to Commander of the allied powers in name while in practice the investigation delegation followed orders from Washington. During the occupation of Japan, the fiscal handling rights were not held by the Japanese Congress but by the Headquarters of the US occupation forces, an above-the-Constitution institute. After stabilizing the declining value of the Japanese Yen against the dollar at 360 yen per dollar, Joseph Dodge also made the yen pegged at gold under the Bretton Woods System, signifying the coming back of Japan to the international community. At the same time, he helped the Japanese government to achieve the fiscal balance. Under the protection of the US, Japan signed a Peace Treaty with the US, joined the IMF in 1952, one year after which the 360 yen per dollar price was taken as the official price by the IMF. In 1950, the North Korean War broke out when the US started to have huge demand for materials, which fueled the Japanese economy and promoted Japan into a 20year fast growing era. The heated investment wave promoted the adjustment of the domestic industrial structure and its productivity and the economic strength of Japan was further enhanced. In 1970, the economic strength of Japan already reached 13.7 times of that before the war. During that period, the Japanese government also loosened its regulations on the Japanese Yen. On April 1st 1964, Japan announced its promise to the 8th article of the IMF Agreement and realized the free exchange of the yen under current accounts. From 1965 on, Japan

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started to have trade surplus which was growing larger. In the same year, capital imports in the long-term capital balance sheet increased dramatically, making Japan a capital exporting country. From then on, the Yen started to steer away from a soft currency to a hard currency. From 1965 to 1970, trade surplus accumulated for years brought Japan enormous wealth and the surplus was expanding continuously. Under such circumstances, doubts about whether the exchange rate of the Japanese Yen was underestimated abounded home and abroad. Debates about the Yen started to become active and the Japanese Yen was under increasing pressure to appreciate. However, under the Bretton Woods system, the exchange rate of the US dollar against the Japanese Yen remained 1:360 with fluctuations around 10%. In early August 1971, President Nixon announced the suspension of the exchange of the US dollar with gold, which marked the collapse of the Bretton Woods system. For a while, the international community was in chaos. After repeated considerations, the Japanese government decided to let the Japanese Yen float temporarily on August 29th, marking the beginning of the Yen appreciation. In the same year, the Japanese Yen appreciated 16.88% against the US dollar, from 360 yen per dollar to 308 yen per dollar. Up till 1973, the appreciating Japanese Yen was considered as 'a hard currency as strong as the mark'. In September when the first oil crisis broke out, the whole western world fell into an economic depression in which the Japanese Yen was affected and the floating exchange rate regime started. In November 1978, Japan was forced to implement 'Carter supporting the US dollar plan' and the exchange rate of the dollar against the Yen broke the 1:200 mark. From the first oil crisis to the 1980s, Japan took a series of economic measures to fight against the economic

Plaza Accord Between 1980 and 1985 the dollar had appreciated by about 50% against the Japanese yen, Deutsche Mark, French Franc and British pound, the currencies of the next four biggest economies at the time. This caused considerable difficulties for American industry but at first their lobbying was largely ignored by government. The financial sector was able to profit from the rising dollar, and a depreciation would have run counter to Ronald Reagan's administration's plans for bringing down inflation. A broad alliance of manufacturers, service providers, and farmers responded by running an increasingly high profile campaign asking for protection against foreign competition. Major players included grain exporters, car producers, engineering companies like Caterpillar Inc., as well as high-tech companies including IBM and Motorola. By 1985, their campaign had acquired sufficient traction for Congress to begin considering passing protectionist laws. The prospect of trade restrictions spurred the White House to begin the negotiations that led to the Plaza Accord. The Plaza Accord or Plaza Agreement was an agreement between the governments of France, West Germany, Japan, the United States, and the United Kingdom, to depreciate the U.S. dollar in relation to the Japanese yen and German Deutsche Mark by intervening in currency markets. The five governments signed the accord on September 22, 1985 at the Plaza Hotel in New York City. Devaluing the dollar made U.S. exports cheaper to purchase for its trading partners, which in turn allegedly meant that other countries would buy more American-made goods and services. The exchange rate value of the dollar versus the yen declined by 51% from 1985 to 1987. The Plaza Accord was successful in reducing the U.S. trade deficit with Western European nations but largely failed to fulfill

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depression and recession, such as reducing investment, cutting expenditure, implementing innovative technology, reducing energy consumption. Measures like adjusting industrial structure, developing high-tech industries and the tertiary industry were implemented nationwide. The timely adjustments of industrial structure had immediate effects. Japan was not hit hard during the crisis and made a fortune instead when other countries were in crisis. With the accumulation of huge surplus in Japan, the international trade deficits for the US became bigger and eventually Japan replaced the US as the largest lender and creditor in the world, which shocked the international community. There arose a stronger call for the appreciation of the Yen. In 1985, the US, under great pressure, held the 'square conference' which made the Yen to appreciate enormously. After that, Japan started a 10-year appreciation process under the huge balance deficits. its primary objective of alleviating the trade deficit with Japan. This deficit was due to structural conditions that were insensitive to monetary policy, specifically trade conditions. The manufactured goods of the United States became more competitive in the exports market but were still largely unable to succeed in the Japanese domestic market due to Japan's structural restrictions on imports. The recessionary effects of the strengthened yen in Japan's export-dependent economy created an incentive for the expansionary monetary policies that led to the Japanese asset price bubble of the late 1980s. The signing of the Plaza Accord was significant in that it reflected Japan's emergence as a real player in managing the international monetary system. Yet it is postulated that it contributed to the Japanese asset price bubble, which ended up in a serious recession, the so-called Lost Decade.

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In the early 1980s, Japan started to advance the internationalization of the Yen. From the mid-1980s on, with massive outflow of the appreciated yen, the areas where the Yen was used gradually broadened and the currency became more international. At the end of 1986, the Tokyo offshore financial market was officially established and the internationalization of the Yen deepened with an increased role in international settlements, reserve, investment, credit and intervention. In the fixed basket of Special Drawing Rights (SDR), the proportion of the Yen was raised twice to 21% and its position in the international community was fully confirmed. But generally speaking, the internationalization of the Yen was not as ideal as other international currencies because unlike the dollar, the franc and the pound, there has never been a country whose currency was pegged at the Yen. On the other hand, the Yen as an international

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reserve currency was not in a good situation. From 1997 on, the Yen accounted for about 5% in the total global reserve assets and actually tended to decrease a bit. In history, there were quite a few huge fluctuations in the exchange rate of the Yen to the dollar, reflecting the dependence of the Yen on the dollar. The Japanese economic system was not able to react flexibly to the economic and financial globalization. Without an independent currency, there would be no independent economic and financial policies or financial markets in Japan. Nor would there be controllable fluctuations of the Japanese exchange rate. Indeed, Japan paid huge price for the internationalization of the Yen. As a result of the long-term huge surplus in the international payments, there was long-term imbalance in the external economic situations with the Yen appreciating for a long time, bringing hard hit to the Japanese economy and causing serious Yen appreciation syndrome. Its exports were suppressed; there were asset bubbles; Japan became a target for international venture capital while losing its real value in the monetary game. Once there was any change in the US economy, the Yen would appreciate with the depreciating of the dollar no matter the Japanese economy was good or bad. In summary, the internationalization process of a currency is in fact one to improve the domestic financial system. If the financial system is not sound or open enough to adjust to the requirements for being an international currency, the internationalization can not happen. As a typical 'trade country', Japan's efforts to challenge the supremacy of an already dominant currency were destined to fail when its domestic financial markets were not yet open enough.

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The Euro: a successful model as a regional currency The issuance of euro was decided in 1992 in the European Union Treaty signed in Masterihert in order to establish an EMU. Member countries needed to meet a series of high requirements such as fiscal deficits no more than 3% of GDP, ratio of loans no more than 60% of GDP, and inflation ratio and interest rate close to the average level of all the EU countries. On Jan 1st 1999, the unified European currency - Euro - came into being officially. After a 3-year transitional period, the Euro replaced currencies in the 12 EU countries and started to circulate. The 304 million people from the 12 countries no longer used currencies that circulated for generations including Franc, Mark, Rila and started to use Euro. The birth of the Euro was inspired by an America economist Robert Mundell's ideas put forward in 1961. Mundell was born in Ontario province in Canada in 1932 and was educated in Columbia University and Washington University before he went to London School of Economics for research. In 1956, the 24-yearold Mundell became famous for his Doctor's thesis titled On the Direction of International Capital and was rewarded a Doctor's Degree from MIT. Between 1961 and 1963, Mundell was working in the research department of the International Monetary Fund. In 1961, Mundell raised a question in one of his articles: 'When will some countries be willing to give up monetary sovereignty and utilize a common currency?' According to his thought, western European countries with similar economic conditions and highly liquidated factors can form a currency zone in which all the member countries can implement a fixed exchange rate

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or even use the same currency. His ideas guided the decision-makers in Europe in turning a concept in books into reality. Therefore, Robert Mundell is called Father of Euro. The optimum currency area refers to the optimum area where the exchange rate should be fixed. Traditionally, people think that it is justified for a country to used one currency. However, according to Mundell's research, in a large area which consists of many countries, if producing factors like labor and capital flow freely between countries, theoretically these countries should use one currency because the flow of factors makes changes of exchange rates unnecessary. The all-direction flow of factors will reduce the pressure on changing the actual price of factors when there are fluctuations influencing supply and demand and thus reduce the requirements for using the changes in exchange rates to change actual prices of factors. Based on Mundell's concept, Euro came into being through ups and downs. The birth of Euro was a milestone in the world's monetary history because it is the first regional currency that does not depend on gold or any single country. The appearance of the Euro is a totally new international economic and political phenomenon, providing new development opportunities for the arrangement of international monetary systems as well as advancing the world economy toward deeper regional integration. On Oct 13rd 1999, the Swiss Royal Academy of Sciences rewarded the Nobel Economics Prize to Mundell for his great contributions to the monetary and fiscal policies under different exchange rate regimes and the optimum area analysis. The 7-page long words of compliments by the academy confirmed his position as 'Father of Euro'. The Euro is managed by the European Central Bank 21

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(ECB) and the European System of Central Banks (ESCB) composed of the central banks in the euro zone countries. The ECB, headquartered in Frankfurt in Germany, has independent power in making monetary policies. It also takes part in the printing, coining, and issuance of paper money and coins and is responsible for the operation of the Euro Zone payment system. The use of the Euro not only simplifies procedures, saves time and accelerates the circulation speed of commodities and funds, but also reduces losses of the 30 billion USD exchange and commission, reducing costs for enterprises in the area and enhancing their competitiveness. With an improved status of the Euro and the development of the European capital market, the fund costs in the member states would drop, thus benefiting the growth of investment and economy. The birth of the Euro made up for the defects in the Bretton Woods System in its overemphasis on global monetary cooperation while ignoring regional cooperation. When the conditions for global fixed exchange rate are not ready, regional monetary cooperation realizes the integration of regional currencies. More importantly, the monetary integration in Europe is a successful model for regional monetary integration. Forming regional monetary union and stabilizing regional exchange rates are the basic way for developing countries or small countries to fight against external shocks and intensify internal economic connections. They also are the foundation for the international monetary system in realizing international monetary integration. Different from the internationalization of the US dollar, the positions and interests for member countries in the EU zone can be adjusted through negotiation and each party has equal rights and obligations, which forms

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the foundation for fixed exchange rates. However, the internationalization of the US dollar is a unilateral action in which other countries have to give up their own currencies and accept a strong currency on the policy level.

Common Features of Monetary Internationalization Monetary internationalization can be summarized into the following four paths. The first is that suzerains force their own currencies upon colonies after wars and then advance their monetary influence to other countries, which was the British path. The second path can be found in the US dollar which became an international currency after being a central currency in the international monetary system. The third path is that for the Euro which was cultivated into a regional currency through strategic planning and then developed into an international currency. The fourth path goes to the Japanese Yen that became internationalized after various steps of monetary convertibility. The above four paths have their own distinctive characteristics as well as some common features.

Strong Economic Power The currency internationalization is sustained by strong economic power which provides the currency in the process of internationalization with an unparalleled economic advantage over other currencies. When the British pound and the US dollar were going global, both countries were the international economic hubs and stronger than other countries in the economic strength. Therefore, the two currencies (the British pound and the 23

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US dollar) sustained by the two economic powers were able to beat other currencies and play an essential role on the international monetary stage. Strong economic power is not a meaningless word or a slogan but a comprehensive indicator. Whether a currency has the capacity to become an international currency should be evaluated from two aspects. The first aspect is whether the country has an efficient and world-class economic size and scale and whether its economy has the potential for sustainable and healthy development based on reasonable resource allocation. The second aspect is whether the country has enough means of international settlement (international reserve in a broader sense) or is able to attract foreign capital.

International Reserve International Reserve (also called Official international reserve) is assets held by central banks and monetary authorities, usually in different reserve currencies, mostly the United States dollar, and to a lesser extent the euro, the United Kingdom pound sterling, and the Japanese yen, and used to back its liabilities, e.g., the local currency issued, and the various bank reserves deposited with the central bank, by the government or financial institutions. Such assets allow a central bank to purchase the domestic currency, which is considered a liability for the central bank (since it prints the money or fiat currency as IOUs). Thus, the quantity of foreign exchange reserves can change as a central bank implements monetary policy, but this dynamic should be analyzed generally in the context of the level of capital mobility, the exchange rate regime and other factors.

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Beside strong economic power, countries should also stand in a leading position in other aspects including political powers, international status, international reputation and military power. Only with economic power and other supplementary conditions can a currency be internationalized. Economic strength alone can not ensure the achievement of the final target.

Developed Financial Markets When the pound was dominant in the world, London was the trade and financial center of the world; when the dollar rose, the New York financial markets gained an equal status to that of London and gradually became dominant; the internationalization of Mark depended on the financial markets of Frankfurt and Luxemburg; the Japanese Yen achieved an international place at a later stage because of the Tokyo financial markets; during the birth and growth of the Euro, the foundation of the ECB and the restructuring of the European banking industry deepened the integration of the financial system in Europe and the development of the financial markets

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went deeper. Therefore, it can be concluded that in the currency internationalization, developed financial market are indispensable. We can also see that developed financial markets should be open in which various traders and all kinds of capital can enter freely. These financial markets serve as places for value reserve and added investment to non-residential traders. In this way, the safety of the currency is further enhanced so that such traders have no worries about it and it also guarantees that the currency can fully play its role as an international currency in economic exchanges. Developed financial markets should also be highly efficient and have breadth, depth and flexibility. Breadth refers to massive and diversified financial tools; depth refers to developed secondary markets; flexibility refers to the capacity to rapid price adjustment after responding to unexpected events and enormous trading volume, that is, the ability to adjust and recover after sudden changes in supply and demand. In developed financial markets, a great number of financial tools can bring various investment paths, adding energy to the currency and thus improving the willingness for people in other countries to hold and use the currency. Large-scale financial markets and frequent transactions will enhance the liquidity and safety of the currency and reduce its transaction costs, increasing its international demand. Developed financial markets should also be regulated in order to ensure an efficient, centralized, transparent, fair, and open environment for investment.

Rise and Fall of International Currencies Just as prime time passes for all things, the once dominant currencies also went from prosperity to

Fixed Exchange Rate System A fixed exchange-rate system (also known as pegged exchange rate system) is a currency system in which governments try to maintain their currency value constant against one another. In a fixed exchangerate system, a country's government decides the worth of its currency in terms of either a fixed weight of gold, a fixed amount of another currency or a basket of other currencies. The central bank of a country remains committed at all times to buy and sell its currency at a fixed price. The central bank provides foreign currency needed to finance payments imbalances. The gold standard or gold exchange standard of fixed exchange rates prevailed from about 1870 to 1914, before which many countries followed bimetallism. The period between the two world wars was transitory, with the Bretton Woods system emerging as the new fixed exchange rate regime in the aftermath of World War II. It was formed with an intent to rebuild warravaged nations after World War II through a series of currency stabilization programs and infrastructure loans. The early 1970s witnessed the breakdown of the system and its replacement by a mixture of fluctuating and fixed exchange rates.

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decline. The paper-gold pound and the gold-equivalent dollar both had a period of glory before their fall which can be attributed to different reasons. For those interested scholars can analyze them from various aspects including politics, economics, psychology, sociology, anthropology, and history. From the perspective of (monetary economics) numismatics????? alone, the overvaluation of currencies is one of the key reasons. Here overvaluation refers to the nominal or official value of a currency being higher than its real value. In the international arena, the overvaluation of a currency meant that the gold content (nominal value) decided by its monetary authority or in the international agreement is high than its real gold content (real value) before 1976. After 1976, there was no regulated gold content and the value of a currency referred to its real purchasing power. Then overvaluation meant that the official price or the nominal price of a currency in the market being higher than its real purchasing power and the exchange of currencies was done at a price higher than its real purchasing price, enhancing the prices of export commodities from its issuing country. How much a currency is overvalued will be reflected in the enhanced price of export commodities. In the long run, overvaluation will lead to a decline in the country's international competitiveness. The Gold Standard under the dominance of the pound and the Gold Exchange Standard under that of the dollar in essence are fixed exchange rate regimes. The overvaluation of the pound resulted from the restoration of its value according to outdated parity without considering inflation. After the war, commodity prices went up which means that the pound was depreciated. By restoring the pound to its previous gold content, the currency was overvalued. We can also say that the overvaluation of the pound was an artificial act because 26

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the UK wanted to curb inflation, get back to its previous prosperity, and reestablish the monetary supremacy of the pound. Before the 1960s, a balance was kept between the issuance of the dollar and gold reserve in the US as well as its national wealth. Then the Vietnam War led to a huge increase in military expenses and the expansionary monetary policy brought a massive growth in the issuance of money and fiscal deficit, which caused serious inflation. On the other hand, the American international settlement started to experience a surplus which was expanding consistently. These two aspects led to a severe imbalance in the amount of dollar issued and its national gold reserve. The real gold content of the dollar dropped while the fixed official gold price of the dollar required an unchanged gold content and thus the dollar was overvalued. Generally speaking, when a currency is overvalued, the prices of the commodities will go up in the international market and its export will be affected. The overvaluation of a currency will enhance export prices while reducing import prices. If raw materials of export enterprises come from the international market, the overvaluation reflected in affecting international balance of payments will be offset by reduced prices of import raw materials; if raw materials do not come from the international market or the international prices of imported raw materials go up, the country's balance of payments will deteriorate. Reduced import prices caused by overvaluation will also enhance overseas payments. Drop in export and growth in import will worse the country's international payments, adding pressure on the domestic economy. Therefore, it is unavoidable for the currency to go from prosperity to decline. In summary, by looking at the history of the currency 27

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internationalization in developed countries, we can have some conclusions. First, the internationalization depends on its economic, military and political strengths which serve as real backup. Moreover, developed financial markets and financial innovation are key methods to realize the currency internationalization. After the internationalization, with the country's further participation in the international economic, financial and capital games, it will experience cycles and crisis. Whether its currency can succeed in being a key international currency depends on how the leadership will guide the economy with wise decisions made in view of history.

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The Bumper Car Game between RMB and the Dollar in the Process of Internationalization

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In fact, no countries share the same domestic or international environments and every country is going on a unique path. Currently, China is gradually treading on the path of financial liberalization and RMB internationalization. Though it is not possible for China to copy the paths other countries took, China will only have the right steps by learning from those countries which once contributed to the international monetary systems. As we all know about the bumper cars game in the amusement park, if there is only one bumper car wandering in a large stadium, one will easily get bored. The game can only be fun if another car is chasing and bumping against yours. The RMB is playing such a game with the dollar. There may be other bumper cars joining them in future, but now the above two, one of the strongest economy and the other the largest growing developing economy, are the main characters and may stay this way for decades to come. In the process of RMB internationalization, the RMB and the dollar will be fighting against each other while being interdependent at the same time till one of them beats the other in strength and capability and becomes the final winner. The disadvantages of being a dominant currency have been recognized after the financial crisis which happened once in a century and when the dollar dominated the world's monetary system for half a century. When a crisis comes, one will fall into the deadly abyss without support. The RMB should make good use of the honeymoon period to expand its own influence and stand stable in the international monetary system.

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Timely Help in the International Financial Crisis The US took its own way without considering other countries even including the EU in the Iraq War, which caused a lot of crises. The country now has realized that in a serious financial tsunami like the one that happened in 2008, the US would not be able to live through with the support of its allies and the cooperation from emerging economies like China. The disadvantages of being a dominant currency have been exposed after the financial crisis which happened once in a century and when the dollar dominated the world's monetary system for half a century. After the financial crisis, fluctuations of the dollar led by new contradictions in the America economy and finance were worsened. Against the drop of credit crunch and affected by irregular easy monetary policy of the Fed and historically large purchase of treasury bonds, the US would inevitably experience long-term expectations of inflation. In 2009 when most of the world experienced a negative growth, there was a declining trend for the US to export the dollar to other countries. In February 2009, trade deficit for the US was only 26 billion US dollars, a decade low. The decline in trade deficit means that 31

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the total volume of the dollar supply overseas dropped. Therefore, it was of high importance to make up for the lack of the dollar in the offshore markets and avoid the worsening of credit crunch. One year after the financial crisis broke out, China increased its reserve of US treasury bonds worth USD 100 billion, which brought China's foreign reserve and US treasury bonds closer. Only then did they realize that the RMB was a friend in need to the dollar. Similarly, the RMB that is further pegged at the dollar exhibited some distinctive features of 'RMB dollar' and with the process of the RMB internationalization, it will transform into 'dollar RMB'. China had a choice facing the financial crisis. It can either respond to the needs of the US and work together to help the US live through the crisis or stand by and make itself stronger while weakening the US. China chose the former.

Deflation In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). This should not be confused with disinflation, a slow-down in the inflation rate (i.e., when inflation declines to lower levels). Inflation reduces the real value of money over time; conversely, deflation increases the real value of money - the currency of a national or regional economy. This allows one to buy more goods with the same amount of money over time.

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Premier Wen Jiabao made it clear that China will try its best to help the US live through the financial crisis when he attended the annual conference of the UN because if the financial interests of the US got harmed, it would eventually harm those of China that holds huge US debt. And the shrinking of the US market will affect China's export. After that, President Hu Jingtao, in his phone conversation with President Bush, confirmed the stance that China and the US are interrelated and interdependent. In the time of financial crisis, China was faced with another temptation that major economies in Asia that went through the Asian financial storm wanted to work with the RMB and establish Asia's own currency because they no longer trust that western countries would care about the economic safety in Asia and even worry that the west would transfer disasters to them.

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In the past, China was confronted with various barriers and 'troubles' from the US and now when the US is suffering, China could give up 'the thought of saving America' while taking the lead to unify forces in Asia and create a regional 'firewall' to replace the dollar with a unified Asian currency. However, if China did so, it would definitely harm the mutual trust between China and the US as well as Europe. China could even be misused by other countries. Therefore, it was a better choice to offer timely help in the crisis which helped to save the US as well as China itself. In fact, such an attitude of returning good for evil has won China a good reputation and respect from Europe and the US.

RMB- Golden Partner for the Dollar On Aug 19th 2009, an article by Kissinger was published on Washington Post in which he expresses that the world in the past several decades has been used to America's 'good-appetite' and massive consumption and China has provided the US with a great number of commodities. China used to be attracted by such a model of 'low risks and high growth'. After the financial crisis, the confidence of the international community in the dollar has been shaken. The systemic financial crisis in the US brought huge risks to the dollar assets held by China. To protect its dollar assets China had to continue buying enormous dollar assets, resulting in an unavoidably difficult situation for both countries. On the one hand, the interdependence between the two big economies further increased and the financial stability and economic growth of the US are in the interest of China. On the

Kissinger Henry Alfred Kissinger (born on May 27, 1923) is a German-born American statesman and political scientist. A recipient of the Nobel Peace Prize, he served as National Security Advisor and later concurrently as Secretary of State in the administrations of Presidents Richard Nixon and Gerald Ford. After his term, his opinion was still sought by some subsequent US presidents and other world leaders.

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other hand, it is in the long-term interest of China to reduce its dependence on the US. At the same time, inflation or deflation in the US would not only harm the US but also be a nightmare for China. However, from another perspective, China has already got a huge economic leverage in its hands to influence the US. According to Kissinger, a lot of phenomena have shown the interative trend between China and the US. No matter in public or in private, Chinese officials talk ('finger point') more frequently about the dollar than ever before and express ideas of China. China is also promoting trades with India, Brazil, and Russia and using currencies of these countries. Moreover, its central bank (PBOC) is trying to diversify its foreign exchange reserve. A lot of Americans ignored China's increasing influence on the US. However, numerous historic events have shown that in pursuit of its goals, China has always been extremely patient. Therefore, the Americans should pay more attention to China's growing influence and support China to enhance its speech rights in the decision making about global economic system. Kissinger points out in the end that if China changes its growth model from export-driven to domestic consumption driven and the US reduces its domestic consumption, the world economy will regain some impetus. However, not everyone has realized that such changes in economic patterns will inevitably lead to changes in the world's political pattern. At that time, China would depend less on the export to the US and its neighboring countries will depend more on the Chinese market which will greatly enhance China's political 34

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influence. The decrease in Sino-US interdependence in trade will have to be made up for in political cooperation. In fact, after entry into the WTO, China's financial industry achieved full-grown development with financial assets and capital doubled. Industrial and Commercial Bank of China (ICBC) has became the largest bank in the world by market capitalization and China Construction Bank (CCB) and Bank of China (BoC) are listed in the top ten, which has made some first-class US banks such as Citibank envious. However, we should notice that the Chinese financial sector has a lot to learn from their peers in the US. In the process of the RMB internationalization, the young RMB should learn from the experienced dollar and the dollar will also feel the exuberance and confidence in the RMB. In the hinged transition from 'RMB-dollar' to 'dollar-RMB', the two currencies will have a golden partnership in the next three decades and if well done, the world economy will benefit a great deal. It should be noticed that with the progress of scientific technology and the accelerating process of economic globalization and financial integration, the integration process of the three main currencies (the dollar, the Euro, and the RMB) in the future will be sped up. In such a period, the dollar and the RMB will continue to be indispensable partners to each other. For the RMB, by cooperating closely with the dollar, its foundation for internationalization will be consolidated and the internationalization process of the RMB will be an inevitable choice for China to be independent from the dollar in its trades. The RMB will need to partner with the dollar to embrace a future international monetary system.

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Healing the International Monetary System Together More and more Americans have realized that the US should give up some attractive policies to contain China left from the Cold War 'dictionary'. China should also be cautious about the ideas of defeating the American dominance and establishing the Asian group. If China and the US went against each other in issues including global energy, climate change, and nuclear nonproliferation, the world would face disastrous results.

G2 The Group of Two (G-2 or G2) is a proposed informal special relationship between the United States and the People's Republic of China. Originally initiated by C. Fred Bergsten as primarily an economic relationship, it began to gain wider currency and scope from foreign policy experts as a term recognizing the centrality of the US-China relationship near the beginning of the Obama Administration. Prominent advocates include former National Security Advisor Zbigniew Brzezinski, historian Niall Ferguson, former World Bank President Robert Zoellick and former chief economist Justin Yifu Lin. As the two most influential and powerful countries in the world, there have been increasingly strong suggestions within American political circles of creating a G-2 relationship where the United States and China would work out solutions to global problems together. One possible reason for the G-2 to possibly be created is to prevent another cold war.

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Different voices appear in the international community that China and the US have established a two-country group (G2) while the two countries are making efforts to heal the international monetary system. Kissinger does not agree with the saying because he thinks that this is not in line with interests of China and the US and nor is it in compliance with global interests. In the 21st century, the world is calling for a multilateral mechanism. The ethnic identification in the Asia-pacific region has been stronger than that in Europe in the WW Ⅱ . Therefore, we should be cautious in order not to reestablish the international political view of keeping balanced forces. In Kissinger's opinion, the focus of international affairs has been shifted to Asia and the US is learning to play a leading role different from being dominant. The world calls for close Sino-US relations which are also open to country in the Asia-Pacific region. In such an international situation, China should be keenly aware of its status quo and future developments. In 2008 China's GDP accounted for 7% of the world's total and its trade scale 10% while the proportion of the RMB accounted for less than 1%. The voting right in the IMF for China only counted for 3.66% and the SDR for 3.72%.

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The Bumper Car Game between RMB and the Dollar in the Process of Internationalization

From these statistics, it can be seen that the current international monetary system is incompatible with the world's economic trends and the imbalances in the structure enlarged the influence of financial and economic risks in developed countries on the whole world. Positive responsive effects of such a structural imbalance is one of the deep-seated reasons for the expansion and transition of the mortgage crisis into a global financial crisis. In the advancement of the RMB internationalization especially in its regionalization, the expanding demand of neighboring countries for the RMB will be met and it will also help to mitigate structural risks in the international monetary system and benefit its longterm optimization. The promotion of the RMB crossborder settlement will help to reduce structural risks in the international monetary system which may result from the contradictions between major currencies and changes in the global economic and financial forces. China's priority should settle its own problems based on the realization of the RMB internationalization. Firstly, China should handle imbalances in the international trade; Secondly, China should be prepared for potential inflations in future through its currency internationalization.

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Gradual Rise of the RMB on the International Stage

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There is a saying in the ancient Chinese military tactics that when confined and hampered by geographic conditions it is advisable to seize nearby enemies first rather than attack enemies far away. This is the so-called befriending distant enemies while attacking enemies near home. On the path of the RMB internationalization, strategies are key. From the standpoint of geopolitics, the RMB should first be recognized by neighboring countries and win support from developed countries such as the US and European countries rather than attacking them hard. If a country wants its currency to be held by other countries, it is necessary for the country to have produce other countries are in dire need of or else it would have no speech rights about settlements in its own currency. Based on China's current export structure, such requirements cannot be met and thus China still worries about drop of its export. Only after this stage can China start to consider free exchanges, interest rate and exchange rate liberalization as well as the establishment of a mature financial market. That is the gradual progress of the RMB internationalization which should support the stability of the value of the RMB and also trade surplus. Currency internationalization could be an angel or a devil. And we may have lower expectations on the narrowly defined RMB internationalization.

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RMB on the Path toward Free Exchange Free exchange of the RMB is the basic premise for its internationalization. Now the RMB is convertible under current accounts, but this is not free exchange and can only be exchanged in banks backed up by contracts and receipts and is confined to a quotas. Moreover, the RMB is still unconvertible under capital accounts and is under strict regulation. Therefore, there is a long way to go for the RMB to be fully convertible.

What is Free Exchange of a Currency? Then what is full convertibility of the RMB? And what are the pros and cons? Full convertibility refers to free exchange of a country's currency into another currency under a unified or sound international monetary system. The convertibility of a currency can be traced back to the exchanges of metallic money in ancient times. However, the free exchange of currencies is traditionally thought to be originated from the Gold Standard Period. In the 19th century, major western countries started to implement the Gold Standard System under which currencies can be converted fully between countries without constraints. Full convertibility is one of the main contents or typical characteristics of the Gold Standard System. According to the IMF rules, full convertibility means no restraints on exchange. The international community decides whether a currency is convertible based on the 41

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8th Rule of the IMF Agreement, which defines that if a member country impose no constraints on the fund payment and transfer under current accounts, has no biased arrangement or multiple exchange-rate regime, and has the obligation to convert back its own currency surplus if required by other countries, its currency is convertible. The IMF distinguishes convertibility under current accounts from that under capital accounts. Full convertibility refers to that under both accounts. Full convertibility under current accounts means free exchange of currencies related to foreign trade, repayment of principle, depreciation of direct investment and remittance of living expenses. Now the RMB is fully convertible under current accounts which include commodity trade, service trade, dividend payment, and unrequited transfers. However, there are no strict definitions of full convertibility under capital accounts. Generally speaking, such convertibility refers to the removal of restrictions on foreign exchange revenue and expenditure from short-term financial capital, direct investment, and securities investment so that capital could flow freely across borders. Now the RMB is not fully convertible under capital accounts which include direct investment and indirect investment (stocks, bonds, international borrowing and deposits). In practice, in the internationalization of some reserve currencies, some restraints on convertibility have been implemented under capital accounts such as control of the structure of foreign direct investment and the scale of foreign debts. These in essence will not affect the convertibility of a currency. It is commonly thought that convertibility under current accounts is of the lowest level while that under capital

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accounts is of the highest.

Capital Accounts: Key of Full Convertibility Chinese citizens can travel to quite a number of foreign countries, before which they can exchange some RMB for foreign currencies and bring them overseas for consumption. Then why do people still want full convertibility of the RMB? In fact, free exchange will bring more convenience to ordinary people, but the biggest significance is to open capital accounts rather than to satisfy consumption or investment. After the opening of capital accounts, deposit assets, no matter held by Chinese or non-Chinese, can be freely exchanged from the RMB to foreign currencies and vice versa. When the Chinese market is going low, the RMB denominated assets can be changed into foreign currencies and invested in foreign markets; when the Chinese market turns better, foreign assets can be changed into domestic investments. For a long time, the RMB has been classified into an unconvertible currency by the international community. Generally speaking, the internationalization of a currency can be accomplished after it becomes fully convertible. The internationalization of the RMB requires further opening-up of capital accounts because convertibility under capital accounts ensures that the RMB can flow on a large scale globally and can also enhance its reputation and acceptability. Among the 43 sub-accounts required by the IMF, the RMB has been basically convertible in 45% of them while partly convertible in 25% of them. In summary, the RMB has realized multi-faceted convertibility and is fully convertible under current accounts, partly convertible under capital accounts, partly convertible domestically and in some foreign countries and regions. 43

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History of the RMB Convertibility In the past thirty years' reform and opening-up, economic ties between China and the rest of the world have been closer, with rapidly growing international revenue and payment as well as foreign reserve. In addition, China has started reform on the foreign exchange system and clearly pointed out that the final target is to realize full convertibility, which marks the opening of RMB free exchange. From Jan 1st 1994 on, official exchange rates and rates of the foreign exchange swap market were unified for the RMB, after which unified exchange rates were closer to market rates. This established a unified and managed floating exchange rate regime based on market demands. On July 1st 1996, foreign exchange transactions by foreign investment enterprises were included in the banking settlement and sales system and constraints on current account were lifted. On Nov 27th 1996, Dai Xianglong, President of the PBOC at that time, sent an official letter to the IMF that China no longer applied to the transitional arrangement of the Second Act of the Fourteenth Rule under the IMF Agreement and would started to accept the obligations under the second, the third and the four acts of the eighth rule and implement a full liberalization under the current account. It has become the final target for China's foreign exchange administration regime to accomplish the full convertibility of the RMB including the capital account. In 2003, the agreement Decisions on Issues in Improving the Socialist Market Economy System of the CPC Central Committee passed in the third plenary session of the 16th conference put forward the idea of selectively loosening constraints on crossborder capital transactions step by step and gradually realizing convertibility under the capital account based on effective risk prevention. On Oct 15th 2007, 44

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the report of the 17th Communist Party Conference again emphasized the 'step-by-step accomplishments of capital account convertibility'. In practice, China is consistently loosening control on foreign exchange used by residents in relevant policies. In 2006, the PBOC announced its decision to make the Pudong area of Shanghai as a pilot place for small-amount of foreign currency exchanges. In 2008, the State Administration of Foreign Exchange Bureau approved the piloting of individual exchange of the RMB and foreign currencies for some special businesses in Beijing and Shanghai, which made it possible for some qualified domestic non-banking financial institutions to provide RMB and foreign currency exchange businesses for individuals. On Mar 25th 2009, Premier Wen Jiabao's remarks that 'China aims to build Shanghai into an international financial centre in compliance with the international position of the RMB and the country's economic strength by 2020' were paid close attention to. This can be interpreted as a time table for the full convertibility of the RMB as no country has ever established an international financial centre without a free currency.

Capital Account-Constraints on the RMB Internationalization Based on experiences of other countries, it takes a long time to prepare and make a transition to the full convertibility of the RMB under the capital account. Now China has signed currency swap agreements with some countries which received a large amount of the RMB. This may seem that free exchange has been accomplished between governments and enterprises can get the RMB through this channel. But in reality, the operation mechanism of currency swap is that foreign

Foreign Exchange Spot Transaction A foreign exchange spot transaction, also known as FX spot, is an agreement between two parties to buy one currency against selling another currency at an agreed price for settlement on the spot date. The exchange rate at which the transaction is done is called the spot exchange rate.

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central banks can get some RMB through swap and inject it into financial institutions in their countries so that their enterprises can borrow the RMB to pay for debts to China and purchase China's products. That is to say, signing currency swap agreements is in essence to promote consistent stability, accelerate trade recovery and it focuses on the current account rather than the capital account. Enterprises in these countries still have to access to the RMB exchange under the capital account and cannot invest under the capital account in China. They can only do trade under the current account based on contract receipts and within the scope of the contracts. Therefore, the situation that the RMB cannot be fully convertible is still not changed.

Advantages and Disadvantages of Full Convertibility There will be a great number of benefits associated with the opening of the capital account including easy capital for projects in need and risk diversification for external investment. Enterprises can benefit a great deal from open capital account. If an enterprise has a lot of branches overseas and can invest in foreign countries, when the domestic market turns low, the overseas investment will make up for the loss in the domestic market and its profitability will remain stable and vice versa. If the free flow of capital can bring higher return, it will stimulate deposit and investment as well as economic growth. Of course, opening the capital account will also bring some risks. The full liberalization of the RMB is not a simple maths problem, which brings both benefits and risks and can lead to a major financial crisis. Therefore, all relevant departments should work together to make a necessary strategic plan and time table. The opening 46

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of the capital account makes it convenient for Chinese capital to flow overseas and for foreign capital to flow into China. When foreign securities investment capital enters China, it will bring in new opportunities as well as enhance market competition. This entices enormous operational risks and if not well controlled, it may lead to a crisis. From the currency liberalization under the capital account in other developing countries, we can see that when a country fully opens its capital account, it may incur a large amount of capital inflow and overheating of the domestic economy which could lead to inflation and eventually an economic crisis. Under other circumstances, when the capital account is opened, large amount of hot money from international investors will frequently flow in or out of the country, which may seriously affect the financial market. In summary, China needs to prepare and regulate the capital market step by step and according to a plan before opening the capital account in order to promote China's economy and attract more foreign capital. After the WW Ⅱ , it took major western countries many years to prepare for the opening of the capital account. France was a big financial country in history and was very familiar with financial operations, but even such a country had been implementing capital control and opened its capital account after 30-year preparation. The full convertibility of the RMB will take at least 10 to 15 years and the steps toward developing the financial market should be implemented. Any impulsive decisions may destroy the achievements made in China's economic reform.

Forward Exchange Transaction Financial transaction involving the exchange of currency to be completed at a future date. For instance, an individual may exchange the greenback for the yen because the exchange rate is better on a given date, but request that the transaction be completed in the future. Essentially, the individual is able to lock in the current rate to avoid possible changes in the exchange rate in the future.

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Testing of the RMB Settlement of Cross-border Trade The RMB settlement of cross-border trade refers to customs declaration and import and export trade settlement in RMB. Its business categories include settlement ways such as Letter of Credit, collection, remittance (advance payment and cash on delivery). Now import and export enterprises legally registered can take part in the test of the RMB settlement of crossborder trade if approved by regional governments and the PBOC.

The Financial Crisis Stimulated the RMB Internationalization In the 1990s, China's neighboring countries started to use RMB settlement in cross-border trade. Up till now, China has signed agreements on cross-border trade RMB settlement with central banks of Vietnam, Mongolia, Laos, Nepal, Russia, Kirghizia, North Korea and Kazakhstan. In recent years, with the development and opening-up of China's economy, trade volume between China and its neighboring countries saw a continuous rise and there is a growing demand to expand the RMB settlement from cross-border trade to general international trade. The RMB settlement not only reduces risks caused by exchange rate fluctuations to export enterprises but also reduces the cost of sales and purchase of foreign exchange. On Dec 24th 2008, the State Council decided to implement the RMB piloting in commodity trade in Guangdong, the Yangtze River Delta, Hong Kong, Macao, Guangxi, Yunnan and the ASEAN countries. On Jan 20th 2009, the PBOC signed a currency swap 48

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agreement of three years and RMB 200 billion with the Hong Kong Monetary Authority to promote the RMB settlement. On April 8th 2009, the executive meeting of the State Council made a decision that the piloting of the RMB settlement in cross-border trade would be implemented in Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan, which marks the expansion of the RMB settlement from border trade to general international trade. On June 29th 2009, Zhou Xiaochuan, President of the PBOC, signed an MOU ( Momorandum of Understanding ) with Ren Zhigang, President of the Hong Kong Monetary Authority in the HK Airport, marking the completion of the preparation for the RMB settlement in trade between Mainland China and HK. On the 2nd and 3rd of July 2009, the PBOC, Ministry of Finance, Ministry of Commerce, General Administration of Customs, State Administration of Taxation, and the CBRC jointly published the Cross-border Yuan Trade Settlement Pilot Management Measures and bylaws. The RMB settlement channel for trade between Mainland China and HK was officially opened.

Active Preparation by Earliest Pilot Banks As one of the earliest pilot banks, the Shanghai branch of Bank of China was in active preparation. On July 4th 2009, the next day after the opening of the settlement channel was declared, the Guangdong branch of Bank of China signed the RMB Settlement and Clearing Agreement respectively with Bank of China International and HSBC. Bank of China became the first Chinese bank to sign the settlement and clearing agreement with its overseas agent banks. Following it, the Guangdong branch of ICBC, ABC, CCB, Bank

Foreign Exchange Swap In finance, a foreign exchange swap, forex swap, or FX swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward). Foreign Exchange Swap allows sums of a certain currency to be used to fund charges designated in another currency without acquiring foreign exchange risk. It permits companies that have funds in different currencies to manage them efficiently.

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of Communications, Citic Bank and China Merchant Bank all started to implement cross-border settlement businesses. On July 6th 2009, the opening ceremony of Crossborder Trade RMB Settlement Pilot was held in the Four Seasons Hotel by the Shanghai Municipal government, where Bank of Communications and Bank of China signed their first deal, marking the localization of such business in Shanghai. Shanghai Electronic, Shanghai Silk, and Shanghai Huanyu Import and Export signed trade contracts with partners in Hong Kong and Indonesia using RMB as the settlement currency in their cross-border trade for the first time. Bank of China Shanghai Branch and Bank of Communications Shanghai Branch respectively accomplished the first RMB inward and outward remittances, an export project of RMB 13.98 million and an import project of RMB 300 thousand. The success in the remittances and the start of the pilot project marked the promotion of the RMB from a denomination currency to a settlement currency in the international trade settlement.

Depreciation and Appreciation of Currency Currency depreciation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system. It is most often used for the unofficial increase of the exchange rate due to market forces, though sometimes it appears interchangeably with devaluation. Its opposite, an increase of value of a currency, is currency appreciation.

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Zhang Xiaoming, general manager of the international business department of Bank of Communications, said 'banks in Cambodia and Indonesia are also striving to be agent banks' and described the RMB settlement business as 'sweet pastry'. Fierce competition was not only among earliest pilot banks such as Bank of Communications and Bank of China but also among foreign banks located in Hong Kong, Macao, and the pilot ASEAN regions which cover the most concentrated areas for Chinese enterprises going global. Yang Min, a senior manager of the international business department of Bank of Communications, said that some overseas branches of Bank of Communications have opened RMB interbank transaction accounts

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with its domestic branches. 19 overseas agent banks including HSBC Hong Kong, HSBC Macao, Heng Seng Bank, Vietnam Joint Stock Commercial Bank for Industry and Trade, Canadia Bank, and ChongHing Bank signed RMB settlement agreement and opened RMB interbank transaction accounts with Bank of Communications. Bank of China Shanghai Branch also signed the RMB trade settlement and clearing agreement as well as opened RMB clearing accounts with 11 overseas agent banks. It also opened RMB clearing account for 17 overseas branches of Bank of China. The 11 overseas agent banks are mainly located in Hong Kong, Macao, and the pilot ASEAN regions where there is strong demand for corporate RMB settlement business. They include Standard Chartered Bank (Hong Kong), Bank of East Asia, The Malayan bank in Malaysia, Bank of Bangkok, OCBC Bank, WingHang Bank, Bank of Tokyo-Mitsubishi UFJ Hong Kong branch, Mizuho Financial Group Hong Kong branch, Bank Mandiri Hong Kong branch, and Hana Bank Hong Kong branch.

Several Urgent Matters Cross-border trade RMB settlement pulled open the curtain of the RMB full convertibility, which is related not only to regulation of the gradual opening of the capital account but also the macro environment of China's currency and exchange rate. The pilot programs undoubtedly paved the way for the RMB internationalization and marked the start of it, but several matters need to be addressed. The first is where foreign import and export enterprises can get the RMB. Currently there are two channels, through currency swaps with the Chinese government 51

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and through export. But it is limited and more channels need to be built. The second is the RMB exchange rate regime. The RMB exchange rate against the dollar is now the dominant determinant while others are cross rates. With the increase of the cross-border trade RMB settlement, exchange rates of foreign currencies against the RMB, which depends on the exchange rates of the RMB in the Chinese market, became more important. Therefore, liberalization of the RMB exchange rates will help other countries decide on the exchange rates of their currencies against the RMB and thereby is conducive to balancing foreign and domestic exchange rates. The third is the free exchange of the RMB, which is becoming more urgent. If the RMB cannot be fully tradable with other major currencies, import and export enterprises will be less willing to hold the RMB, which is not helpful to the internationalization of the RMB. The fourth is the contra flow of the RMB. Now the RMB serves as a settlement currency in trade and there will be surplus of the RMB fund for foreign import and export enterprises. In the short term, overseas branches of Chinese banks should keep the RMB deposit and provide channels for investment. In the long term, the Chinese market should gradually allow the contra flow of the RMB fund. In summary, the piloting of the RMB cross-border settlement is just the first step of the long march of the RMB internationalization. As the RMB is more frequently used as a settlement currency, there will be more favorable policies to be implemented in order to improve the infrastructure and the basic policy. China's financial market will be more in line with the

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global financial market and its economy will more open.

Prospects for the RMB Internationalization In the world's monetary system, the prospects for the RMB Internationalization have been greatly enhanced because of the collapse of the Japanese Yen. In the recent ten years, with a receding economy, low interest rates, and a pessimistic stock market, the economic strength of Japan has been far exceed by that of the US and the EU. Moreover, Japan is not well positioned politically in Asia and Asian countries lack confidence in Japan, which hinders the process of its currency internationalization. In 1999 when the use of the euro started, the yen accounted for 6.4% in the global foreign exchange reserve while the euro accounted for 17.9%; the two numbers rose to 3.9% and 24.9% respectively in 2004. In 2006, the pound overtook the yen and became the third most important reserve currency. The Japanese yen fell because of the rise of the pound and lost its competence against the dollar and the euro, which marked the change of the global monetary systems representative of the three major currencies including the dollar, the euro and the yen. The fall of the yen means that the global monetary system lacks an Asian force, which is incommensurate with the global economic structure. In the long run, there will be a position for an Asian currency as a major force in the international monetary system and the RMB is a competitive candidate. The current financial cooperation in Asia is providing a broad stage for the RMB. After the Asian financial crisis, regional monetary and financial partnerships were going strong in which the ASEAN countries, China, Japan, and South Korea started currency swaps and the arrangement of the Asian bond fund as well as put

ASEAN The Association of Southeast Asian Nations is a geo-political and economic organisation of ten countries located in Southeast Asia, which was formed on 8 August 1967 by Indonesia, Malaysia, the Philippines, Singapore and Thailand. Since then, membership has expanded to include Brunei, Burma (Myanmar), Cambodia, Laos, and Vietnam. Its aims include accelerating economic growth, social progress, cultural development among its members, protection of regional peace and stability, and opportunities for member countries to discuss differences peacefully. ASEAN covers a land area of 4.46 million km2, which is 3% of the total land area of Earth, and has a population of approximately 600 million people, which is 8.8% of the world's population. The sea area of ASEAN is about three times larger than its land counterpart. In 2011, its combined nominal GDP had grown to more than US$ 2 trillion. If ASEAN were a single entity, it would rank as the eighth largest economy in the world.

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multilateral reserve in its agenda. Trade liberalization in East Asia and investment convenience are calling for a regional currency. As China is becoming an economic leader in Asia, it should take the responsibility to promote the regional economic development and enhance its role as a major country. Its position as an economic leader has also laid a foundation for the RMB to become a regional currency. In the regional monetary cooperation, a competition between the RMB and the yen will be unavoidable. In the short run, by participating in the establishment of the '10+3' monetary union, the RMB will play a key role, but still not as key as the yen; in the long term, after a currency takes the leading position in a region, its role will be strengthened. Unlike Japan, China has no historic issues with other East Asian countries and the responsible attitude of the Chinese government has been recognized by most countries in the region. As a regional monetary union is becoming a trend, by appropriately handling partnerships and competition, the RMB will eventually be able to fight against the yen. There have already been some good signs in the prospects of the RMB internationalization. In the international community, the recognition and influence of the RMB are higher than the degree of its internationalization. Major countries have made the RMB a currency indicator. Some Asian countries, such as the Philippines, have made the RMB a convertible currency. The RMB futures and options contracts have been transacted in the Chicago Mercantile Exchange. In 2005, the IMF started to debate on whether or not to include the RMB into the SDR (special drawing rights) currency basket and it is expected that the RMB will be included soon. People both home and abroad have confidence in the prospects of the RMB and some even predicted that in the next 20 years a new monetary system represented by the dollar, the RMB, and the euro will be established. Even though this is to be tested, 54

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the RMB has the potential to be one of the secondtier currencies like the yen and the pound and will represent Asia along with the yen in the global monetary system. This will enhance the advantages and reduce disadvantages of the RMB internationalization.

Charm of Potential—the RMB and Regional Anchor Currency According to the three-step path, the RMB is first to become a settlement currency for neighboring countries, then a regional investment currency, and finally an international reserve currency which is accepted by all countries in the world. That is to say, if the RMB is to become an international currency, it should first be regionalized by being a regional anchor currency.

Contribution of the Mark to the Euro A regional anchor currency refers to a currency which plays a central role in the regional monetary integration. Take the European monetary integration for example. The German Mark was accepted as the regional anchor currency, which played a key role in the formation of the Euro zone. In the process of establishing the European monetary union, the German Mark, on the one hand, met basic requirements to be a regional anchor currency; on the other hand, some core countries strongly promoted the process while other countries cooperated, which was why the mark naturally became an anchor currency. There were three stages involved in the German monetary integration. The first stage started before the 1980s when East Germany and West Germany were

Optimum currency area In economics, an optimum currency area (OCA), also known as an optimal currency region (OCR), is a geographical region in which it would maximize economic efficiency to have the entire region share a single currency. It describes the optimal characteristics for the merger of currencies or the creation of a new currency. The theory is used often to argue whether or not a certain region is ready to become a monetary union, one of the final stages in economic integration. An optimal currency area is often larger than a country. For instance, part of the rationale behind the creation of the euro is that the individual countries of Europe do not each form an optimal currency area, but that Europe as a whole does form an optimal currency area. The creation of the euro is often cited because it provides the most modern and largest-scale case study of the engineering of an optimum currency area, and provides a comparative beforeand-after model by which to test the principles of the theory. In theory, an optimal currency area could also be smaller than a country. Some economists have argued that the United States, for example, has some regions that do not fit into an optimal currency area with the rest of the country. The theory of the optimal currency area was pioneered by economist Robert Mundell. Credit often goes to Mundell as the originator of the idea, but others point to earlier work done in the area by Abba Lerner.

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united, in which the currencies of both sides were used without a common national currency. The second stage lasted from the unification to the start of the Euro, when Germany promoted the monetary integration of Europe. The third stage refers to the period when the Euro was used and mark exited from the market. A country can benefit from seigniorage of its internationalized currency, but should also take its international responsibilities. On the path of the birth of the Euro, Germany provided enormous help for other countries to meet the financial requirements of the 'Optimum Currency Areas' so that the Euro was started successfully. Germany is the largest country in the Euro zone and also the largest fiscal contributor. Therefore, Germany shouldered responsibilities as a big economy so that other countries in the zone could benefit from the monetary integration and thereby were willing to give up their own currencies. The pound was once the strongest competitor for the mark. Although the German economy was stronger that the British economy, London still is the largest foreign exchange center and the more active off-shore financial market for the dollar due to historic reasons. However, the UK gave up the idea of joining the Euro zone and then the Euro took the mark as a template just as the central bank of the Euro zone, headquartered in Frankfurt, used the policies of the German central bank as its blueprints. This was decided by the economic and political strength of Germany. The socialist market economy model and independent policies of the central bank of Germany became a paradigm for Europe. Mundell, Father of the Euro, pointed out that the strongest currency is provided by the strongest political force. Who can play the role of the mark in the monetary integration of East Asia? There is no consensus on the 56

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question of which currency to be the regional anchor though most scholars are focusing on the RMB and the yen. However, due to special economic and political backgrounds, such a choice is extremely difficult.

Which will Be the 'Anchor Currency'? The RMB or the Yen? Then is China able to play the role of a large country as Germany? The monetary integration relates to currencies of different sovereign nations, so the position of the regional anchor currency is often taken by a strong currency which is most in compliance with the standards of an anchor currency through competition. In the regionalization and regional cooperation of the RMB, is it competitive enough to be the anchor currency? After its opening up and reform, China has become more active in regional economic cooperation. In 2001, China overtook Japan to be the largest investor in the ASEAN countries. At the same time, the increasingly open and expanding Chinese market has played a key role in absorbing exports from other Asian countries. According to statistics, the total volume of China's export and import in Asia amounted to 807.9 billion US dollars, accounting for 56.8% of the overall export and import of China in the whole year. Although China is a trade surplus country, there has always been a deficit in its trade with other Asian countries. Take the year 2005 for example. China's export to Asia amounted to 366.4 billion US dollars while its import reached 441.5 billion with a deficit of 75.1 billion dollars. (see the chart below) Besides, the China - ASEAN free trade agreement symbolizes the birth of a regional economy with a huge market and development potential. With the growing strength of the Chinese economy and stability in the RMB exchange rates, the RMB will be more 57

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frequently and broadly used in the economic exchanges between China and its neighboring countries and will embrace an enhanced international status. The Total Trade and Investment Volume of China in Asia Unit: ten thousand US dollars category trade FDI

Time China’s export China’s import Total outflow inflow

2004 Asia 29548698 36941949 66490647 300027 3761986

Global 59332558 56122875 115455433 549799 6062998

2005 Asia 36640758 44147945 80788703 437464 3571889

Global 76195341 65995276 142190617 1226117 6032459

Source: China Statistical Yearbook, Volume 2006

Let's look at the yen, the biggest competitor of the RMB in being a regional anchor currency. As early as the 1970s when the yen was in the initial stage of internationalization, the financial liberalization of Japan was started. Now Japan has complete financial markets and developed financial systems with Tokyo as an important international financial center, all of which have laid a necessary foundation for the yen to become a regional anchor currency. However, there are some problems such as strict financial regulation, worsened non-performing loans, and underdeveloped capital markets, which have not yet been handled in the internationalization of the yen. These problems have been covered to a large degree and may incur some disasters. The yen internationalization disrupted normal steps of its financial reform and some complicated contradictions came into being. These problems were fully exposed in the financial crisis in the 1990s when a lot of banks and securities firms went bankrupt and the financial system was hit hard. This seriously affected the stability of the Japanese financial market and its position as an international financial center. The position of the RMB has been recognized even by 58

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the Japanese media. On August 2nd, an article titled the RMB started the attack on Asia was published in Asahi Shimbun, in which two examples were listed testifying the expanding influence of the RMB. One example is that a Japanese man who is running a restaurant in Vietnam goes to the black foreign exchange market in Hanoi once a month to exchange the Vietnamese dong received from his customers into the RMB and then uses the RMB to purchase imported vegetables and seafood from China. The other example is that an Indonesian car seller paid a car component manufacturer in RMB rather than the US dollar. Entrusted by the seller, ICBC issued an L/C of 370,000 RMB to make the payment. The interest base for the competition between the RMB and the yen is the monetary supremacy in Asia when one wins. By being a regional anchor currency through broader functions including exchange, settlement, evaluation, and reserve currency, the winning currency will have an opportunity to enjoy positive effects brought about by its internationalization such as an enhanced international position, bigger speech rights, more seigniorage, and reduced exchange risks and transactions costs. In the next decade or several decades, if one of the two currencies stands out, it will become a regional leader in the East Asia monetary integration; if without noticeable advantages, neither will become a core currency in the region and then the two currencies will need to cooperate with each other and decision will be made on whether to issue a common currency - the Asian currency. Although Japan's economy is more developed that China's and the yen already is one of the three major international currencies, in the recent decade the Japanese economy has been deeply dragged by deflation and lacked motivation for development. However,

The Asian Currency On the ASEAN Summit in 1997, the Malaysian Prime Minister Mahathir Mohamad, based on the lessons learned from the Southeastern Asian financial crisis, put forward the idea of 'Asian Currency Area'. During the APEC in 2001 in Shanghai, Mundell, father of the Euro, expressed his ideas on the future global monetary structure: 'There will be three monetary zones, that is, the euro zone, the dollar zone and the Asian currency zone'. In 2003, Mundell suggested that a common currency composed of a basket of currencies be created in Asia and efforts should be made to make such a currency circulate in Asia while countries in the region do not give up their own national currencies. This suggestion was well received by many Asian countries. In early 2006, the Asian Development Bank put forward a monetary unit called 'Asian monetary unit' which is similar to the 'European monetary unit'. It is not a unit in circulation but a visual currency based on the weighted value of currency value, GDP and trade scale of many Asian countries. The Asian Development Bank will calculate its exchange rates against the dollar and the euro which are to be published on the website so that the change laws and fluctuation controllability of exchange rates of Asian currencies could be evaluated. Countries can also adjust their financial and monetary policies based on this to push the monetary mechanism to get close to 'Asian monetary unit' in order to lay solid foundation for the official issuance of the Asian currency. However, such a plan has been delayed due to disagreements on which currencies should be included in the monetary unit and how to decide its composition.

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China's economic development has caught the attention of the whole world with a strong currency. Therefore, China has more potential from the perspective of development. China should work hard on creating an Asian monetary fund, an Asian currency unit and an Asian exchange rate regime. China should also enhance the influence of the RMB and make it a leading currency in the region to gradually enhance the proportion of the RMB in the Asian currency unit. When time is ripe, the RMB should completely replace other currencies in the region step by step and achieve its regionalization.

Two Preparations for the RMB Regionalization Some preparation should be done while trying to achieve the RMB regionalization. The first is to establish a contra flow regime of the RMB in order to strengthen the confidence of foreign residents and non-residents in holding the RMB. To advance the internationalization of the RMB, the RMB contra flow should be addressed from a technical level. Without a smooth channel for the RMB to flow back to China, its neighboring countries and other countries in the world will be less motivated to use the RMB as a regional reserve currency. Besides expanding the RMB settlement in the border trade, the purchase of the Chinese government bond or direct investment in China with the RMB by neighboring countries and other countries in the world should also be taken into consideration. The second channel is to improve the monitoring regime of the cross-border flow of the RMB in order to prevent and resolve financial risks. In the internationalization of the RMB, there will be some RMB circulating in the international financial market which may weaken the Chinese central bank's ability to control the RMB in the domestic market and affect the effects of the domestic macro-economic

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policies. In order to prevent and resolve such risks, a monitoring regime of the cross-border flow of the RMB should be established and improved. It should emphasized that the RMB can only become a leading currency in Asia when it becomes a fully convertible currency. To be an anchor currency is to be a regional leading currency, which is the mid-stage of the RMB internationalization. Now China only accomplishes the international settlement of the RMB without full convertibility of the RMB under the capital account, but no one can deny the possibility of the RMB to be a leading currency in Asia. The RMB is a rising star in Asian and has inspiring prospects.

The Role of Hong Kong With special location and culture, Hong Kong will play a key role in the RMB internationalization. For example, Hong Kong can serve as a platform through whose developed international trade network the RMB settlement can be accomplished. Hong Kong is a completely open offshore city where capital and information can flow in and out freely and the Hong Kong dollar is fully convertible. All these conditions make Hong Kong a test place for the RMB internationalization. Besides, as an international financial center, Hong Kong is fit to operate the RMB business and can help the advancement of the RMB internationalization. At the same time, Hong Kong is experienced in the development, design and marketing of financial products, which can also fuel the RMB internationalization. Apart from being a direct promoter and participant, Hong Kong can also play an indirect role as an outreach of the Chinese financial market to promote the gathering and flow of the RMB fund. 61

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The RMB Internationalization - Go on Its own Path Path of the RMB Internationalization Economists have made various suggestions on the paths of the RMB Internationalization. Wu Jiandong, Chief economist from the Science Times Agency, thinks that the dollar, the euro and the RMB should be integrated into one standard currency in the international monetary system in the next five to eight years. The integrated currency should be the foundation for a new international monetary system and the interaction of the three currencies should be the main structure and principle in the standard system. The strategic steps in establishing the RMB into a standard currency in the international monetary system should include the following three. The first is to realize the settlement and sale of foreign exchange under the current account and regulated capital account in the first three years; the second is to loosen the settlement and sale of foreign exchange under the capital account in the next three to five years; the third is to realize the full convertibility of the RMB under the capital account except some special account within around eight years and to promote the RMB to become an international standard currency. Hard Currency Hard currency, safe-haven currency or strong currency refers to a globally traded currency that is expected to serve as a reliable and stable store of value. Factors contributing to a currency's hard status might include the long-term stability of its purchasing power, the associated country's political and fiscal condition and outlook, and the policy posture of the issuing central bank.

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Tang Shuangning, Chairman of China Everbright Bank, used two three-step methods to describe the path. The first is the three-step method in terms of region. Now in the neighboring countries the RMB has already become a hard currency, which marks a quasi-regionalization and will develop into an official regionalization, quasiinternationalization and real internalization. The second three steps mean that the RMB should develop from a

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regional settlement currency into a regional investment currency and then into an international reserve currency accepted by the whole world. Some people think that there should be four steps before the RMB is internationalized. The first step is to allow neighboring countries to reserve the RMB; the second step is to encourage the RMB settlement in China's export and import trade; the third step is to implement currency swaps with neighboring countries; the fourth step is to establish an RMB transaction market with a broader base of participants in Hong Kong and to set up an RMB derivatives market in Guangdong where its foreign capital and foreign trade account for 30% to 40% of the whole country in order to help financial institutions and enterprises to combat currency exchange rate risks and then loosen restrictions on the RMB internationalization. Li Daokui from the China and the world economic research center of Tsinghua University thinks that a double-track and gradual approach should be taken in the RMB internationalization based on characteristics in China's economy. The first track is to realize a stepby-step and gradual convertibility of the RMB under the capital account domestically while enhancing the efficiency of the Chinese financial system. Various measures are included in the first track including Qualified Foreign Institutional Investor (QFII) plan and Qualified Domestic Institutional Investor (QDII) plan; the step-by-step opening of capital such as investment in Hong Kong stocks by domestic fund but it should be constrained and oriented. Moreover, some high-quality overseas enterprises such as Apple, IBM, Intel should be invited to issue the RMB bonds or stocks in the A-share market so that some RMB could be exchanged into the dollar and flow overseas and it could also enhance the corporate governance of Chinese firms and the efficiency of the capital market.

QFII The Qualified Foreign Institutional Investor (QFII) is a program that was launched in 2002 in People's Republic of China to allow licensed foreign investors to buy and sell yuan-denominated "A" shares in China's mainland stock exchanges (in Shanghai and Shenzhen). Chinese mainland stock exchanges were previously closed off to foreign investors due to China's exercise of tight capital controls which restrict the movement of assets in-and-out of the country.

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The second track concerns development overseas especially in Hong Kong. In Hong Kong the scale of the RMB denominated bonds should be enlarged as well as other RMB denominated financial assets and their transactions should be enhanced in order to establish an RMB financial market with euro securities and dollar securities as competitors. The gradually expanded and RMB denominated financial transactions will greatly promote the process of the RMB internationalization when times comes. Such a measure will alleviate the pressure of the foreign capital on betting on the appreciation of the RMB. Therefore, the central bank could consider the establishment of an RMB foreign exchange market in accordance with the scale of local capital market, but the scale should be constrained. For example, the transaction participants should be participants in the RMB securities market while the volume of their transactions should be within the limits of the securities market. Such constraints should be set to avoid shocks against the RMB policies.

QDII Qualified Domestic Institutional Investor, also known as QDII, is a scheme relating to the capital market set up to allow financial institutions to invest in offshore markets such as securities and bonds. Similar to QFII (Qualified Foreign Institutional Investor), it is a transitional arrangement which provides limited opportunities for domestic investors to access foreign markets at a stage where a country/territory's currency is not traded or floated completely freely and where capital is not able to move completely freely in and out of the country.

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Some scholars think that in the current international politics and economic structure, the RMB has basically achieved convertibility in neighboring countries. The RMB regionalization can be gradually achieved through monetary cooperation in the economic cooperation framework between China and the ASEAN countries. By fixing exchange rate and making it float against other currencies, the RMB can replace other currencies in the region or a single currency led by the RMB can be created in order to realize monetary unification. After that, the cooperation can be expanded to China, the ASEAN and South Korea and Japan when the RMB can really become an influential international currency, the same as the euro to Europe and the dollar to the Americas. In fact, there already has been an approach as for how the RMB can be internationalized, which is making the

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RMB a settlement currency for trade in Asia, issuing RMB denominated bonds in Hong Kong, cultivating open and regional bond market so that the RMB can be reserved and invested, deepening the off-shore RMB market in Hong Kong through the development of the bond market, advancing the convertibility of the RMB in the capital account and making Hong Kong a real off-shore RMB financial center to facilitate the RMB internationalization. All the above mentioned approaches are designed from the perspectives of region, functions of a currency or the currency standard. From the perspective of region, the three-step approach should be followed to make the RMB convertible in neighboring countries, then to be regionalized and to be international. However, during regionalization, the RMB should not be made convertible only in East Asia but also in the whole Asia as well as Africa which has caught the attention of more and more developed countries. China has established diplomatic ties with 48 African countries with an expanding trade volume. The RMB should enhance its influence in Africa and more networks for the RMB cross-border settlement should be added in order to accomplish the regionalization of the RMB in Africa. From the perspective of functions of a currency, the RMB internationalization should be step by step, from the domestic market to the international market and from small functions to key functions. It can be seen from the analysis of the current stage of the RMB internationalization that the RMB has limited functions in the international market while its main functions are played in neighboring countries. Therefore, the RMB internationalization is still in the deepening stage of the currency liberalization and the initial stage of the currency regionalization. From the perspective of the currency standard, there 65

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will be several round of currency competition before the RMB becomes a standard currency. The basic approach for this should be dollar - RMB, RMB-dollar, and the RMB standard.

New Currency Competition With the appearance of currencies did their competition come into being and it has been an old topic. The initial competition took place among shale, stone and cloth. When the metal currencies took the dominant position with their fine quality, the competition was among private issuer till the issuing right was monopolized by the government. The issue caught attention again after the WW Ⅰ when governments issued too much paper currency and there was serious inflation around the world. After the WW Ⅱ , the supremacy of the dollar in the international monetary system was established due to the Bretton Woods system and the competition structure in the international monetary system looked like a pyramid with the dollar in the top, the pound, the German mark, the French franc and the Japanese yen in the middle and currencies of developing countries in the bottom. With the collapse of the Bretton Woods system and the establishment of the euro zone, the euro started a direct competition with the dollar while the yen was marginalized and not able to compete with the euro and the dollar on the same level. In the 1970s, the overflow of the dollar led to its depegging against the gold and the collapse of the Bretton Woods system. After that, the economic power of France, Germany and Japan experienced rapid growth and the dollar standard was hit hard. However, the dollar still remains the leading reserve currency, the settlement currency and the 66

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foreign exchange currency in the world. In the late 1990s, more than four fifths of foreign exchange transactions were done in dollar and nearly half of the export was settled in dollar. The proportion of the official dollar reserve rose from a half in 1990 to two thirds in 1999. Now the international monetary system looks like a pyramid which is categorized into seven currency levels by economists abroad: 1. Top currencies: the leading currency, such as the pound before the WW Ⅱ and the dollar after the WW Ⅱ ; 2. Patrician currencies: internationally popular but not dominant currencies, such as the German mark, the euro and the yen; 3. Elite currencies: able to function as an international currency but not able to play a critical role outside its issuing country, such as the current pound and Dutch dong. 4. Plebeian currencies: used in limited areas internationally, but their authorities are challenged by other higher-level currencies, such as the Singaporean yuan and the Australian yuan; 5. Permeated currencies: Currencies whose authoritative domain is compromised even at home, mainly through the market-driven process of currency substitution. 6. Quasi currencies: Currencies that are supplanted not only as a store of value but as a unit of account and a medium of exchange. Currencies of the Latin American countries and the Soviet Union are in this category. 7. Pseuso currencies: Currencies that only exist in name without any economic function and are fully supplanted.

M e a s u r e o f Va l u e ( U n i t o f Account) The money function in which money is used as the common benchmark to designate the prices of goods throughout the economy. Measure of value, or unit of account, means money is functioning as the measuring unit for prices. In other words, prices of goods are stated in terms of the monetary unit. This is one of four basic functions of money. The other three are medium of exchange, store of value, and standard of deferred payment.

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The RMB is getting closer to the top of the pyramid, that is, to advance from the Patrician currency to the Top currency. With the start of the currency integration in East Asia, currency competition takes the form of the competition to be the regional anchor currency and the relationship between the RMB and the yen, two key currencies in the region, can not be neglected. With the currency integration comes currency competition among countries in the region. Generally speaking, the regional currency should either be the currency of the strongest country in the region and be applied by all the other countries in the region; or a new currency should be issued in the regional which is pegged to currencies of several countries in the region. A typical example of the first form is shown in the dollar zone and the second form is shown in the euro zone. No matter what form is it, the regional currency leading country always benefits more from such cooperation than other countries. Currency competition is based on the rational choices of the economies in terms of the stability of the currency value, transaction costs, and convenience. Therefore, currency competition is similar to commodity market competition which applies to the Survival of the Fittest principle. Generally speaking, any form of currency competition will eventually lead to currency replacement as shown in the replacement of the pound by the dollar to be the leading international currency after the WW Ⅱ . In some particular cases, currency replacement refers to the situation that residents of a country lose confidence in the value of its currency or a large amount of the currency is exchanged when its earnings ratio is low so the functions of the currency is fully or partly supplanted by foreign currencies. The regionalization of the RMB is the process in 68

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which the RMB participates in currency competition and gradually supplants other currencies in the region. We should be clear-minded and confident in its regionalization based on the position it owns now. M o s t i m p o r t a n t l y, t h e s t r a t e g y o f t h e R M B regionalization should go along with the reform and opening up of China. To succeed in the competition, China should enhance its economic strength and shorten the gap with the US, Japan and Europe while accelerating the development of the financial market by developing more RMB financial tools and enhancing market liquidity. The central bank should enhance its ability to control and manage the currency, accumulate experience, and create necessary conditions for the regionalization and full convertibility of the RMB. It can be predicted that in its internationalization, the RMB will compete with the yen for regional rights and also with the dollar and the euro in the international field. Therefore, competition is unavoidable except that it has different competitors, scopes, and contents at different stages. This can be called 'new currency competition' because no developing country in history has competed with developed countries in the international monetary system. A new round of international monetary shuffling has started and there will be winners as well as losers.

Strateg ies to Advance the R M B Internationalization The strength of a currency is determined by t h e e c o n o m i c p o w e r. I n e s s e n c e , t h e c u r r e n c y internationalization is a result of market choice. However, the role played by the government should 69

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not be ignored and the government should consider measures from a strategic height in order to steadily advance the RMB internationalization. First, a principle of prudence and neutrality should be taken in order to adjust to the development and requirements of the market. The key is doing without saying. If the processed attracts too much attention, there will be some unnecessary troubles. For example, the economic rise of China incurred the saying of 'China Threat' which may be aroused again and the RMB internationalization will be compared to 'currency colonization'. The RMB internationalization means that China will should more international responsibilities which may be overemphasized and used by other countries to transfer risks to China. In the 1980s when the internationalization of the yen was advanced, the US required Japan to open its financial market by way of the yen-dollar committee conferences. Secondly, the RMB internationalization should focus on Asia. The RMB can go global only after it is fully convertible in Asian, so its internationalization should stick to the path of regionalization to internationalization. The influence of the RMB in East Asia should be enhanced based on the cooperation among the ASEAN, China, Japan, and South Korea ('10+3'). The share of the RMB in the regional trade should be gradually improved and then permeate to regional investment. More channels should be created to satisfy the needs of some East Asian countries to use the RMB as reserve assets. The special position of Hong Kong and the neutral position of its currency should also be made good use of. In the process, the negative impacts of the 'small dollar' should be noticed. In the past, the RMB was pegged to the dollar to maintain its stability and thereby named as the 'small dollar', which played a positive role in the initial stage of its internationalization. However, in the long run, this will 70

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require frequent interventions on the foreign exchange market and the RMB will be dependent on the dollar. The image of the 'small dollar' will limit the width of its internationalization. The yen internationalization is a case in point. Thirdly, unnecessary and outdated foreign exchange regulations should be lifted. Convertibility is the foundation for internationalization and convertibility in the current account is a necessary condition. The higher the convertibility, the looser the capital account regulations and the further the currency internationalization will go. In fact it is also a requirement of the economic development and the rise of China to loosen capital controls. The consistently rapid economic growth, the increased comprehensive national strength, and the enhanced macro-adjustment capability have enabled China to improve the convertibility in the capital account and also provided an opportunity to put forward relevant reforms. Therefore, a proper opportunity should be found to realize the convertibility of the RMB in order to lay a solid foundation for its internationalization.

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The RMB has participated in the international racing ever since its birth. For six decades, the RMB has been striving and catching up especially during difficult racing periods including the Asian financial crisis and the international financial crisis. The RMB has stuck to the principle of no depreciation and won a good reputation. However, will and perseverance alone are not enough to stand out in the international racing track. The application of techniques and skills is a guarantee for the RMB to be listed among the first-tier team of leading currencies.

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The RMB Overseas Years ago the biggest headache for Chinese people travelling abroad was the exchange of currencies. If they could use some RMB in the foreign markets, they should have felt very convenient and proud. However, now Chinese tourists can enjoy some treatment when they travel to neighboring countries, which resulted from the flow of the RMB overseas due to travelling of the Chinese to neighboring countries and their investment. The flow of the RMB overseas has been common especially in neighboring countries and areas due to China's economic development and the RMB has been partly regionalized. The Chinese government has loosened its control on the cross-border flow of the RMB since its reform and opening-up, which is the key for the RMB to flow overseas.

Sharp Increase of the RMB flow due to Loose Policies In 1951, China implemented Regulations on Banning on the RMB Outflow of the People's Republic of China, which banned the RMB on being carried or smuggled out of China or else it would all be confiscated. Since the 1980s, the government has taken relatively loose policies on the cross-border flow of the RMB required by the economic development. From 1987 on, the Chinese government started to allow the RMB to 75

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flow out of its border, which admitted the cross-border flow of the RMB legally. In the same year, the limit of the RMB allowed to be carried overseas was adjusted to RMB200. In 1990 when the Asian Games were held in Beijing, the limit of the RMB allowed to be carried overseas was adjusted to RMB2000, but the adjustment was ended after the games. In 1993, the PRC Currency Outflow and Inflow Administration Rules was enacted, specifying the implementation of limit on the amount of RMB allowed to outflow and inflow which is decided by the PBOC. In the same year, the limit allowed was raised to RMB6000 per person per time by the PBOC. On December 2nd 2004, the number was further increased to RMB 20,000. The amount of the RMB which stayed overseas gradually increased due to the rise in the amount of money allowed to ve carried overseas. Some scholars have done a research on the amount of the RMB flowing overseas between 1993 and 2003 and pointed out that the figure should be RMB 200 billion if various factors are taken into consideration. An investigation done by the PBOC showed that by the end of 2004 the amount of the RMB staying in neighboring countries and in Hong Kong and Macao had reached around RMB 21.6 billion. It also showed that in 2004 the total amount of the RMB cash flowing outward and inward was RMB 771.3 billion with net outflow amount of RMB 9.9 billion. According to the State Administration of Foreign Exchange Bureau, the amount of cross-border flowing RMB was approximately RMB 100 billion in neighboring countries and areas with RMB 20 billion staying abroad and in 2007 and 2008 the figures kept growing.

Growth in China's National Strength - the Key As mentioned before, governments of neighboring 76

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countries and areas generally accept the RMB to circulate within their borders in order to increase tourism revenue and promote border trade. Governments of Miamar, Cambodia and Napel openly welcomed the RMB to circulate in their countries and the RMB bank cards are allowed to be used in some other countries. In fact, it is no accident that the RMB started to flow overseas in a large volume, which is a natural consequence of China's economic development. Since reform and opening up, China has been politically stable, with enhanced national strength and the value of the RMB grew steadily with relatively small exchange rate risks, all of which played an important role in maintaining a good image of the RMB. Residents in neighboring countries and areas are generally willing to accept the RMB and regard it as a tool for value maintenance and appreciation, especially after the 1997 Asia financial crisis in which currencies of many neighboring countries and areas experienced a heavy depreciation while the RMB appreciated a bit during that period due to years' of surplus. Therefore, the stable position of the RMB is the basic reason for its circulation overseas. In the recent 30 years, with frequent trade exchanges between China and its neighboring countries, the influence of the RMB has been improving. Now the RMB has become a settlement currency in transactions between China and its neighboring countries which gained some net inflow of the RMB with trade surplus. The RMB as a payment and settlement currency is commonly accepted in countries like Vietnam, Thailand, Myanmar, Cambodia, Nepal, North Korea, Russia, Pakistan etc. Moreover, as a result of increased income of Chinese residents, they can afford to travel abroad and do

Asian Financial Crisis The Asian financial crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown due to financial contagion. The crisis started in Thailand (well known by the Thais as, literally translated as Tom Yam Kung crisis) with the financial collapse of the Thai baht after the Thai government was forced to float the baht due to lack of foreign currency to support its fixed exchange rate, cutting its peg to the US$, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies,http:// en.wikipedia.org/wiki/1997_Asian_ financial_crisis - cite_note-2 devalued stock markets and other asset prices, and a precipitous rise in private debt.

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some shopping, which contributed to the expansion of where the RMB is used and has influence. According to the World Tourism Organization, by 2015 China will become the fourth largest tourism country with a number of 100 million tourists traveling abroad each year. Up till now, more than 130 countries have become destinations for Chinese citizens to travel abroad, among which over 20 have accepted free travel of Chinese citizens. According to the data provided by the Chinese National Tourism Bureau, from January to April 2009, the number of foreign travelers to Mainland China amounted to 6.739 million, representing a decrease of 21.82% year on year. However, in the same period, the number of Chinese citizens travelling abroad amounted to 15.875 million person times, an increase of 4.64% year on year. In 2008, the number reached 46 million person times, an increase of 12% over 2007. Now Mainland Chinese tourists have become the most important group of travelers to Southeastern countries. At the same time, more and more Chinese enterprises are encouraged to go global, to invest in other countries and regions especially to neighboring countries where the RMB is highly recognized. In these countries, the direct investment is done in RMB which is a key part of the RMB flowing overseas.

The RMB in Short Supply In fact, the supply of the RMB through official channels cannot meet its demand from neighboring countries and illegal exchanges are very active. There are a lot of unofficial financial organizations doing RMB exchange such as 'street banks' and underground exchange. The RMB is sold and purchased as a special commodity in order to provide market arrangement for local circulation of the RMB. The so-called 'street 78

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banks' refers to unofficial currency exchange institutions on the China-Vietnam and China-Cambodia borders and are organized loosely. Their main operations include currency exchange and credit businesses. Because these 'banks' are unofficial and operated on the streets, local people call them 'street banks'. In 2002, the government of Vietnam started to issue certificates to these 'street banks' and make them legalized. Currently there are more than 600 'street banks' on the border between China and Vietnam, where more than RMB 1 million is exchanged in each bank that is playing a key role in border settlement and the RMB exchange rate. However, the RMB is still not fully convertible in the capital account and a large volume of the RMB flowed overseas through illegal channels. Such RMB funds are used for smuggling, drug trafficking, gambling and money-laundering through three main channels including underground banks, corporate transfer and carry-on. Underground banks are open secrets in the Southeastern coastal areas of China, where tens of millions of RMB is exchanged each day. Customers can give their cash (in RMB or in foreign currency) to these underground banks in China and withdraw RMB or foreign currencies abroad. Corporate transfer means reporting more than or less than the real amounts in import and export so that a large sum of money which is represented in foreign trade in the current account can be transferred overseas. There are also some illegal means such as drug trafficking assisted by 'street banks'. Now Hong Kong has become a linking hub for the RMB to flow to neighboring countries or areas. There is a kind of overseas transportation of 'expensive articles' (including all kinds of currencies transportation), through which channel the RMB is transported to neighboring countries or areas. There are several channels for the RMB to flow back to

Important Indicators of Money Supply M1: Bank reserves are not included in M1. M2: Represents M1 and "close substitutes" for M1. M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation. M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer tracked by the US central bank. However, there are still estimates produced by various private institutions. In China, M0 refers to cash in circulation. M1 (narrow money) = M0 + corporate current deposit + institutional and army deposit + rural deposit + individual credit card deposit M2 (broad money) = M1 + residential deposit + corporate fixed deposit + trust deposit + other deposit M3 = M2 + financial bonds + commercial paper + Negotiable Certificate of Deposit Among them, M2 minus M1 is quasimoney and M3 is created based on innovations of financial tools. M1 reflects real purchase power in economy; M2 reflects not only real purchase power but also potential purchase power. If M1 grows fast, consumption and end markets will be active; if M2 grows rapidly, investment and intermediate markets will be active. The central bank and commercial banks will make monetary policies based on them. If M2 is too high and M1 is too low, it means there is too much investment, not enough demand and potential risks; if M1 is too high and M2 is too low, it means there is strong demand, not enough investment and potential risks for price rise.

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China from neighboring countries or areas. The first is through surplus in border trade; the second is through the banking system, where foreign residents deposit RMB in Chinese banks near the border or foreign banks transfer RMB which is absorbed overseas to Chinese banks; the third is through investment, starting a business, property purchase in RMB by foreign residents; the fourth is by way of visiting relatives and travelling of foreign residents; and the fifth is through currency smuggling. In summary, there are diversified ways for the RMB to flow overseas, legal and illegal. Illegal channels result from huge RMB demands on the border, which reflects the potential for the RMB regionalization. The volume of the RMB circulating in neighboring countries or areas is considerable; and there have been big changes since 2008 in the RMB cross-border flow. However, it should be noticed that the amount of the RMB flowing overseas only amounted to less than 2% of M2 and the regionalization of the RMB is one starting point for its internationalization.

Different Lengths of the RMB 'Shadows' There are shadows of the RMB in every East Asian country, different in lengths. They are similar to interpersonal relationships which differ in terms of closeness and look like dimples spreading from the center. Actually the closer the country is to China geographically, the more frequent the RMB is used and vice versa. In Southeaster Asia, the RMB has become a hard currency only inferior to the dollar, the euro, and the yen. In Southwestern Asia, the RMB has replaced 80

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its own currency in the three northeastern provinces of Laos and its influence goes farther to the capital Vientiane. The RMB is circulating all around Vietnam and the RMB deposit business is started in the National Bank of Vietnam. In Northwestern Asia, the RMB is circulating in the five countries in Central Asia, Russia and Pakistan, with the largest volume in Kazakhstan of over RMB 1 billion. In Northeastern Asia, the RMB is flowing cross-border to Russia, North Korea and Mongolia. In Mongolia, all the banks have RMB businesses and in its border trade the transaction volume of the RMB amounts to more than third of all bilateral trade. The largest RMB circulation is in Hong Kong SAR where the RMB can be exchanged freely through various channels and can also be used as a reserve currency. There are three different categories in terms of degree of acceptance for the RMB flowing in neighboring countries and areas.

The First Category: Close Mutual Economic Ties This category mainly refers to Hong Kong and Macao with close economic ties with the mainland and common use of the RMB. People who have travelled to Hong Kong and Macao must have noticed that the exchange rate of the RMB against the HK dollar is shown in most hotels and shopping malls where people can direct pay in RMB. The HK dollar can be directed exchanged into the US dollar and thereby the RMB can also be exchanged into the US dollar. There are more than 100 currency exchange centers and over thirty banks which operate RMB exchange business. Therefore, the RMB exchange is very convenient in Hong Kong and Macao. From February 25th 2004 on, the PBOC started to further open the Hong Kong RMB business including its 81

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exchange scope and amount and the Hong Kong residents were allowed to pay for their consumption (no transfer) in Guangdong province with RMB cheques no more than RMB 80,000 per account per day. In Hong Kong and Macao, the RMB has become an important circulating currency second only to the HK dollar. In 2004, the amount of RMB cash flowed to Hong Kong and Macao amounted to RMB 379.8 billion and RMB 372.4 billion flowed back to the Mainland with a total volume of RMB 752.2 billion accounting for 97.5% of the total RMB cash cross-border flow. Financial institutions in Hong Kong started to do RMB businesses a long time ago such as the RMB exchange, t h e R M B b a n k c a r d s , s e m i - u n d e rg r o u n d R M B remittance between Hong Kong and the Mainland. In 2003, the Closer Economic Partnership Arrangement (CEPA) was assigned between the Mainland and Hong Kong in order to promote further development of their economic and trade relationship. In November of the same year, the PBOC published the 16th announcement that the central bank started to provide clearing services for banks running RMB deposit, exchange, remittance, and bank card business in Hong Kong. On January 18th 2004, mainland bank cards were approved to be used in Hong Kong, which stimulated the RMB business and then the RMB circulation volume in Hong Kong accounted for the largest proportion of the overall overseas RMB circulation. Six years after the CEPA was signed, on June 29th 2009, Zhou Xiaochuan, governor of the PBOC signed a memo with Ren Zhigang, president of the Hong Kong Financial Administration Bureau, in which enterprises based in Hong Kong were allowed to do RMB settlement with pilot enterprises based in Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan. Ren Zhigang explained that if import firms from Hong Kong come to the Mainland to purchase and there is 82

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insufficient RMB for them, they can borrow from local banks because the PBOC and the Hong Kong Financial Administration Bureau have signed currency swap agreement, 'which is equal to RMB trade finance'. Ren was not worried about the RMB reserve of only RMB 50 billion in Hong Kong either because when mainland importers purchase in Hong Kong they can pay in RMB in Hong Kong or the Mainland, which will increase the volume of RMB in Hong Kong.

The Second Category: Dependent on the Chinese Economy Countries that fall under this category include Myanmar, Vietnam, Laos, North Korea, Mongolia, Russia, Pakistan, Nepal etc. These economies have strong reliance on China's economy and in the border trade with these countries, the RMB is commonly used. In some countries, the RMB is used nationwide. In Vietnam, the RMB is almost the most popular currency. Guangxi is the only province in China which borders on Vietnam with Pingxiang and Dongxing next to Liangshan and Mangjie respectively. Take Pingxiang for example. In 2008, its international trade volume amounted to USD 1.7 billion and the border trade volume reached USD 8.1 billion of which 60% was settled in RMB. In Hanoi, capital of Vietnam, a lot of Vietnamese are doing RMB exchange by the river in the downtown area. However, the RMB is mainly circulating in its Northern provinces especially in border areas and rarely in the south. Petty border trade between Guangxi and Vietnam in 2002 amounted to USD 345 million which grew by 55.2% to USD 535 million, accounting for 17% of the total foreign trade volume in Guangxi. Over 90% of such trade was settled with bill of exchange or special voucher for border trade settlement through RMB accounts. 83

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In the northern parts of Myanmar and Laos, the RMB is the main currency for transaction and can be used in any trade or purchase. In the Chiengmai airport in North Thailand, the RMB can be exchanged freely. In March 2002, Hongsen, prime minister of Cambodia said that the RMB was commonly recognized as the most stable currency in Asia and called for more frequent use of the RMB among Cambodians. He also mentioned that the RMB started to circulate in the black market and if the black market accepted the RMB, why should the currency be allowed to circulate officially? In North Korea, the RMB is called the 'second US dollar' and it is used for settlement, commodity transactions, hard currency reserve in all the border cities and even nationwide. The commodities sold in stores are also priced both in Korea-North Won (KPW), RMB and euro. In Mongolia, the RMB accounts for 80% to 90% of the currencies circulating around the border and 50% of the currencies in circulation nationwide. In Russia, with the implementation of the Sino-Russia Agreement on the Interbank Trade Settlement in Border Areas, from January 1st 2003 on, the dollar was replaced by the RMB as the trade settlement currency on the longest border line. According to the agreement, this kind of settlement and payment can be done by Russian branch banks located in the border areas (Altai Republic, Primorsky Krai, Khabarovsk Territory, Amur Oblast, Chita Oblast and Jewish Autonomous Oblast) and Chinese banks located near the border (Heilongjiang, Inner Mongolia, Xinjiang, Jilin). In the border trade between China and the Russian Far East, Heihe City is the most representative where four state-owned banks have established correspondent bank ties with eleven Russian 84

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commercial banks. The Bank of China Heihe branch and the Agricultural Bank of China Heihe branch signed RMB and rupee border trade settlement account agreement with the Russian bank (VTB) based in Blagoveshchensk and Blagoveshchensk branch respectively. By 2004, China had signed bilateral settlement and cooperation agreement with Vietnam, Mongolia, North Korea, Russia, Laos and Nepal. In 2004, the RMB settlement accounted for 81% in border trade between China and Vietnam, 90% between China and Mongolia, 15% between China and North Korea. Besides, direct investment in RMB through unofficial channels also existed in some border areas.

The Third Category: Tourism Driven Countries under this category include Singapore, Malaysia, Thailand, South Korea etc, where large volumes of Chinese tourists travel for visiting and shopping which resulted in the occurrence of RMB exchange stores and RMB businesses in banks. In these countries, items in shops, restaurants and hotels are priced both in RMB and local currencies and there are RMB exchange services in most commercial banks. After January 10th 2005, the Unionpay card was officially put into use in South Korea, Thailand, Singapore and card-holders can consume and withdraw money within certain caps.

The World's Largest Free Trade Zone —— a New Stage for the RMB On August 15th 2009, the 8th Sino-ASEAN ministerlevel economic and trade conference was held in Bangkok, where the Sino-ASEAN Free Trade Zone Investment Agreement was signed marking the

Free Trade Zone A free trade zone (FTZ) or export processing zone (EPZ), also called foreign-trade zone, formerly free port is an area within which goods may be landed, handled, manufactured or reconfigured, and reexported without the intervention of the customs authorities. Only when the goods are moved to consumers within the country in which the zone is located do they become subject to the prevailing customs duties. Free-trade zones are organized around major seaports, international airports, and national frontiers-areas with many geographic advantages for trade. It is a region where a group of countries has agreed to reduce or eliminate trade barriers.

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completion of the main negotiations on the SinoASEAN Free Trade Zone. From January 1st 2010 on, more than 7000 commodities were sold free of duties between China and the ASEAN countries. A multinational market covering 13 million square kilometers, with 1.9 billion population and a total GDP of USD 6 trillion came into being. In terms of economic scale, the free trade zone exceeded that of the European Union and the North American Free Trade Zone and became the large free trade zone of developing countries in the world. There are three free trade zones in the world, namely the Sino-ASEAN Free Trade Zone, the European Union and the North American Free Trade Zone. The European Union was an international institution based on the European Union Treaty signed in 1992 with 27 member countries, now the world's largest economic entity. The North American Free Trade Zone consisted of the US, Canada, and Mexico that reached a consensus on the North American Free Trade Agreement on August 12th 1992. On December 17th leaders from the three countries officially signed the agreement in their own countries. Different from the European Union, the North American Free Trade Zone Agreement is not above the government and laws of its member countries. The Sino-ASEAN Free Trade Zone Investment Agreement marked a successful step in China's regionalization and a great breakthrough in China's overseas economic strategy after its entry into the WTO, which bears significance to the economic development and the RMB internationalization. The free trade zone will strengthen regional economic development and contribute to the economic and financial stability, thereby conducive to the RMB regionalization. For China, the promotion of the economic and trade cooperation in the region have geopolitical and strategic importance. Since the mid-1990s, China and the ASEAN 86

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have increasingly closer exchanges on security and trade and their peaceful co-existence has played a key role in maintaining regional peace, stability and prosperity. By the end of 2008, the total investment from the ASEAN to China amounted to USD 52 billion; China is also actively going global with a rapid growth in its investment to the ASEAN countries. In 2008, the direct investment from China to the ASEAN reached USD 2.18 billion, representing a year-on-year growth of 125%. More and more Chinese enterprises regard the ASEAN countries as a main investment target. Through ups and downs, more countries in Asia have realized that to get a win-win result, close cooperation is needed. Regional partnership will provide equal trade and investment opportunities especially for weaker countries in the region in order to enhance their capacity to fight against risks. These weaker countries can also bring in technologies and funds from stronger countries to shorten wealth gap and promote regionalization. The free trade zone will enhance regional stability and common development while serving as a real economy foundation for regional monetary development. From the perspective of the global financial development trends and the European monetary integration, the panAsian free trade zone means that the regional monetary integration will soon be realized which will be a larger stage for the RMB regionalization.

Currency Swap Agreements Frequently Signed by the PBOC Since 2008, the financial tsunami caused by the US mortgage crisis further developed with severe

World Bank The World Bank is an international financial institution that provides loans to developing countries for capital programs. The World Bank's official goal is the reduction of poverty. According to its Articles of Agreement (as amended effective 16 February 1989), all its decisions must be guided by a commitment to the promotion of foreign investment and international trade and to the facilitation of capital investment. The World Bank comprises two institutions: the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). The President of the Bank, currently Jim Yong Kim, is responsible for chairing the meetings of the Boards of Directors and for overall management of the Bank. Traditionally, the Bank President has always been a US citizen nominated by the United States, the largest shareholder in the bank. The nominee is subject to confirmation by the Board of Executive Directors, to serve for a five-year, renewable term. While most World Bank presidents have had banking experience, some have not. The vice presidents of the Bank are its principal managers, in charge of regions, sectors, networks and functions. There are two Executive Vice Presidents, three Senior Vice Presidents, and 24 Vice Presidents.

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turbulences and loss of liquidity in the international financial markets. Central banks of major countries all signed currency swap agreements in order to stabilize the global financial markets, provide liquidity support and restore confidence of investors. Take the Fed for example. More and more countries have signed currency swap agreements with the Fed and the amounts signed have become increasingly higher. Currency swap agreements signed by other countries also increased. Besides, since the end of 2008, media coverage on China's participation in regional monetary cooperation have been frequently seen.

History of Currency Swap

The Boards of Directors consist of the World Bank Group President and 25 Executive Directors. The President is the presiding officer, and ordinarily has no vote except a deciding vote in case of an equal division. The Executive Directors as individuals cannot exercise any power nor commit or represent the Bank unless specifically authorized by the Boards to do so. With the term beginning 1 November 2010, the number of Executive Directors increased by one, to 25.

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Currency swap to be put in a simple way means 'I lend my own currency to you and you lend me yours', which was initially used among commercial institutions so as to reduce financing costs and fix exchange rate risks. In recent years, central banks started to use currency swap in regional financial cooperation to enhance financial stability. When the finance crisis comes, the increase in the amount in and the number of currency swap agreements aims to provide liquidity, avoid exchange rate risks, stabilize international financial markets and protect trade. When a currency swap agreement is signed between two central banks, the two countries confirm the amount of currency to be swapped in order to provide short-term liquidity and convenience to its own commercial banks to be finance in branches from the other country. Such an agreement symbolizes the will of cooperation in fighting against crisis, strengthening confidence and promoting regional financial stability. The first commercial currency swap agreement appeared in 1981 between the World Bank and IBM with Saloman Brothers as the match-maker. But before

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the commercial currency swap agreement, there were currency swap agreements between countries. The Fed signed a bilateral currency swap agreement with the central bank of France in May 1962 and by the end of May 1967 the Fed had signed currency swap agreements with 14 central banks and international clearing banks. By the middle of the 1990s, the amount in the currency swap agreements signed by the Fed had reached USD 30 billion. However, the purpose of currency swap agreements between countries is not to reduce financing costs but to stabilize the foreign exchange market and provide liquidity in emergencies. After the September 11th event, the Fed signed temporary currency swap agreements with the European central bank, the central bank of England and the central bank of Canada. Since 2008 when the US mortgage crisis developed into a financial crisis, the Fed started to sign currency swap agreements with central banks of other countries more frequently with an unprecedented amount and in some agreements there were no cap of the currency to be swapped. It can be seen that the Fed has regarded currency swap agreements as a policy tool to liquidity support, live through the financial crisis and restore confidence. The 1997 Asian financial crisis brought harm to Asian countries, which enhanced the awareness of regional financial stability. Besides, aids from international financial institutions were not satisfying and Asian countries started to explore how to promote local financial stability by themselves. Therefore, the ASEAN countries along with China, Japan and South Korea ('10+3') held the first '10+3' leadership conference in 1997 and then established the '10+3' finance minister conference mechanism. In 2000 the '10+3' finance minister conference was held in Chiengmai in Thailand, when all parties voted for the Chiengmai Proposal which agreed to expand the capital scale of currency swap network and called for the 13 countries to sign

Salomon Brothers Salomon Brothers was a Wall Street investment bank, known as a bulge bracket company. Founded in 1910 by three brothers (Arthur, Herbert and Percy) along with a clerk named Ben Levy, it remained a partnership until the early 1980s, when it was acquired by the commodity trading firm Phibro Corporation and then became Salomon Inc. Eventually Salomon (NYSE:SB) was acquired by Travelers Group in 1998, and following the latter's merger with Citicorp that same year, Salomon became part of Citigroup. Although the Salomon name carried on as Salomon Smith Barney, which were the investment banking operations of Citigroup, the name was ultimately abandoned in October 2003 after a series of financial scandals that tarnished the bank's reputation.

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bilateral currency swap agreements based on common principles in order to provide emergency foreign capital to member countries when there is a lack of liquidity or international payment problems.

China's Participation in the Currency Swap

BIS The Bank for International Settlements (BIS) is an international organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks". As an international institution, it is not accountable to any single national government. The BIS carries out its work through subcommittees, the secretariats it hosts and through an annual general meeting of all member banks. It also provides banking services, but only to central banks and other international organizations. It is based in Basel, Switzerland, with representative offices in Hong Kong and Mexico City. The BIS was established by an intergovernmental agreement in 1930 by Germany, Belgium, France, Great Britain and Northern Ireland, Italy, Japan, United States and Switzerland. The Bank was originally intended to facilitate reparations imposed on Germany by the Treaty of Versailles after World War I.

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Currency swap agreements signed by China were all based on the Chiengmai Proposal. In May 2006, the third round of expansion on the Chiengmai Proposal was completed with a total volume of USD 75 billion signed in 18 bilateral currency swap agreements, among which China signed five. In May 2007, in the tenth '10+3' minister-level conference, consensus was reached by all parties to advance the Chiengmai Proposal and a joint agreement was established, according to which all the member country should invest money in the joint foreign reserve fund so as to help a member out of crisis when need arises. In the Chiengmai Proposal, currency swap should meet the requirements of the IMF aid plan and reform and it is only a supplement to the IMF aid. However, the joint foreign reserve fund broke such a limit and the regional self-assistance mechanism in East Asia was greatly strengthened. In May 2008, member countries agreed to contribute USD 80 billion to joint foreign reserve fund, of which 80% came from China, South Korea and Japan while the remaining 20% came from the ASEAN countries. In December 2008, Secretary of the ASEAN announced that against the background of turbulences in the international financial crisis, the joint foreign reserve fund to be established by the '10+3' ministerlevel conference will be expanded from USD 80 billion to USD 120 billion. On December 12th 2008, the PBOC signed a bilateral currency swap agreement with Bank of Korea with a

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volume of RMB 180 billion (38 trillion Korean yuan) and the two parties agreed to explore the possibility and proportion of changing swap currency to reserve currency. The term for the agreement is 3 years but can be rolled over. The purposes of the agreement include providing short-term liquidity to financial systems of two sound economies and advancing bilateral trade. This was the first time for the RMB to be used in currency swap agreements. (Before that, in such agreements the Korean yuan was exchanged with the US dollar.) On January 20th 2009, the PBOC announced that a bilateral currency swap agreement was signed with Hong Kong Financial Administration with a volume of RMB 200 billion (HKD 227 billion) in order to promote regional financial stability. On February 8th 2009, the PBOC announced that a bilateral currency swap agreement was signed with National Bank of Malaysia with a volume of RMB 80 billion (40 billion Ringgit) in order to advance bilateral trade and investment as well as to promote the growth of the two economies. The term for the agreement is 3 years but can be rolled over. This expression is different from what the PBOC expressed when signing agreements with South Korea and Hong Kong because the purpose of promoting regional financial stability was not mentioned. This currency swap agreement can be considered as a measure in close relation to the ASEAN commodity trade settlement piloting. According to official statistics, Malaysia has become the largest trading partner of China among all the ASEAN countries with a bilateral trade volume of USD 53.47 billion last year. Compared with such a trade volume, the amount in the currency swap agreement is not small. On March 11th 2009, there was an announcement on the official website of the PBOC that 'a bilateral currency swap agreement was signed with National Bank of The

Investment Banking An investment bank is a financial institution that assists individuals, corporations, and governments in raising capital by underwriting and/or acting as the client's agent in the issuance of securities. An investment bank may also assist companies involved in mergers and acquisitions and provide ancillary services such as market making, trading of derivatives and equity securities, and FICC services (fixed income instruments, currencies, and commodities). Unlike commercial banks and retail banks, investment banks do not take deposits. From 1933 (Glass-Steagall Act) until 1999 (Gramm-Leach-Bliley Act), the United States maintained a separation between investment banking and commercial banks. Other industrialized countries, including G8 countries, have historically not maintained such a separation. As part of the Dodd-Frank Act 2010, Volcker Rule asserts full institutional separation of investment banking services from commercial banking. There are two main lines of business in investment banking. Trading securities for cash or for other securities (i.e. facilitating transactions, market-making), or the promotion of securities (i.e. underwriting, research, etc.) is the "sell side", while buy side is a term used to refer to advising institutions concerned with buying investment services. Private equity funds, mutual funds, life insurance companies, unit trusts, and hedge funds are the most common types of buy side entities.

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Republic of Belarus with a volume of RMB 20 billion (BYR 8 trillion) in order to advance bilateral trade and investment as well as to promote the growth of the two economies. The term for the agreement is 3 years which can be rolled over.' Currency swap agreements signed by PBOC since 2008 Date

The other party and volume (RMB)

Dec 12th 2008

South Korea, 180 billion

Jan 20th 2009

Hong Kong Financial Administration, 200 billion

Feb 8th 2009

Malaysia, 80 billion

Mar 11th 2009

The Republic of Belarus, 20 billion

Mar 24th 2009

Indonesia, 100 billion

Mar 29th 2009

Argentina, 70 billion

Currency Swap between Countries in the Economic Winter In history currency swap was not rare during financial crises and in the economic winter, such mutual help through currency swap was common. Therefore, the currency swap agreements signed by the PBOC were understandable, but its huge volume, swap frequency and RMB focus were very eye-catching. It is not difficult for us to notice that among the countries that China signed currency swap agreements with, South Korea has experienced huge depreciation of its currency and plunge in the stock market since the latter half of 2008. The situation in the Republic of Belarus was worse. According to the estimation of the Ministry of Commerce of China, by January 2009, the amount of foreign debt by the Republic of Belarus broke a new record to USD 4.31 billion which could lead to bankruptcy of the country with a population of only 10 million. With decreasing export and severe domestic 92

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economic situation, the Republic of Belarus made a good choice by signing currency swap agreements to help each other get out of difficulties. There is no doubt that the expansions in the countries signing currency swap agreements and the increase in the agreement amount have created opportunities for the RMB internationalization. Before that, in the agreements signed by the PBOC with Thailand, Malaysia, and Indonesia the swaps were between foreign currencies and the dollar while in the agreements signed with Japan, the Philippines and South Korea the swaps were between foreign currencies and the RMB. The second way should be applied in the bilateral currency swap agreements in order to enhance the influence of the RMB.

Changes in the Exchange Rates of the RMB against Currencies in Major Countries Looking Back on the Exchange Rates of the RMB The exchange rates of the RMB went through a process from step-by-step depreciation to slow appreciation, of which the turning point was the exchange rate reform policy implemented in 1994. On December 28th 1993, the PBOC published the Statement on the Further Reform of the Foreign Exchange Rate System which stipulated that from

Exchange Rate In finance, an exchange rate (also known as a foreign-exchange rate, forex rate, FX rate or Agio) between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country's currency in terms of another currency.

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January 1st 1994 on the RMB exchange rate system would be combined into a basic, single, managed floating exchange rate regime based on demand and supply of the market. Before 1997, the RMB exchange rate remained stable with some slight rise. However, after the Asian financial crisis, the PBOC shortened the RMB floating space to prevent the crisis from being deepened because of currency depreciation in neighboring countries and areas. After 1997, the RMB exchange rate remained at a stable level of 1:8.27 to the dollar. In 1999, based on the actual performance of the RMB, the IMF defined the RMB exchange rate system as fixed peg system of a single currency.

Currency Basket A currency basket is a portfolio of selected currencies with different weightings. A currency basket is commonly used to minimize the risk of currency fluctuations. An example of a currency basket is the European Currency Unit that was used by the European Community member states as the unit of account before being replaced by the euro. Another example is the special drawing rights of the International Monetary Fund. In China, the currency basket of the central bank consists of the dollar, the Japanese yen, the euro, the Korean won, the Singapore dollar, the pound, the Malaysian Ringgit, the Australian dollar, and the Canadian dollar.

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On July 21st 2005, the Statement of the PBOC on Improving the RMB Exchange Rate Mechanism was published and the managed floating exchange rate regime pegged to a basket of currencies and based on demand and supply of the market was re-implemented. Therefore, a more flexible RMB exchange rate regime was established. This is a kind of floating exchange rate regime which expanded the degree that the dollar and other currencies are allowed to float. However, SinoUS trade accounted for the largest proportion in China's overall foreign trade and though the RMB is pegged to a basket of currencies instead of the dollar, the regime is more close to a fixed exchange rate system which mainly pegged to the dollar. More risk-mitigation tools appeared in the foreign exchange market with more flexible transaction ways and exchange rate changes between 2005 and 2009. However, from the performances of the RMB exchange rates, we can see that the dollar still had the dominant position in the basket of currencies and the RMB maintained the trend to appreciate against the dollar. China's position in the international industry chain meant that China would accumulate enormous trade surplus which will turn into pressure on the RMB to

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appreciate under the current exchange rate regime. Such pressure will be enhanced through capital flow in the capital account. On the last trading day of 2008, the exchange rate of the RMB to the dollar was 1:6.8346, with an appreciation of 6.88% which was basically the same with 6.9% of 2007. Such a result shocked the market as it was commonly estimated at the beginning of 2008 that the appreciation would exceed 10%. Even so, the RMB was one of the few currencies which appreciated against the dollar in 2008. Different from the tempo in the years before, the RMB appreciated fast against the dollar before it slowed down and became stable in 2008. In the first quarter, the RMB appreciated by 4.16%; on April 10th the exchange rate dropped below 7; for the first half of the year the RMB appreciated by 6.50% overall. In August before the Olympic Games were held, the RMB remained stable against the dollar and the exchange rate experienced bilateral oscillation. On September 23rd, the RMB midpoint decreased to 6.8009. Changes in the appreciation tempo broke the expectation of appreciation and solved problems lying in exchange rate reform providing guidance for market expectation.

Changes of the Dollar Exchange Rate In 1973, the collapse of the Bretton Woods system marked an important watershed in the international economic and financial history, after which the international monetary system fell into a chaos and exchange rates of major currencies fluctuated frequently resulting in worsened imbalance in the international payment. In the Jamaica Conference held in 1976, the floating rate regime was recognized symbolizing the start of the Jamaica international monetary system.

Stagflation Stagflation, a portmanteau of stagnation and inflation, is a term used in economics to describe a situation where an inflation rate is high, the economic growth rate slows down, and unemployment remains steadily high. It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate unemployment, and vice versa. The term is generally attributed to a British politician who became chancellor of the exchequer in 1970, Iain Macleod, who coined the phrase in his speech to Parliament in 1965. In the version of Keynesian macroeconomic theory which was dominant between the end of WWII and the late-1970s, inflation and recession were regarded as mutually exclusive, the relationship between the two being described by the Phillips curve. Stagflation is very costly and difficult to eradicate once it starts, in human terms as well as in budget deficits. In the political arena, one measure of stagflation, termed the Misery Index (derived by the simple addition of the inflation rate to the unemployment rate), was used to swing presidential elections in the United States in 1976 and 1980.

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In 1980, the nominal effective exchange rate of the dollar depreciated by 10.4% compared with 1975 while the actual effective exchange rate depreciated by 13.5%. During those five years, the US implemented easy monetary policy, resulting in a soar of currency supply in the US and around the world. The prices of oil, gold and raw materials increased sharply and the world economy was in stagnation. Latin America, including Mexico, Brazil, and Argentina, was in a debt crisis with too many petrodollars flowing in and too much foreign debt.

Nominal Effective Exchange Rate The unadjusted weighted average value of a country's currency relative to all major currencies being traded within an index or pool of currencies. The weights are determined by the importance a home country places on all other currencies traded within the pool, as measured by the balance of trade. Real Effective Exchange Rate The weighted average of a country's currency relative to an index or basket of other major currencies adjusted for the effects of inflation. The weights are determined by comparing the relative trade balances, in terms of one country's currency, with each other country within the index.

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The interest rate of Federal fund was raised greatly from 1979 and reached an unprecedented 16% in 1981 while the dollar ended a sustainable weak trend which lasted for 10 years and entered into a circle of strength. In 1981 the nominal and actual effective exchange rates rose by 10% year on year and continued to rise. In 1985, the nominal and actual effective exchange rates rose by 44% and 36% respectively from 1980. During that period, tax reduction policy supported by the supply-side economics stimulated the strong growth of the American economy while the soaring military expenditure by the government led to huge fiscal deficit and deficit in the current account. The double deficits with the appreciation of the dollar were a distinctive characteristic of the era. On September 5th 1985, the Plaza Accord was signed by the Group Five, requiring other major currencies to appreciate orderly against the dollar. After the Plaza Accord, the Fed intervened in the foreign exchange market many times through open market operations buying in yen and mark while selling out dollar. In 1986, the nominal and actual effective exchange rates of the dollar depreciated by 17.5% and 17.3% respectively from 1985. Then the dollar entered a new round of depreciation. Till 1995, the nominal and actual effective exchange rates depreciated by 36% and 43% respectively

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from 1985. In 1996 the dollar entered a new round of appreciation. In that year, the nominal and actual effective exchange rates of the dollar appreciated by 4% and 2% respectively from 1995. Till 2002, the nominal and actual effective exchange rates appreciated by 28% and 31.5% respectively from 1995. During that period the current account deficit still remained, but the Clinton government succeeded in improving fiscal deficit and realized a consecutive three-year fiscal surplus. The information revolution in the US attracted a large volume of dollar to flow into the country and supported the strong dollar policy of that time. However, the policy shift from a strong dollar to a weak dollar was an important aspect leading to the Asian financial crisis. Before 1996, the weak dollar led to a large flow of speculative cash into Asia while between 1997 and 1998 its turn into a strong dollar caused a backflow of international capital into the US stock market and other asset markets. The rapid outflow of speculative money from Asian countries accelerated the break of bubbles in their asset prices. From 2002 on, the Fed continued to decrease the benchmark interest rate consistently in order to avoid a recession and in 2003 the benchmark interest rate fell to a historic low of 1%. In 2003, the nominal and actual effective exchange rates depreciated by 12% and 10% respectively and the depreciation trend continued. In 2007, the nominal and actual effective exchange rates depreciated by 25.7% and 25.3% respectively from 2002. During the five years, low interest rates led to a soar in liquidity in the financial market with credit expansion in the property market which created bubbles in the US economy. After that the policy shift caused the bubble to burst and thus induced the financial crisis.

Benchmark Interest Rate Also called base interest rate, it is the minimum interest rate investors will demand for investing in a non-Treasury security. It is also tied to the yield to maturity offered on the comparablematurity treasury security that was most recently issued (on-the-run). It is also an interest rate against which other interest rates are calculated. For example, LIBOR is considered a benchmark rate because floating-rate instruments are related to it (for example, one may be calculated as LIBOR + 1%). Central banks make loans to banks under their jurisdiction at certain interest rates, which are then used as benchmarks for the loans those banks make.

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Changes of the Euro Exchange Rate Since the start of the euro, its exchange rate against the dollar has been fluctuating. .

Direct Quotation A direct quote, also called a price quotation (although a price quotation is also used to refer to other things), is a foreign exchange rate quoted as home currency per foreign currency. A foreign exchange rate expresses one country's currency, or money, in terms of another country's currency and is usually quoted to between 4 and 6 decimal places. For example, France uses the euro (EUR), and suppose the EUR stated as a unit, were worth half of the U.S. Dollar (USD). In the U.S., a direct quote for France would be 0.5 dollars per 1 euro. In France, or any country that uses the euro as its currency, a direct quote for the U.S. would be 2 euros per 1 dollar. This also means if a person from France wanted to exchange 500 EUR for USD, he would get 250 dollars back. If a person from the U.S. traded 500 USD for EUR, he would get 1,000 euros back. Most countries, including the United States, use a direct quote when expressing foreign exchange rates. Other countries, however, use indirect quotes, including Australia, New Zealand, and the Eurozone, or the group of European countries using the euro as currency. Indirect quotes put the exchange rate in terms of foreign currency per domestic currency. So, using the hypothetical situation above, an indirect quote in France for the United States would be 0.5 dollars per 1 euro.

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From 1999 to 2001, after a short time of appreciation, the euro started to depreciate continuously. Though some interval rebounds occurred the overall trend was a unilateral depreciation. The Euro was sold at 1.183 on the first day and then rose to a high point of 1.19 where it stayed for only a week before turned into a depreciation path lasting for three years. During the first six months of 1999, the exchange rates of the euro against the dollar were 1.161, 2.221, 1.055, 1.070, 2.063, and 1.035 respectively for each month. After that the euro continued to depreciate and in November when it dropped below parity with the dollar it began to pick up a bit and then the exchange rate maintained on the parity level. In 2000, the depreciation trend of the euro continued and after it dropped below parity with the dollar in February it depreciated to a historic low of 0.82 in spring and summer. On September 20th the exchange rate was only 0.846. The joint intervention of Europe, the US, Japan and the UK brought the euro back to a period of rebound which lasted for only a short period before it started to depreciate again. In October the euro depreciated by 30% and then experienced a short period of appreciation at the year end before it dropped to a low point in the middle of 2001 when the exchange rates vibrated around 0.85. From 2002 to 2004, with some good news of the euro, the currency entered a long-expected circle of appreciation. On February 1st 2002, the exchange rate of the euro rose from 0.856 and between February and June the average exchange rates were 0.870, 0.876, 0.886, 0.917, and 0.995 respectively for each month, representing a period of stable mild appreciation. In the middle of July, the exchange rate rose above 1, a key

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point. During the next four months it remained basically at the parity level with the dollar. In November the same year, the euro continued to appreciate after rising above the parity level and in only one month, it broke the points of 1.01, 1.02, 1.03 and achieved an overall appreciation of 20%. In 2003, the euro kept the trend of appreciation and on May 23rd, it broke its starting point of 1.183. After a short period of vibrations, the euro rose consistently to 1.224 on December 9th and 1.26 on December 31st. It appreciated further to 1.329 in August 2004, marking a new high. From 2002 to 2004, the economic performance of the Euro zone was not so good as that of the US while the euro appreciated enormously during that period. It was mainly due to some political events in the US (September 11th, corporate scandals and the Iraq war) and the US economy stalled with rising unemployment. Thought the US government claimed to implement a strong dollar policy, it took a negligent attitude toward the dollar's weakening because of domestic call for more export to stimulate the economy.

Changes of the Yen Exchange Rate After the WW Ⅱ , the world political and economic structure was reorganized with the US being a dominant country and its currency as a major international one to which most other currencies were pegged to. Japan was no exception. The exchange rate of the dollar against the yen was pegged at 360:1 as a result of the US economic assistance to Japan. Because of the low rate and no big domestic demand, Japan started to export in large volumes after its economy picked up. The Japanese economist Yoshino fukui wrote in his book The History of the Yen that the history of the yen is no different from the tragedy of the yen, which

Excess Liquidity Excess liquidity means the amount of money in circulation exceeds what is required. More money with not enough commodities and when there is a sharp increase of money, to pursue high profits, it will break away from real production system and the bulk commodities will be more expensive.

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is quite true. General Headquarters decided to set a fixed exchange rate of one dollar to 360 yens, which lasted as long as 22 years, longer that the 20-year Gold standard system before the WW Ⅰ . During those 22 years, Japan sold the yen consistently in exchange for the dollar to maintain the exchange rate, which led to an overflow of liquidity that pushed up the price level and the Japanese government and banks paid huge economic price for it.

Lost Decade The Lost Decade or the Lost 10 Years is the time after the Japanese asset price bubble's collapse within the Japanese economy, which occurred gradually rather than catastrophically. The term originally referred to the years 1991 to 2000, but recently the decade from 2001 to 2010 is also sometimes included, so that the whole period of the 1990s to the present is referred to as the Lost Two Decades or the Lost 20 Years. However, there is serious dispute on whether or not such "lost decade" or decades actually took place. The key determinant seems to be how the various theorists chose to measure the merits of the Japanese economic system, i.e. by rise in standard of living, stock market valuations, realestate prices, debt to GNP ratio, corporate investments, infrastructure development, etc. Depending on the criteria utilized, the interpretations of Japan's "lost decade" can vary greatly. In fact, some interpretations claim Japan actually performed significantly better than the United States and other nations during the so-called "lost decades"

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With consistent deficit in the US international payments, the US gold reserve reached a breaking point of USD 10 billion in 1971 and on August 15th President Nixon was forced to announce the suspension of the dollar exchange with gold, with which the Bretton Woods system collapsed. Under the Nixon shock, the yen started its first floating rate regime on August 28th and restored the fixed exchange rate regime at the end of the year before resuming the floating rate regime in February 1973. It should be noticed that under the floating rate regime the yen exchange rate was mainly determined by market supply and demand, but the US did not give up its efforts to influence the yen which included compelling the yen to appreciate and financial liberalization. In 1983 the US asked the Japan to liberalize its service industry which centered on the financial and capital market. The Reagan government expanded the opening of the already opened trade sector to Japan to financial capital trade sector. Its purpose was to attract Japan to invest more in the US with high investment earnings ratio reflected in high interest rates in order to solve the trade imbalance between the US and Japan. The Plaza According passed in the Group Five finance minister and central governor conference on September 22nd 1985 fully reflected the economic purposes of the US in promoting financial liberalization in Japan. The

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Plaza Accord successfully advanced a yen appreciation and dollar depreciation path. In the 17 months after the Plaza Accord was passed, the yen rose 55% against the dollar. On January 4th 1988, the exchange rate of the yen against the dollar reached 1:121.65. After the Plaza Accord was passed, the yen appreciation raised its foreign exchange risks. In 1986 alone, the seven life insurance companies in Japan lost an accumulated number of USD 1.7 trillion, which was 23% of the balance of all the foreign securities investment made by the seven companies. Bank of Japan intervened in the market by selling out the yen and buying in the dollar in the New York market and doing the opposite in the Tokyo market. Bank of Japan's selling out the yen and buying in the dollar led to a sharp increase in the foreign exchange reserve and an inflow of the Japanese assets into the domestic financial market. The implementation of the Plaza Accord accelerated and expanded lending to the real and a large amount of capital went into the securities market, which provided conditions for the bubble economy. In 2000, Japan started to recover from the lost ten years and entered the longest period of growth after the WW Ⅱ . The average economic growth from 2001 to 2005 was 1.7% while the figure rose to 2.2% in 2006. The first quarter of 2007 saw an increase of 3.3% and a good economic outlook for the whole year was expected. Conversely, the yen exchange rate started to depreciate from mid-2005 and the depreciation worsened after June 2007. On June 15th the exchange rate of the yen against the dollar was lower than 1:123, the lowest point in four years.

Indirect Quotation A foreign exchange rate quoted as the foreign currency per unit of the domestic currency. In an indirect quote, the foreign currency is a variable amount and the domestic currency is fixed at one unit. For example, in the U.S., an indirect quote for the Canadian dollar would be C$1.17 = US$1. Conversely, in Canada an indirect quote for U.S. dollars would be US$0.85 = C$1.

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Currency is the capital of a country which, according to Karl Marx, is value that can bring in surplus value. A direct advantage for a country to internationalize its currency is to bring in more surplus value. The internationally famous investor Soros published an article in Financial Times on January 23rd 2008 titled The World's Worst Financial Crisis in 60 Years, in which he predicted that the current financial crisis will be a fundamental restructuring of the global economy and in the process the US will fall while China and other developing countries will rise. To rise, China need to internationalize its currency and become a strong economic country; or else its rise would only be temporary and restricted by strong foreign currencies and finance. In recent years, China has accumulated almost two trillion US dollars of foreign exchange reserve. With the consistent appreciation of the dollar and instability in the US economy, the best way to increase the value of foreign exchange reserve is to support the internationalization of the RMB. In the first half of 2008, China's CPI exceeded 8% and when people were worried about the hovering inflation, the mortgage crisis in the US turned into an international financial crisis. In the second half of 2008, the international financial crisis dragged down the world's PPI and China's CPI also dropped to a negative point. Although the financial crisis stopped China's high CPI, how can the CPI figure be prevented to rising to another high in future? The only key lies in the internationalization of the RMB.

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Seeking Opportunities among Risks A young British man named Alan Lane inherited his uncle's business and became chairman of the Cid Publishing House. At that time, the company was having a difficult period and Lane was thinking hard to find a way out. One day when Lane was looking purposelessly at the books by the waiting room, he found they were nothing but newly published books with ordinary contents. More importantly, most of these books were expensivehardcover which he himself would not buy, not to mention ordinary people. The discovery gave him an idea that the only way to save his publishing house was to publish affordable paperback. Therefore, he started his plan to publish a series of paperback books. In order to reduce costs, he published his first series of paperback books by means of purchasing the reprint rights of republished books and narrowing the size in order to save paper and production costs of the cover. He reduced the price of every book to six pennies which was the price of six cigarettes. There were controversies on Lane's cheap publishing plan in the British publishing industry, with some saying that this is a self-destruction and others saying that this will affect the whole press. Though sticking to his plan, Lane was very clear that the cheap price should be offset by a huge sales volume. So if each book was priced at six pennies, the sales volume had to get 17,500 in order to make ends meet. Then he sent people all over Britain to make his books to be published known. In July 1935, 105

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the first volume of the Penguin Series which consisted of ten books was published and they sold more than one million copies within half a year. Lane succeeded. In 1936, the Cid Publishing House was renamed as Penguin Books which sticks to the principle of small profits but quick turnover and serving the public. The company monopolized the paperback market of the UK for several decades and has become an internationally famous publishing group. What can we learn from Lane's story? There was a saying in an ancient Chinese book named Sunzi Warcraft that . no matter in history or in reality, there have been many examples of good strategies coming out of predicaments. Opportunities are hidden in difficult situations and what really matters is whether you can find a way out. Facing the international financial crisis, China is confronted with the problem of how to seek opportunities among risks. Accelerating the RMB internationalization may to one of the good ways out.

The R M B Internationalization Accelerated by the Financial Crisis Difficult Time for the RMB to be an Attendant Chairman of the Fed is called 'Governor of the world's central bank' by some people because the dollar was held in a large volume by many countries, companies and the trading volume of the dollar amounts to several trillion every day, accounting for 70% of the total. Moreover, fluctuations in the dollar exchange rate and changes in the US Macro-economic and exchange rate 106

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policy will affect all countries in the world. In the current international trade settlement, the dollar accounts for more than 60% while the euro and the yen account for less than 10% respectively; among the foreign exchange trade currencies, the dollar accounts for more than 40% while the euro and the yen together account for less than 30%; in the international reserve currencies, the dollar accounts for more than 40% while the euro and the yen together account for less than 20%. Overall, in spite of the international financial crisis, the dollar still is the most widely accepted international currency. At the same time, the US continued to expand its monetary market through the issuance of money and bonds while strengthening its pricing authority in the international monetary market and commodity markets including the oil and iron ore markets. Currently there are three futures exchange in China which has some influence on the prices of some commodities. However, such commodities are still limited and the pricing rights of most commodities are dependent on the international futures market which is controlled by several major futures exchanges. The international oil price is determined by the US New York Futures and the British London Futures; the international farm produce price is determined by the US Chicago Futures; the international metal price is determined by the British London Futures. Under such circumstances, the prices of the import and export bulk commodities of China are dependent on the international market. On the other hand, foreign suppliers can predict the reserve, timing purchase, variety and quantity of the bulk commodities in China and speculate in the futures market while raising prices and making profits from the price gaps. Besides, there is no corresponding domestic futures market to mitigate risks, which means that most of the risks of import commodity prices will be taken by import enterprises

Futures In finance, a futures contract (more colloquially, futures) is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed upon today (the futures price or strike price) with delivery and payment occurring at a specified future date, the delivery date. The contracts are negotiated at a futures exchange, which acts as an intermediary between the two parties. The party agreeing to buy the underlying asset in the future, the "buyer" of the contract, is said to be "long", and the party agreeing to sell the asset in the future, the "seller" of the contract, is said to be "short". The terminology reflects the expectations of the parties-the buyer hopes or expects that the asset price is going to increase, while the seller hopes or expects that it will decrease in near future.

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themselves. The dollar still is the 'Big Brother' among all the currencies. In the Jamaica system, the dollar is not as strong as it used to be in the Breton Woods system. In recent 30 years, with the accelerated steps of economic globalization, demand for currencies in the international field has been growing and only the dollar is able to be the 'Big Brother' which still is in the leading position in the monetary system. Dependence on the dollar means that when the crisis comes very few countries could stay out of it. Instead, most of them are like locusts on the same string sharing losses suffered by the dollar. According to the information disclosed in the Chinese economic evaluation of the financial research institute of the Chinese social and science academy, the balance of the US national debt was 11.2 trillion dollars by May 7th 2009. On May 11th 2009 the accumulated fiscal deficit for that year was predicted to reach USD 1.84 trillion, four times of that for 2008. The fiscal deficit between October 2009 and September 2010 was estimated to reach USD 1.26 trillion and the total amount of deficit between 2010 and 2019 was estimated to reach USD 7.1 trillion. In the next 75 years, the debt for social security plan which is not guaranteed by provisions is estimated to ascent to USD 51 trillion. It can be seen that the US sovereign debt is a ditch difficult to be filled and the rest of the world are still paying for it. According to a report on the international capital flow by the US treasury, in May 2009 China increased the amount of US debt it holds to USD 38 billion, the highest increase for a single month since the breaking of the financial crisis and the total amount held exceeded USD 800 billion for the first time to USD 801.5 billion, the biggest in the world.

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Then why is China spending money to fill a ditch that can never be filled? Because China and the US are economically interdependent. China already has enormous foreign exchange reserve and cannot afford not to buy any more US bond. Also because of the huge volume, the dollar takes the biggest proportion in its foreign reserve. By helping the US economic recovery, China also helped itself.

The Financial Crisis Sounding the Alarm In the real world, there is no global government or global central bank and some currencies also play the role of international currencies. The international monetary system based on the internationalization of several national currencies intrinsically specifies inequality in the exchange rate system. The international monetary system mainly consists of the dollar, the yen and the euro, which is unsymmetrical. With more speech rights in the international monetary system, developed countries take a dominant position in the system. Conversely, developing countries are in an inferior position in the system due to historic reasons. The financial crisis led to deep reflection on the international monetary system dominated by the dollar. Obviously, internal defects including the unipolarity of the international monetary system, lack of checks and balances, and imbalance in rights and obligations have become severe barriers for the development of the world economy. In the G20 summit held in Washington at the end of 2008, President Hu Jintao made four suggestions with special reference to diversification in the international monetary system which includes the 109

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RMB internationalization. The RMB needs to become a settlement currency, money of account and also a reserve currency. To transform from a large economy to a strong economy, China has to address contradictions between being a large trading country and being a small financial country, which depends on the enhancement of its financial strength that requires an internationalized monetary environment.The current international financial crisis has created some basic conditions for the RMB to become a completely negotiable international reserve currency.

Floating Exchange Rate Regime A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. A currency that uses a floating exchange rate is known as a floating currency. A floating currency is contrasted with a fixed currency. From 1946 to the early 1970s, the Bretton Woods system made fixed currencies the norm; however, in 1971, the United States government would no longer uphold the dollar exchange at 1/35th of an ounce of gold, so that the US dollar was no longer a fixed currency. After the 1973 Smithsonian Agreement, most of the world's currencies followed suit. Few countries fixed their currency with another currency, however, lately some of these countries are causing their economy to slow its growth. For example, most of the Gulf States had their currency fixed with the US Dollar, and by this strategy it resulted in dragging their currency value down with the US Dollar's declining value. A floating currency is one where targets other than the exchange rate itself are used to administer monetary policy.

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The several international financial crises which took place in the 21st century can be attributed to the single dollar standard system and the oversupply of the dollar. Countries around the world are calculating earnings and costs of breaking the dollar inertia and when the estimated earnings exceed the costs, the dollar will no longer be able to maintain its leading position. World trade has exhibited a diversified and open structure and changes in the world financial reserve system and trade settlement systemwill inevitably promote the adjustments in the international monetary system. To currency issuance countries, holding the pricing rights of currencies and bulk stock means holding unlimited rights of affecting and controlling wealth of other countries. Due to the dominant position of the dollar in the international monetary system, the US can make up for the deficits in its international payments with its dollar liabilities. In this way resourcesfrom the real economic sector from countries holding the dollar reserve will be transferred to the US. In order not to be controlled by other countries in its foreign reserve, China has no other choice but to internationalize its own currency. The current international political structure should

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be multipolar instead of being dominated by a single country. There is no global fiscal system to redistribute public earnings to dollar consumers around the world. After 1973, the fixed exchange rate regime was replaced by the floating exchange rate regime, with the US gaining most of the benefits while not taking responsibilities of stabilizing the price level and guaranteeing employment. In the global economic adjustment, there is no central bank system to support it and the costs for all countries have risen. Therefore, it is urgent to reform the monetary system of the 20th century. We cannot expect those which already benefited from the system to reform it, but we should make concerted efforts to enhance the awareness of policy makers that over-reliance on the dollar debt will be destructive to any economy. There is only one way out, to promote a new global financial system and end the dollar supremacy. The international financial crisis in 2008 did not change the leading position of the dollar in the system, but it provided an unprecedented opportunity for the RMB internationalization. The US financial crisis should be attributed to the severe imbalance between the real economy and the fictitious economy and a currency sustained by real economy is expected to be added to the international currencies. The RMB is no doubt favored by many.

Monetary Demands of China at the Current Development Stage Since the 1990s, China's average annual GDP growth has reached 9.3% and its economic aggregate has exceeded all the other developing countries. Its market-oriented reform has made remarkable progress 111

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and its socialist market economy has been basically established. After opening up to the outside world, its economy achieved rapid growth and a comprehensive open economic structure has basically come into being. All social industries including science, technology and education have embraced all-round development. In 2008, China's economic aggregate overtook that of Germany to be the third in the world with an overall import and export volume of USD 2.56 trillion, maintaining the third position in the world. In the same year, its dependence on foreign trade reached 60% with an annual foreign direct investment of over USD 90 billion, which means that China's economy has also reached a high degree of openness. With the deepening of the world's financial integration and further development of China's economy, there will be more market demand for the RMB in the international arena. Since the international financial crisis, the exchange rates of major international currencies such as the dollar and the euro have experienced strong vibrations while the slowdown of the world economy has also hit trade finance. Strong vibrations of exchange rates and weakening of trade finance have brought harm to demand for trade. During the exchange rate fluctuations, Chinese enterprises and their counterparts in other countries wanted to use the relatively stable RMB to do valuation and settlement in order to mitigate the exchange rate risks of the dollar and euro settlement. In fact, China has been exploring ways to avoid exchange rate risks in foreign trade. On November 10th 2008, PBOC held a bank president conference to discuss the implementation of the moderately easy monetary policy, in which it put forward the idea of 'encouraging and guiding financial institutions to expand export

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credit and explore ways of providing mid and long-term financing in export credit'. On December 8th 2008, the Chinese State Council published Suggestions on Promoting the Economic Development through Finance and started to allow financial institutions to operate RMB export buy-side credit business and to allow Hong Kong enterprises or financial institutions which operate a large scale of businesses in Mainland to issue RMB bond. The State Council also started to support the development of the RMB business in Hong Kong and expand the scale of valuation and settlement of the RMB in trade with neighboring countries in order to reduce exchange rate risks in overseas economic activities. On December 24th 2008, an executive meeting of the State Council was held discussing measures to invigorate circulation, expand consumption and maintain stable growth in foreign trade and the idea of the RMB settlement piloting in commodity trade in Guangdong, the Yangtze River delta, Hong Kong, Macao, Guangxi, Yunnan and the ASEAN countries. The influence of the RMB as a settlement currency will be enhanced. The promotion of the RMB settlement will benefit Chinese enterprises in the international economic exchanges in terms of controlling exchange rate risks, reducing transaction cost and facilitating transactions. It will also help to prevent illegal transactions between the RMB and foreign currencies to safeguard the financial order and safety. Ten years ago, the total market capitalization of the A-share market was only about that of the General Motors while in 2007, the figure surged to over RMB 800 billion, making it the largest financing market in the world. At the end of 2007, the total market capitalization of the A-share market reached RMB 32.4 trillion and among the largest listed companies in the world there 113

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were five from China. Some experts predicted that by 2020 the capital market in China will have got to over RMB 100 trillion, which cannot be absorbed from China alone but should come from all countries in the world. The mortgage crisis led to the slowdown of the US economy and the capital market experienced violent fluctuations and weakening. There were few opportunities for speculative money and investment risks increased. However, the Chinese economy is likely to maintain a high-growth trend. Zhou Xiaochuan, Governor of PBOC, pointed out that there still was room for raising interest rate in China, which would enhance the interest rate gap between China and the US, providing chances for speculative money from overseas to enter the Chinese market. The worsening of the mortgage crisis made it possible for China to improve its capital market making use of foreign capital. With the rise of the capital market, China is becoming a large capital country. The world's financial tycoons were hit hard by the financial crisis and the international financial center may well drift to China which will sustain the IMR internationalization. In order to find out ways to promote the RMB internationalization, research teams were set up by PBOC and China Academy of Social Sciences and investigations are being done in China's bordering areas. One point appeared in recent reports of both PBOC and NDRC (National Development and Reform Commission) that promotion of the RMB regionalization and internationalization should be accelerated during a period of the RMB appreciation. The PBOC report pointed out that 'the RMB internationalization has started and we should seize opportunities to promote it at a proper time and to a proper degree'. The NDRC report pointed out that 'the opportunity of the RMB popularity around the worlds should be made good 114

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use of and we should explore the RMB regionalization with Hong Kong as an operating platform in order to reduce our dependence on developed economies in in the international payments. The target is to establish relations between the domestic market and neighboring countries based on the RMB settlement.' In August 2009, Gang Yi, vice-governor of PBOC, was reported to become head of SAFE (State Administration of Foreign Exchange) and before that there had been media coverage on the appointment of Hu Xiaolian, previous head of SAFE, to be vice-governor of PBOC and one of her chief responsibilities was to improve the RMB internationalization. Such appointments were implying the government's intention of promoting the RMB internationalization, as pointed out by the press.

China's Foreign Exchange Reserve ——Solid Backup for the RMB Internationalization Since the US mortgage crisis especially when it developed into a financial crisis, China has been tested in an unprecedented way to manage and invest its huge foreign exchange reserve. How should China invest and manage its USD 2 trillion foreign exchange reserve? This has become a hot-spot issue among the Chinese. On July 10th 2009, data published by the Chinese Customs Bureau showed that in June 2009 the total import and export volume of China amounted to USD 182.57 billion with a year-on-year decrease of 17.7%, among which the export dropped by 21.4% year on year and the import decreased by 13.2%. Contrary to the trade surplus and decrease in FDI, China's foreign reserve grew by a large amount in the second quarter 115

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of 2009. In April and May, the foreign exchange reserve grew by USD 55.1 billion and USD 80.6 billion respectively. In June 2009, the foreign exchange reserve grew by USD 55.1 billion, representing a year-on-year growth of USD 30.2 billion. By the end of June 2009, the balance of the foreign exchange reserve reached USD 2.1316 trillion, growing by 17.84% year on year, which is equal to the annual GDP of Italy in 2006. The surplus in the current account for China mainly comes from developed countries such as the US and European countries. When people exchange dollar or euro they receive in trade, the foreign spot exchange will flow to SAFE which will use them to purchase dollar and euro bonds. After that the dollar and euro spot exchange will circulate back to their issuing countries. Therefore, most of the foreign reserve assets for China are US and European bonds. And though PBOC holds huge number of such assets, they cannot be distributed among the public. Under current circumstances, to support the RMB internationalization will not bring loss to China's foreign exchange reserve but instead it will bring huge longterm benefits. In the 1970s and 1980s, the large volume of foreign exchange reserve in Japan pushed up asset prices and meanwhile continuous surplus in Japan increased the pressure on the yen to appreciate. At that time, the Japanese government did not actively transport the yen overseas but tries to prevent the dollar to flowing in while transporting dollar in its domestic market out, which resulted in a low supply of the yen in the international market. Therefore, the trend of the yen appreciation was not controlled which led to recession in Japan's economy and bubbles in the fictitious economy. Under the same circumstances, Germany uses its 116

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huge dollar reserve assets as buffer fund to adjust the exchange rate of the mark while exporting the mark externally via the capital account so that the proportion of the Western Germany Mark from 0 after the WW Ⅱ in the international reserve currency to 18%. Without the Western Germany Mark, it is hard to imagine that the euro could become an international reserve currency because other currency components of the euro, such as the French Franc and the Spanish peso, combined were less than 2%. The basic and most important function of a country's foreign exchange reserve is to guarantee the stability of its currency. In view of the experiences of Japan and Germany, one of the best usages for China's foreign exchange reserve would be to support the RMB internationalization which is both realistic and bears long-term significance to the Chinese nation. Without being internationalized, the RMB cannot be used to invest in the international financial market and nor can it be a hedge against risks of the dollar reserve assets. The dollar bonds increased as times passed by and domestic holders of the dollar assets became more and more worried about risks of the RMB appreciation against the dollar and thereby were trying to hold more RMB which led to its appreciation. At the same time, foreign investors complained that China's trade surplus continued to grow due to the underestimated RMB and called for its appreciation, which enhanced the pressure on the RMB to appreciate and increased dollar investors' concern. Once the trend of exchanging the dollar with the RMB started, the Chinese government would be put into a predicament. China is confronted with a historic choice that Germany and Japan experienced. However, China seems to be taking similar measures Japan did years ago, including encouraging the use of foreign exchange to invest overseas like purchasing US

Hedge A hedge is an investment position intended to offset potential losses/gains that may be incurred by a companion investment. In simple language, a hedge is used to reduce any substantial losses/ gains suffered by an individual or an organization. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of over-the-counter and derivative products, and futures contracts.

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aircrafts with dollars and entrusting foreign institutional investors to manage China's foreign exchange assets. These measures will not reduce domestic liquidity and nor will they fundamentally change the pressure on the RMB appreciation. Once the RMB appreciates to a certain level, what happened to Japan will happen to China and the door of the RMB internationalization will be closed.

Stabilization Fund A stabilization fund generally refers to a mechanism set up by a government or central bank to insulate the domestic economy from large influxes of revenue, as from commodities such as oil. A primary motivation is maintaining a steady level of government revenue in the face of major commodity price fluctuations (hence the term "stabilization"), as well as the avoidance of inflation and associated atrophy of other domestic sectors (Dutch disease). This generally involves the purchase of foreign denominated debt, especially if the goal is to prevent overheating in the domestic economy. The notion may overlap with sovereign wealth fund.

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Therefore, China should grasp the opportunity of its rapid economic development and high expectation of the RMB appreciation to open the capital account and actively promote the RMB internationalization and export the RMB. When the RMB is internationalized, not all the RMB exported can turn into international reserve, but the enormous foreign exchange reserve in China can used to offset the RMB backflow. If the RMB is exchanged with the dollar at 1:6.8, China's foreign exchange reserve of USD 2 trillion will counterbalance part of the RMB backflow while maintaining the RMB exchange rate within a certain scope. Therefore, China's foreign exchange reserve can be used as buffer fund to adjust the RMB exchange rate on condition of establishing an international transaction platform for the fictitious economy especially for the bond assets. At the same time, China's foreign exchange reserve can be used to increase its gold reserve in order to support the RMB internationalization. In April 2009, SAFE announced that China's gold reserved grew by 454 tons to 1054 tons from 2003. On the one hand, the dollar will depreciate in the long run and the purchase of gold is good choice; on the other, gold is needed as a foundation for the RMB internationalization. China should enhance the proportion of its gold reserve in its foreign exchange reserve. The gold reserve accounts for 76% in the foreign exchange reserve of the US; the percentage for Italy, Germany and France are 76%, 65% and 60% respectively while it is only 1.6% for China.

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Now China's GDP accounts for 6% in the global GDP and thereby its economic strength is able to sustain the internationalized RMB to account for 6% to 10% in the international monetary reserve, which is equal to USD 420 to 700 billion (RMB 3 to 5 trillion with the exchange rate of 1:6.8). Such a large amount of internationalized RMB requires enough foreign exchange reserve to stabilize its exchange rate when the RMB backflows. That is to say, when the exchange rate of the RMB dropped dramatically, the dollar and euro assets in the foreign exchange reserve can be sold to sustain the RMB exchange rate and strengthen the position of the RMB in the international reserve currency system. This is the most significant role for China's foreign exchange reserve. The most effective way of using the foreign exchange reserve in the long run is to purchase the issuance right of the RMB as an international reserve currency and sustain its position in the international monetary system. Only in this way can the RMB gain a position in the dollar dominated monetary system and not to be controlled by developed countries. Therefore, it is an urgent task to advance the RMB internationalization with large foreign exchange reserve so that China would have speech rights in the international monetary system.

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The writer of this book thinks that after the financial crisis, there will be 'RMB dollar' in the international market which will later transform into 'dollar RMB'. In the first three decades of the 21st century, the RMB will become one of the main currencies in the world and by the mid-21 century, the RMB, along with the dollar and the euro, will accomplish an important change in people's economic life, that is, to achieve the target of 'One world one currency'. The prospect of the RMB internationalization may still be a dream, but in the near future it will be internationalized. China's RMB will definitely become the world's RMB. It is said that receiving is the beginning of losing and without receiving there will be no losing. Some people may never get the simple idea. In the process of the RMB internationalization, there will be pros and cons. Another saying goes like 'there is no best choice in life but to face your choices'. That is to say, there is no best choice for China but to move forward with the choice of the RMB internationalization. Let's take a look at the advantages and disadvantages of the RMB internationalization.

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Advantages of the RMB Internationalization International currencies such as the dollar and the euro are enjoying benefits brought by their internationalization. There will also be advantages of the RMB internationalization.

Improvement of Chinese Enterprises In early July 2009 when the Chinese government implemented the RMB settlement on cross-border trade, Sun Huaibing, director of the Chinese Textile Economic Research Center and Editor in chief of Chinese Textile said: 'that such a policy would play an active role in Chinese textile export enterprises avoiding exchange rate risks. In the first half of 2008 the RMB appreciation against the dollar brought huge loss to the export and the same happened to the exchange rate of the euro in the second half.' Sun Huaibing gave the following example: If a domestic enterprise wants to import commodities worth half a million dollars at the exchange rate of 1:6.8, the enterprise should pay RMB 3.4 million. However, the payment will usually be done in ten days when the commodities are transported here and the exchange rate becomes 1:6.85. That is to say, the dollar appreciates and the Chinese enterprise will pay RMB 3.425 million, RMB 25,000 more than the original figure. Sun Huaibing mentioned the commonality of such 123

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examples especially in 2008 when the exchange rate market experienced lots of fluctuations and numerous enterprises were hit hard. If the settlement is done in RMB, the exchange rate changes will not be a problem. In the past, most of China's foreign trade was evaluated and settled in dollar, euro and Japanese yen and exchange rate risks were taken mainly by domestic enterprises. Ms Ren, from a glasses export company based in Shenzhen whose products are mainly exported to Europe, mentioned an example she experienced. In May 2008 she received an order of over RMB 2 million, 30% of which was required to be paid in advance as a guarantee while the remaining 70% was to be paid when commodities were transported out. In September 2008 when the remaining payment should be done, the exchange rate of the euro dropped by 12% and the company lost more than RMB 200,000. Ms Ren said that if the settlement could be done in RMB, the company would not have made such a loss. From the above two examples, we can see that domestic Chinese enterprises doing import and export businesses are worried about risks when the international trade and investment are evaluated and settled in international currencies such as the dollar. When the RMB is internationalized and becomes a key international settlement currency, dependence on these international currencies as well as exchange rate risks and transaction costs will be reduced.

Exchange Rate Risk Also called foreign exchange rate risk and refers to the possibility for economic entities to experience losses in economic activities due to foreign exchange rate fluctuations.

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International currencies are widely used in cross-country valuation, payment and settlement, making them precious resources in the international market. To gain such resources, other countries must do trade and have economic cooperation with their issuance countries. It is convenient for a country to use its own currency to valuate and settle in its external economic exchanges

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and it is also good for the expansion of its foreign trade. For example, exchange rate risks are one of the main risks importers and exporters are facing and the best way to avoid them is to use the RMB to valuate and settle. It can save the expenditure of Chinese importers and exporters to do hedged tender; it will also facilitate RMB export credit provided to foreign importers so as to enhance competitiveness in China's export and expand economic exchanges. For externally-oriented enterprises, RMB quotation and settlement in export will reduce not only risks associated with exchange rate fluctuations but also costs of purchase and selling of foreign exchanges. Decrease in the number of exchanges will simplify the procedures in capital flow and shorten the process of settlement so that enterprises will not need to implement foreign currency derivative transactions and human and capital resources devoted will be reduced. As the RMB is widely accepted, the RMB will be used as a quotation and settlement currency in more international trade and the dollar and the euro will no longer be used in international settlement. The RMB will become a means for international payment and more foreign enterprises will be able to do settlement via Chinese financial institutions. After the RMB internationalization, more RMB will be exported which can be used in exchange for more foreign resources. More importantly, channels of capital application will be expanded with lower capital collection and transaction costs and higher investment and financing efficiency. Till then Chinese enterprises will be spotted everywhere in the world and Chinese brands will be known in most places in the world. Enterprises no longer need to worry about overseas financing and import and export

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enterprises no longer need to worry about asset losses caused by exchange rate fluctuations. The RMB internationalization will also promote reform and change of operation mechanism among domestic enterprises in order to meeting requirements of the international market. Some conditions have to be met for the RMB internationalization, one of which is to establish a modern corporate system adjusted to economic globalization. The modern corporate system will create a completely new managing and operating mechanism so that enterprises will continue to adjust to changes in the international market. Therefore, the RMB internationalization and the modern corporate system are closely related to the external development of enterprises that will encourage enterprises to deepen reform and accelerate their overseas development. The RMB internationalization will also greatly benefit domestic investors and consumers who can use their own currency in international economic exchanges to avoid foreign exchange rate risks. When their own currency is internationalized, the external economic activities will be less affected by foreign exchange rate risks and the international capital flow will become more smooth and convenient due to reduced transaction costs. Therefore, the currency internationalization will create favorable conditions for Chinese residents and enterprises in their external exchanges so that the efficiency of the real economy and financial economy will both be enhanced. In summary, the RMB internationalization means that China's trade will no longer be directly hit by foreign exchange rate changes. China is a large export country and also the largest manufacturing country with cheap and low value-added export products and high valueadded import products. Therefore, foreign exchange rate changes will hit many Chinese foreign trade enterprises 126

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hard, which will no longer be worried about after the RMB internationalization.

Good for Balancing International Trade A research report of the IMF pointed out that when more and more foreigners accept an international currency, the number of products bought with each unit of the currency will increase, which will essentially improve the trading environment of the currency issuance country. The progress of the RMB internationalization will further improve China's border trade. According to the step-by-step advancement plan, the RMB internationalization will start from functioning as a valuation and trading medium in border trade to expanded use in trade valuation. When it is accumulated to a certain scale and a certain degree of credit, it will switch to function as a settlement currency. All the process will be promoted by international trade. The RMB will become fully convertible and be used as a lending, investment, and reserve currency in the international market when the international trade amounts to a certain scale and the domestic financial market is prepared. Therefore, before the RMB becomes fully convertible, a practical strategy should be applied in the RMB internationalization, starting from regionalization in border trade to progressively enhancing its role as a settlement currency in international trade. At the same time, regulative preparation should be made for its further internationalization. Compared financial institutions with countries and regions with vigorous border trade with China, those in China have higher operation and management level 127

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and are becoming more market-oriented. Moreover, the RMB exchange rate is stable with a trend of rising. Therefore, settlement business done by Chinese financial institutions will help to enhance profits as well as incorporate the RMB circulation in the neighboring countries into China's monitoring system. In recent years, the RMB is increasingly used as a payment currency in border trade, but its real circulation scale cannot be clearly figured out due to lack of laws and differences in understanding. Predictably, the RMB internationalization will reduce exchange rate risks and promote international trade and investment for China. With rapid development of foreign trade, foreign trade enterprises hold a large volume of foreign currency debts and liabilities. Exchange rate fluctuations will affect operation of the Chinese enterprises. After the RMB is internationalized, such risks will greatly be reduced with the RMB used as a valuation and settlement currency in foreign trade and investment. At the same time, financial markets that sell the RMB-valuated bonds will be promoted. It can also be seen that the cross-border circulation of the RMB cash in real economic activities like border trade and tourism can make up for the lack settlement means in bilateral exchanges. Bilateral trade and economic communications will be expanded and economic development of minority groups based in border areas will be accelerated. Besides, a lot of neighboring countries are rich in natural resources but short in market supply, which is complementary with China. The RMB circulation overseas will offset the predicament of China will limited natural resources and oversupply of market. 128

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Overall, with deepened development of trade and economic exchanges between China and neighboring countries and with the steady appreciation expectation of the RMB, the RMB will be more popular in the economic activities with neighboring countries and areas especially those with lack of hard currencies and unstable exchange rates.

Reasonable Earnings China Will Gain Now China has a large amount of foreign exchange reserve, which is no different from free loans and China also has to pay for inflation tax. After the RMB internationalization, losses incurred from foreign exchange can be reduced and international seigniorage will be earned, a new channel for China to make use of fund. The largest and most direct benefits of the RMB internationalization will be international seigniorage, which refers to the gap between the face value of a currency and its issuance cost gained by currency issuer with its issuance right. When money is issued domestically, seigniorage is gained inside the country; but when money is issued overseas, seigniorage is gained from other countries without any costs. To put it simple, the print cost of a 100-dollar bill may be only one dollar but can be used to buy 100 dollars worth of products. The gap of 99 dollars is seigniorage. Seigniorage is an important source of government income and when other international currencies are used, enormous wealth is given up. The dollar is used as an international settlement currency in the international community and when we are enjoying convenience of a unified settlement currency, we are paying for its seigniorage. To the issuing countries of international currencies, international seigniorage is gained from the

Risk Exposure The quantified potential for loss that might occur as a result of some activity, that is, unprotected exposure. For example, you have income in yen but have to pay a debt in dollar without any hedge transactions such as forward foreign exchange sales and purchases or foreign exchange swaps, so you have a risk exposure of the yen exchange rate against the dollar. In another case, if you buy a corporate bond which has credit risk without any hedge transactions, you have a credit risk exposure. If you buy a fixed interest rate bond without hedge transaction like interest rate swap, you will need to bear interest rate risk which is a risk exposure to you.

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international market and used domestically, which can be regarded as an extra international income and an application of resources from other countries. As the most important currency in the world, the dollar, with its advantages as a strong currency and the economic position and scale of the US, circulates in many countries so that the US is able to make use of resources and wealth from other countries and gain enormous revenue from seigniorage. The dollar is printed by the Fed at a very low cost and is used to purchase resources or exchange with other currencies for investment, which can gain huge interests for the US government. Now there is 900-billion dollar cash circulating around the world, two thirds of which is circulating outside the US. If the cost for the US to print a one-dollar bill is 0.03 dollar, the seigniorage for the US will amount to nearly USD 600 billion. A research on the US seigniorage has shown that the US can gain around USD 25 billion of seigniorage each year and since the WW Ⅱ the total revenue has amounted to USD 2 trillion. Since 1973, the US has reported deficits in the current account for most years and the long-term deficits resulted from attracting international capital. According to estimation, deficits in the current account for the US amounted to USD 3.5 trillion from 1973 to the second quarter of 2003 and the deficit in the current account now accounts for 4% to 5% of the US GDP, not a small number. The deficits remained because the US attracted a lot of international capital as foreign countries purchased the US sovereign debts, corporate debts, and stocks. During the 30 years after 1970, the percentage of foreigners holding US treasury bonds was 10.5% on average, but the number rose to over 25% in the 1980s and over 50% in the 1990s. The US gained an enormous sum from international 130

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seigniorage. It has become an open secret in large countries' financial strategies to internationalize their currencies in order to gain seigniorage. When a currency becomes an international reserve currency, the monetary authority will gain seigniorage from its national citizens as well as foreigners. The higher the inflation rate of an issuing country, the more gains from seigniorage. When the RMB is internationalized, China will get free credit from foreign reserve countries. With increases in China's economic aggregate, demand for the RMB is also increasing; at the same time, the RMB circulation in neighboring countries and areas also pushed up the amount of the RMB circulating in the market. By the end of 2005, the balance of M0 amounted to RMB 2.4 trillion, a year-on-year growth of 9.4%. Such a circulation volume with its holders and in the market has created revenues for the government. Therefore, when the RMB is internationalized, China will export its paper currency and import resources without reducing its foreign exchange reserve while still maintaining or even enlarging surplus in the international payments and earning seigniorage. Some experts have estimated that once the RMB is internationalized China will be able to gain around USD 2.5 billion of seigniorage. If the purchasing power of the RMB remains stable and the scope of its internationalization broadens step-by-step, gains from its international seigniorage could amount to USD 30.02 billion. Besides getting seigniorage, the issuance country of an international currency can also enjoy the benefits of using its foreign currency reserve at a low cost. Such foreign reserve, stored in commercial banks, generates no interest revenue; nor can it be used in international payments. However, it can be used to do overseas investment and in this way it can be regarded as low131

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cost capital for commercial banks whose deposit rates are low and investment earnings ratio is high. Foreign reserve cannot be used by its reserve countries for economic construction, but functions to provide enough fund resources for its issuance country. The pure interest for its issuance country is equal to the gap between the earnings ratio from overseas investment and interest rate of its commercial banks, that is, the gap between its domestic and overseas capital earnings.

Good for the Internationalization of the Financial Industry Financial institutions in the issuance country, with natural advantages of managing the currency, can benefit from its currency internationalization. Therefore, the development of financial institutions will be promoted during the internationalization, with expanded business scope and volume and with increased revenue from services, lending and investment. When the RMB becomes a means for international payment, foreign enterprises will be able to do settlement in Chinese financial institutions, which will facilitate overseas investment of Chinese enterprises while enhancing the internationalization of the financial institutions. There are two operational models in the cross-border RMB settlement business in Chinese commercial banks, that is, the agent model and the clearing model. The agent model refers to the model in which Chinese banks delegate foreign banks to be their correspondence banks overseas where foreign enterprises can open RMB accounts when they do business with Chinese enterprises; the clearing model refers to the one in which foreign enterprises can open RMB accounts in overseas branches of Chinese banks that can conduct 132

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business with the head office inside China. No matter which model is applied, Chinese commercial banks can benefit from the fee and commission business as well as the asset business. Besides, in the first model, foreign banks, without any RMB in hand, need to get the currency from Chinese banks which can gain revenue from the exchange business. When foreign enterprises receive a large volume of the RMB, Chinese banks can benefit from intermediary businesses offered to these enterprises such as wealth management. The internationalization of the RMB can be described as the highest level of opening the Chinese financial sector and can improve the ability of the central bank to do macro-adjustment, strengthen its adjustment of money supply, as well as promote the construction of the capital market, the implementation of the open market businesses, and interest rate liberalization in order to create a banking regime and financial market system in line with market demand. In such a highly open financial environment, foreign banks and financial institution will crowd into China with expanded business areas while Chinese banks will also go global. All this puts higher requirements for China in terms of capital, products, service methods and interest rate and exchange rate risk management, resulting in advancing management and structural changes in the Chinese banking sector. Moreover, when the RMB is internationalized, Chinese banks will be pushed to research on new products and businesses. Now there are less than one thousand products in China while there are several thousand in countries of major currencies. There are over ten thousand different kinds of financial products in the US. The variety of financial products is closely related to the openness and internationalization of the financial industry in a country. Therefore, during the RMB internationalization, Chinese banks will embrace more opportunities for financial innovation which still has a

Open Market Operation An open market operation (also known as OMO) is an activity by a central bank to buy or sell government bonds on the open market. A central bank uses them as the primary means of implementing monetary policy. The usual aim of open market operations is to manipulate the short term interest rate and the supply of base money in an economy, and thus indirectly control the total money supply, in effect expanding money or contracting the money supply. This involves meeting the demand of base money at the target interest rate by buying and selling government securities, or other financial instruments. Monetary targets, such as inflation, interest rates, or exchange rates, are used to guide this implementation.

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long way to go. Higher requirements, an outside force for deepening the marketization, will be put up for the efficiency and quality of the financial market in China when the RMB asset transactions can be done in a large volume and can also be settled in RMB in the overseas market. The market should be able to become an international transaction center and operate in line with market rules because if the RMB can circulate in broader areas and be more convenient, the RMB assets related transactions will be energized no matter in the general market or the offshore financial market. This will be good for cultivating and developing offshore financial markets, diversifying the RMB-priced products, deepening domestic financial markets as well as promoting the internationalization of domestic financial institutions and financial innovation. The RMB internationalization will also promote the RMB offshore market. With its advancement, there will be increasing demand for the RMB and the RMB offshore market providing money for nonresidential investment and financing will come into existence and prosper. With such a platform, the RMB internationalization will promote the formation of a liberalized interest rate regime and will also provide guidance for domestic foreign exchange market adjustment so as to facilitate deep economic cooperation between China and the Asia-pacific region. Off-shore Financial Market An offshore financial centre (OFC), though not precisely defined, is usually a small, low-tax jurisdiction specializing in providing corporate and commercial services to non-resident offshore companies, and for the investment of offshore funds. It is not subjected to local regulations and tax laws and became popular in the 1960s when the international financial market entered a new era.

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Good for the Economic Interaction between Hong Kong, Macao, and Taiwan The RMB internationalization will promote economic cooperation between Mainland China, Hong Kong, Macao, and Taiwan and advance the establishment of a unified free trade zone so that the four areas will be

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interdependent and inseparable. In this way, exchange rate fluctuations will be eliminated and transaction costs will be saved so that the four areas will fight against the international financial crisis together. A picture of the RMB internationalization promoting the unification of the Chinese currencies and vice versa will be seen. The Chinese government must lower the requirements for its citizens to enter and leave the country and encourage them to travel, study, work and trade abroad. First of all, it should be considered that requirements for the Chinese citizens to travel to Hong Kong, Macao, and Taiwan should be lowered in order to enhance economic exchanges. Based on that, a unified economy composed of Mainland China, Hong Kong, Macao, and Taiwan, the so-called 'Greater China Economic Circle', should be created so that the RMB could be accepted by residents in Hong Kong, Macao, and Taiwan. Furthermore, requirements for the Chinese citizens to travel to neighboring countries should be lowered in order to improve economic and trade exchanges. Finally, requirements for the Chinese citizens to travel to other countries should be lowered so that China's involvement in the international economic activities will be enhanced.

Several Difficulties in the R M B Internationalization The RMB internationalization requires strong demands from world dealers, investors and central banks of other countries. The RMB should be used as a transaction intermediate in international trade settlement, a pricing unit of international financial businesses, and store of value applied by central banks. There is consensus among economists on the three pillars supporting 135

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currency internationalization. They include: first, economic scale and trade volume of a country; second, depth, width and liquidity of the capital market; third, stability and convertibility of the currency. Therefore, there are still many obstacles in the path of the RMB internationalization. From the perspective of the real economy, the advancement of the RMB internationalization still needs to be strengthened. In the first place, compared with countries with higher currency internationalization, the economic strength of China still needs to improve. At the same time, there are still some serious problems in Chinese macro-economic environment. Therefore, the foundation for China to massively promote the RMB internationalization is not solid enough. From the experiences of currency internationalization practices around the world, the issuance country needs to satisfy the following requirements: a big share in the world economy, political stability, stable macro-economic environment, mature market economic system and economic sustainability. Secondly, there are a lot of hurdles in the management and systems. Without completed transformation of the industrial structure, China is still weak in combating external shocks. Therefore, the exchange rate liberalization and opening of the capital account cannot be completed at once, which is the system obstacles for the RMB internationalization. Furthermore, there are no laws or accounting and regulatory systems required to guarantee the healthy development of international businesses, so there is still a long way to go for the RMB to get its speech right. Thirdly, China's current economic system still needs to be improved. China has made some progress in its market economy construction, but issues such as interest rate liberalization, the RMB exchange rate regime and convertibility under the capital account make it difficult 136

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for the RMB to be rapidly internationalized. The Chinese financial reform and development started rather late and financial businesses concentrate on traditional credit businesses. Therefore, though Chinese banks were not hit hard in the financial crisis, they would not be able to survive if they had been fully opened because they are big but not strong. Besides, China's capital market is still undeveloped and there is a lack of investment culture and financial products, which may easily cause the phenomenon of chasing going-ups and selling downturns. This is also an aspect detrimental for the RMB internationalization. Fourth, there is not enough circulation of the RMB in the international market. In the Gold Standard age, the UK exported huge amount of pound to the international market in spite of its large volume of surplus in the current account. When the Breton Woods System was created, the US provided dollar liquidity for the international market through deficit in the current account. Though China is the largest surplus country, the scales of its FDI is still small. In sum, there are many contradictions in China's macroeconomy and the micro-systems need to be improved. Its financial system is weak with a need to strengthen regulation and the international environment is severe. Therefore, there will be a long process for the RMB to be fully convertible under the capital account. The gradual model is an unavoidable choice under current circumstances.

Risks in the RMB Internationalization There will be difficulties and conflicts before expectations of the future can be achieved, which is 137

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what we need to face. Economic globalization and financial integration represent the future trend and we should fully understand the RMB internationalization in order to avoid its negative impacts.

Challenges Facing Chinese Enterprises When the RMB is internationalized, export and import payment will both be done in RMB. In this case, there will be operational difficulties in cancelling after verification in import and export because there will be mixed sources of the RMB fund, through domestic and foreign channels, especially after multiple transfers and it will be hard to tell whether the fund comes from overseas. All these will bring negative impacts on the overseas operation and development of Chinese enterprises, which should be granted close attention to by the Chinese government and corporate departments. As mentioned before, the RMB internationalization will bring certain effects on the Chinese economy and financial stability. When it is internationalized, the Chinese economy will be closely related to the world economy and any changes in the international financial market will affect China's economy and finance. If the real exchange rate deviates from its nominal exchange rate or the sight exchange rate and interest rate deviate from the future exchange rate and interest rate, there will be opportunities of speculation for international investors and speculative capital will flow in an accelerated speed, forcing the government to take macro-measures to respond. Changes and adjustments in the monetary policy will bring challenges to the operation and management of Chinese enterprises. Therefore, Chinese enterprises should improve the research on the macro-economy, financial policies and international financial markets. They should also prepare 138

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for policy changes in the RMB internationalization while working on innovations of the corporate financial management system in a new era.

Challenges Facing the Chinese Economy There are two sides in any economic phenomenon and so is the RMB internationalization which will inevitably have positive and negative impacts on China's economic development. The path of the RMB internationalization will be filled with detours and it may bring five negatives impacts to China's economy. First, the RMB internationalization will influence China's economic and financial stability as the opening of the capital account, which makes the RMB a fully convertible currency, will make China's financial markets a target for international speculative capital and may incur serious consequences. Besides, without trade barriers, international economic crisis and inflation can spread to the domestic market, which is particularly evident today when the financial liberalization is completed and a large volume of capital is flowing freely in the international market. Furthermore, when foreigners hold a large volume of China's short-term assets, their preferences for currencies will change, which may lead to huge capital flows and affect China's economy. Secondly, macro-control will be more difficult once the RMB is internationalized. There will be a certain amount of the RMB circulating in the international financial market and its cross-border flow may weaken the control of the PBOC on domestic RMB and thus affect the effects on the macro-economic policies. For example, when interest rate is raised under tight monetary policy to control inflation, the RMB circulating in the international market will find an opportunities to get in and the currency supply will be 139

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increased weakening the tight monetary policy. At a certain stage of the RMB internationalization, inflation may occur in China because when the RMB becomes a means of pricing, payment and reserve, there will be a huge increase in the demand for the RMB which will push up the issuance volume of the currency bringing potential pressure of inflation. At the same time, due to the connection between interest rates and the international market, capital flow especially will affect stability of the RMB interest rates and exchange rates.

Money Supply In economics, the money supply or money stock, is the total amount of monetary assets available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits (depositors' easily accessed assets on the books of financial institutions). Money supply data are recorded and published, usually by the government or the central bank of the country. Public and private sector analysts have long monitored changes in money supply because of its effects on the price level, inflation, the exchange rate and the business cycle.

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The RMB internationalization may also bring operational hardships to China's monetary policy. When the currency is not regionalized or internationalized, it only circulated domestically no matter how much money PBOC injects. After its internationalization and regionalization, some will circulate overseas and will not influence domestic prices temporarily, but it is hard to get the exact figure as well as its changes. In this way it will bring difficulties to PBOC to adjust the monetary supply. The RMB circulating overseas may also flow back and influence the stability of domestic monetary circulation and the value currency. Other than that, when constrains on the inflow and outflow of the RMB are removed, the capital can enter and exit China freely, thus weakening the effectiveness of the monetary policy. Thirdly, conflicts may arise when the RMB functions as an international currency and a national currency. When the currency is internationalized, the integration of the currency and the international financial market will be enhanced and domestic monetary policy will be confronted with more serious internal and external imbalances. The issuance country of an international currency is often confronted with constrains of the currency circulating overseas when it is implementing domestic monetary policies. For example, the US may increase interest rates when inflation occurs in its

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domestic market, but because of the dollar's position as an international reserve currency, the dollar circulating overseas may flow in and increase the amount of dollar in the domestic market, weakening the monetary policy; when there is a deflation and the interest rates are lowered, the dollar may flow out of the country and decrease the amount of dollar in the domestic market, damaging the monetary policy. Fourthly, the RMB internationalization may lead to some negative impacts on the sustainable growth of the domestic economy. China has a large population causing enormous pressure on employment. Therefore, both domestic and foreign demand should be enhanced in order to promote employment and maintain economic growth. However, the final aim of the RMB internationalization is to make it an international reserve currency and as a reserve currency, the RMB will function as an international liquidity for other countries, requiring China to have deficits in international payments or else other countries will have no source of the RMB reserve. However, long-term deficits in the international payments mean decreased export and increased import, resulting in lower external demand and loss of some domestic markets which may bring negative impacts on employment and economic growth. Fifthly, the cross-border flow of the RMB may lead to an increase of smuggling, drug-dealing, and gambling. Such illegal cross-border movement of the RMB will affect the stability of the Chinese financial markets and enhance the difficulty in anti money-laundering and anti fake money activities. In sum, there will be some inner contradictories in the advancement of economic globalization in the sovereign national system, which makes international financial fluctuations and crises possible. The current design of the international monetary system has defects 141

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and there will be no perfect international monetary system, which is a cost of the economic globalization and we need to know in advance. Of course, the two contradictories refer to constrains in the basic structure of the international monetary system but a lot can still be done such as promoting the balanced development of the economic structure, making strict financial regulatory rules, enhancing transparency in private departments and government finance, popularizing proper international accounting standards and rating methods, and improving sound corporate governance and prudent operation. Though the currency internationalization will bring various negative impacts on the country, the longterm benefits it brings will far outweigh the costs. The internationalization of the dollar and the euro tells us that the issuance right of an international currency means huge economic and political interests in making and amending rules of international affairs. Therefore, it can be predicted that in the process of the RMB internationalization there will be positive and negative impacts. Efforts should be made to make good use of the positive side and avoid negative impacts. In the process of the RMB internationalization, the advantages and disadvantages should be fully recognized and preparation should also be made.

How Far Away will the R M B Internationalization Be Calls for the RMB internationalization started in 1990s in China, but until the US mortgage crisis the Chinese government did not really consider the option. Generally speaking, only developed countries are 142

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strongly motivated to internationalize its currency while China is still a developing country with very low per capita GDP and resources. Besides, China has long had a low-profile foreign policy and lacks strong will to promote the currency internationalization. Since September 2008 when the US mortgage crisis developed into a global financial crisis, the Chinese government has started to take a more active attitude towards the RMB internationalization. More and more countries have recognized that the RMB is close to the level of internationalization because the economic development and stability have guaranteed the appreciation of the RMB which is on the path of becoming international. On September 17th 2009, Robert Mundell, Father of the Euro, pointed out that the RMB zone would replace the Japanese yen zone to be the third largest monetary zone in the world in 2011. He also responded to the suggestion of establishing a super-sovereign currency based on the IMF SDR that this could be regarded as a way forward but the SDR cannot become a world currency. The RMB should be added into the SDR and can account for 10%. If the RMB really became the third most important currency in the world in 2011 as Mundell mentioned, how far away is it from becoming international? In fact, there are three layers of meaning in the RMB internationalization: first, the RMB cash should circulate to a certain degree overseas; second and also the most important, financial products priced in RMB should become investment tools for major international financial institutions and financial markets using the RMB as a pricing tool should be expanded; third, the proportion of the RMB settlement should reach a certain level in international trade and this is a common standard evaluating the currency internationalization

Global Currency The so called global currency is a kind of currency that is used as a universal equivalent in the global market. With the development of international exchanges, the currency began to circulate in the global market with functions of a global currency. Besides the function of unit of account, the global currency also has the following functions: purchasing foreign commodities (means of purchase), paying for international debts, interest rate and implementing other unproductive payment to balance international payments (means of payment), paying for war indemnity and exporting monetary capital. Generally speaking, when precious metal is in circulation, gold and silver are functioning as the global currency instead of local coins. Therefore, the global currency is mainly in the form of gold bullion and silver bullion. In the modern credit currency system, hard currencies that can be exchanged for other national currencies serve as global currencies. However, in such circumstances, countries should still keep a certain amount of gold to be used as reserve funds for balancing international payments.

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degree. When these standards are reached, the RMB is really internationalized. On July 6th 2009, the RMB settlement in cross-border trade was officially started which is good for reducing exchange rate risks and costs and should be regarded as a key step in the RMB internationalization. Li Ruogu, Chairman of the Import and Export Bank of China, regarded the RMB to be half internationalized. On the one hand, the RMB settlement is used in some crossborder trade; on the other, the unionpay card can be used in a lot of places overseas which is also settled in RMB. The RMB internationalization is a process in which the RMB is circulating abroad and widely acknowledged as a pricing, settlement and reserve currency internationally. Although the overseas circulation of the RMB does not mean the RMB is internationalized, the expansion of its circulation will eventually lead to its internationalization. Being a settlement currency in China's import and export does not mean the RMB has replaced the dollar. Its internationalization also depends on whether import and export enterprises accept the RMB and the stability of its exchange rate. When the capital account is not fully opened, the RMB cannot be fully convertible and China's economic strength and financial markets are to be improved. Therefore, there is still a long way to go for the RMB internationalization. Li Ruogu, Chairman of the Import and Export Bank of China, said: 'more policy support needs to be gained for the RMB internationalization and the government should consider allowing foreign countries to purchase Chinese sovereign debt and corporate bonds, which is related to opening the capital account.' Therefore, when the capital account is opened, the RMB internationalization will be close.

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The American economist Robert Solomen once said that the international monetary system is just like red and green lights in cities and an international monetary system with full functions can provide convenience for international trade and investment and adjust to changes naturally while a weak system may hinder trade and investment between countries and even retard and delay the development, thus causing fluctuations in the economic development. The RMB is to be internationalized in the international monetary system, which is not to be changed. There are problems in any international monetary system no matter how good it is and what China needs to do is find a way to survive in such an environment. There are ups and downs in any international monetary system and China should learn to predict the direction of its reform and tread on a path of its own internationalization. To make predictions of the future development of the international monetary system, China should learn from the history of the system and find out the intrinsic laws.

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Gold Standard Era The so-called 'standard', to be put in a simple way, means 'the original position'. When it is used in the monetary system, it means 'to peg'. Currency standard means what the currency is pegged to and the value it represents. For example, gold standard means that currencies are pegged to gold to represent their value. Now let's take a look at the gold standard era and how the international monetary system came into being.

Birth of the International Monetary System The most primitive economic exchanges between nations are commodity trade, in which commodity functioned as both commodities and commodity money. Commodity money is the earliest form of currency in the long-term process of commodity exchange and it is fixed to some specific kinds of commodities. In China, in late Neolithic Age livestock, turtle backs, and farm tools were used as commodity money; in Xia and Shang dynasties cloth and natural shells were used as commodity money. Such commodity trades can still be seen in today's highly developed modern international economic exchanges. With the development of social productivity and the expansion of international economic exchanges, commodity money cannot meet all the requirements of international economic exchanges. With increased demand for international trade, the international monetary system was gradually built to 147

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adjust to the needs of international trade and payment. The monetary system should adhere to rules, measures, and organizational formats determined by governments of different countries. With the progress of economic integration, economic activities such as trade between countries, debts and liabilities, capital transfer all involve management rules of currency exchanges, exchange rate system changes, international payments, and international reserve. Therefore, a monetary system is needed to coordinate economic activities of independent countries. All countries should work together to reach a consensus so as to abide by common rules and establish a management organization. Karl Marx once said that 'Money is an inevitable product of exchanges.' Gold is such a product of historic development. The Gold Standard System is the earliest international monetary system in the world, which came into being after countries used precious metals to be their currencies. The research on the international monetary system should also start from the Gold Standard System.

Three Modes of the Gold Standard System The Gold Standard System is a monetary system using gold of a certain color and weight as a standard. The socalled standard money refers to money which is used as the foundation for a country's monetary system and is created according to the legal monetary metal and unit of a country. Means of Payment Means of payment is using money to pay for debts, taxes, rent and income. Such a function of money makes buy on credit and credit sale possible, which is good for economic development; however, it also enhances the chance for an economic crisis.

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Then why are currencies pegged to gold? Because gold has important natural qualities such as even texture, small size, high value, stable total volume and is more suitable than commodity money to be used as a unit of account, means of payment and store of value. Gold has pure natural quality and though there is no perfect

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gold, it is close to perfect. It has an even texture, is to be cut, low in volume, and difficult to be explored, so it is of high value. With the development of commodity exchanges, gold has become the ideal international currency. There are three modes of Gold Standard System in its development process: the Gold Specie Standard System, the Gold Bullion Standard System, and the Gold Exchange Standard System. The Gold Specie Standard System is also called the Gold Coin Standard System, a typical Gold Standard System. Its main characteristics include: gold is used as the material of the standard money; gold coins have unlimited legal tender; the nominal value of gold coin is equal to the value of its gold content; gold coins can be melted and coined; bank notes can be freely exchanged for gold; gold can be transported freely into and out of the border. The Gold Bullion Standard System have the following characteristics: gold coins are the standard currency, but cannot circulate freely domestically and nor can they be melted and coined; bank notes are used to replace gold coins in circulation but cannot be freely exchanged for gold; only when bank notes are used for international payments or other special purposes can they be exchanged for gold in a certain amount in central banks; the central bank has full control over the import and export of gold and private export of gold is strictly prohibited. The Gold Exchange Standard System is also called Virtual Gold Standard System with the following main characteristics: the state regulates the gold content of the paper money, but gold coins cannot be coined and nor can it be used in circulation; all the money in circulation is bank note; bank notes cannot be exchanged for gold; import and export of gold are strictly prohibited and the

Store of Value What is considered a store of value can be markedly different from one region of the world to another. In truth, any physical asset can be considered a store of value under the right circumstances, or when a base level of demand is believed to exist. In most of the world's advanced economies, the local currency can be counted on as a store of value in all but the worst case scenarios. However, currency can sometimes come under attack as a store of value (such as in hyperinflation). In those instances, other stores of value have proved their consistency over time, such as gold, silver, real estate and art. The price of gold, in particular, will often skyrocket during times of national peril or when a financial shock hits the broad markets, as demand grows for other widely recognized stores of value. While the relative value of these items will fluctuate over time, they can be counted on to retain some value in almost any scenario, especially in those cases where the store of value has a finite supply (like gold).

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central bank has full control over the import and export of gold.

The Classical Gold Standard System The classical Gold Standard System is one form of the Gold Specie Standard System and is one of the most important exchange rate systems. There was a fixed exchange rate between participant countries in the system. Between 1880 and 1914, the Gold Specie Standard System took the dominant position with its pure form. In such a system, currencies of most countries were pegged to gold and the exchange rate system between countries was established based on the Gold Specie Standard System. From the 19th century to early 20th century, most countries in the world established the Gold Specie Standard System. The UK started to implement the Gold Specie Standard System in 1816; France started to officially implement the system in 1928 but actually already used it when silver coins were prevented from being coined freely in 1873; the US started to officially implement the system in 1900 but actually already used it when silver coins were prevented from being coined freely in 1873; Germany and Japan started to implement the Gold Specie Standard System in 1871 and 1897 respectively. Underdeveloped countries implemented the system later than developed countries. Egypt was among the earliest underdeveloped country users and that was in 1885, the second year after goldmines were discovered in South Africa. Mexico and India started to implement the Gold Specie Standard System in 1904 and 1927 respectively. Money Supply Money supply refers to the process in which banks in a certain country or monetary region inject, create and expand (contract) money in economic activities.

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The international Gold Standard System avoids the natural asymmetry of reserve currency standard by staying away from too many currencies. The currency

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of each country is pegged to gold and it is required that gold should be allowed to freely enter and exit each country in order to guarantee that no country has a special right. In other words, each country should take the responsibility of intervening in the foreign exchange on an equal basis. Central banks must fix the gold prices of their currencies, so increase in the money supply will not exceed growth in the demand for money in order to stabilize the price of commodities. Therefore, the classical Gold Standard System is compared to a 'fairy tale'. Foreign exchange rate was not an issue because gold was the common currency in the world. When each country issues its currency, they choose different gold coin units. For example, Queen Victoria in the UK chose the gold content of one fourth of an ounce while President McKinley chose one twentieth of an ounce. Therefore, the weight of the pound was five times that of the dollar and the exchange rate of the pound to the dollar was five to one. This was basically the situation of the Gold Standard System before 1914. Every country wanted to use their own currency and anyone can melt gold coins and sell them at the price of the gold. The exchange rates were determined by the gold content and all country did transactions with the fixed exchange rates in the Gold Standard System except that there were losses in melting, marine transportation, and recoin.

Defects in the Classical Gold Standard System The Classical Gold Standard System, in implementation, is not always like a 'fairy tale'. From its theory, the Classical Gold Standard System is based on rules including free exchange, free coining, and free 151

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transportation of gold. When these rules are well observed and executed, the system will function steadily and can promote the economic growth of countries following the system. However, when these rules are not observed and executed, the stability of the system will be affected. In fact, when the Classical Gold Standard System was implemented, the system experienced repeated fluctuations when each country tried to seek maximized profits. One prominent feature was that during that period it was difficult for many countries to implement a pure Gold Standard System (the Gold Specie Standard System) for a long time. For example, during the 44 years when the Classical Gold Standard System was implemented in the UK and Germany, France and the US used it for 36 years and 38 years respectively (the US continued to used it for another three years); Chile and Mexico implemented for 3 years and 8 years respectively; Argentina implemented for 25 years but was forced to give up and restore; Brazil gave it up after one-year implementation and restored, but altogether only nine years. Besides, the Silver Standard System was used in India, Japan, Mexico, China, Malaysia, Thailand and Peru while the Gold and Silver Bimetalism and unconvertible paper money were used in other periphery countries. When some countries in the system gave up or suspended the Gold Standard, rules including the free exchange and circulation of gold could not be fully observed. Even when the Gold Standard was implemented, policies of some monetary authorities might restrict the free circulation of gold. In terms of the cross-border circulation of gold, a common game rule was observed by central banks, that is, tight monetary policies should be implemented when gold flows out so that foreign capital can be attracted into the country by raising interest rates. Central banks with 152

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net inflow of gold should sell out gold with no interest and purchase domestic interest-bearing assets in order to increase capital export and gold outflow. However, if central banks did not obey the rules for the sake of their domestic economic targets, the import and export of gold would get lost and thus fluctuations would occur. Prices under the Classical Gold Standard System were only relatively stable and unpredictable price changes still occurred often. For example, between 1870 and 1914, price levels in various countries frequently fluctuated with alternant inflation and deflation though the price growth was lower than in the period after WW Ⅱ . Monetary supply was limited by the amount of gold in the traditional Gold Standard System, which cannot meet the needs for economic growth and the automatic adjustment regime was also defective. Therefore, the international Gold Standard System was doomed to failure. In 1914 when WW Ⅰ broke, participant countries gave up the Gold Standard by implementing gold embargo and ban on money-gold exchanges. Then the paper money greatly depreciated and serious inflation occurred, causing huge fluctuations and negative impacts on international trade and payment.

The Gold Exchange Standard System During the twenty years between WW Ⅰ and WW Ⅱ (1919-1939), there were frequent changes in the arrangement of the international monetary system and three stages were included, namely, general floating (1919-1925), the Gold Exchange Standard System (1926-1931), and managed floating (1932-1939). During this period especially in the Gold Exchange 153

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Standard System period, a few countries implemented the Gold Bullion Standard System. Generally speaking, the economic depression ended the Gold Exchange Standard System and WW Ⅱ ended the unstable international monetary system of that time.

The Gold Bullion Standard System and the Gold Exchange Standard System

Currency Depreciation Currency depreciation refers to value decreases contained or represented by a monetary unit, which can be understood from several different aspects. Domestically, currency depreciation in the metal monetary systems means decrease in the legal metal content of the currency; in modern paper monetary system, it refers to the amount of paper money in circulation exceeds that needed when its value decreases. Internationally, currency depreciation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system. It is most often used for the unofficial increase of the exchange rate due to market forces, though sometimes it appears interchangeably with devaluation. Currency depreciation often causes increases of commodity prices in the domestic market. However, currency depreciation can also stimulate production and reduce the prices of domestic commodities in the overseas market. Therefore, it is good for export expansion and import decreases and after the WWⅡ many countries use it as a way to fight against the economic crisis and stimulate economic development.

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After WW Ⅰ , with the development of international politics and relations, there was an increase in international settlement and countries became increasingly aware that gold, as a means of payment, is not convenient to carry. Therefore, more and more countries switched to credit money. However, gold coins were still used as the standard currency of credit money and credit money such as bank bonds could be exchanged freely into gold coins or gold. With continuous decrease in gold reserve for most countries, the system was not able to sustain and in the 1920s, the Gold Standard System entered a new phase, that is, the Gold Bullion Standard System and the Gold Exchange Standard System. The Gold Bullion Standard System and the Gold Exchange Standard System developed from the Gold Standard System and were two of its branches. In countries where the Gold Exchange Standard System was implemented, gold content of the money was regulated and the coining and circulation of gold coins were banned. The paper money circulating domestically could not be exchanged for gold but could be exchanged for foreign currencies which could be exchanged for gold overseas. Exchange rates were fixed between countries with the Gold Exchange Standard System and those with Gold Bullion Standard System and Gold Standard System. Foreign exchange assets were used as reserve fund, in preparation for selling.

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In the Gold Exchange Standard System, gold content of the money was regulated by the state and money in circulation was paper money which cannot be exchanged for gold. Gold could not play the role of adjusting the amount of money in circulation and there was no adjustment mechanism and foundation for stability for money circulation, weakening the stability of the monetary system. If the amount of paper currency in circulation exceeded the amount of money needed, the currency would depreciate. And if the government issued a large volume of paper money to make up for fiscal deficit, there would be inflation, increases in commodity prices and negative impacts on economic development. Besides, exchange rates were fixed between countries with the Gold Exchange Standard System and other countries. The foreign trade and financial policies would definitely be influenced and controlled by monetary policies in relevant countries. Therefore, the Gold Exchange Standard System is a weakened and unstable Gold Standard System. In the Gold Bullion Standard System, gold coins did not circulate domestically and bank notes, when reaching a certain amount, can be exchanged for gold bullion. After WW Ⅰ , the UK, France, Belgium and the Netherlands implemented the system one after another. For example, it was regulated in the UK in 1925 that bank notes could only be exchanged for gold bullion with a net weight of 400 ounces. This was an imperfect and unstable Gold Standard System and collapsed after the 1929 world economic crisis when it was implemented for only several years.

Serious Shortage of Gold During that time, the monetary authorities in many countries started to hedge against the impacts on the domestic monetary environment from the gold flow 155

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John Maynard Keynes John Maynard Keynes was a British economist whose ideas have fundamentally affected the theory and practice of modern macroeconomics, and informed the economic policies of governments. He built on and greatly refined earlier work on the causes of business cycles, and is widely considered to be one of the founders of modern macroeconomics and the most influential economist of the 20th century. His ideas are the basis for the school of thought known as Keynesian economics, and its various offshoots. In the 1930s, Keynes spearheaded a revolution in economic thinking, overturning the older ideas of neoclassical economics that held that free markets would, in the short to medium term, automatically provide full employment, as long as workers were flexible in their wage demands. Keynes instead argued that aggregate demand determined the overall level of economic activity, and that inadequate aggregate demand could lead to prolonged periods of high unemployment. According to Keynesian economics, state intervention was necessary to moderate "boom and bust" cycles of economic activity.[6] He advocated the use of fiscal and monetary measures to mitigate the adverse effects of economic recessions and depressions. Following the outbreak of the Second World War, Keynes's ideas concerning economic policy were adopted by leading Western economies. In 1942, Keynes was awarded a hereditary peerage as Baron Keynes of Tilton in the County of Sussex. Keynes died in 1946, but during the 1950s and 1960s the success of Keynesian economics resulted in almost all capitalist governments adopting its policy recommendations. His main works include The Economic

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through foreign exchange market operations and gold became less convertible. (The monetary authorities of the UK, France, the US and Germany all exhibited such tendencies.) Besides, shortage of gold led to a decrease of gold in the international reserve of different countries. In the Gold Exchange Standard System, countries (other than the UK, the US and France) held their reserve in the form of gold bullion and foreign exchange and the debt ratio of their central banks against the gold base increased, weakening the free flow disciplines of gold. The increase of the debt ratio raised the possibility of write-off operations and the credibility of monetary policies in member countries was discounted by a great degree compared with before WW Ⅰ . Gold shortage was reflected on the decrease of the real price of gold and the Gold Standard was restored when the real gold price was seriously underestimated to 35% to 40% of the price before WW Ⅰ . Gold shortage and its imbalanced distribution led to uncoordinated relations of parity prices in some key countries and misfit monetary policies. The shortage also caused instability of short-term capital flows accompanied with global deflation. In the Classical Gold Standard period, Britain and the pound were in the dominant position which dropped sharply in the Gold Exchange Standard era. After WW Ⅰ , the reserve gold held by the US accounted for the highest proportion in the global reserve gold (more than 40%) and the shares of other countries including the US were much smaller. The economic aggregate of the US exceeded that of the UK, France and Germany. The long-term deficits in the international payment and gold outflow seriously affected the credibility and stability of the pound. From the monetary system, only the US was qualified for the Gold Standard System while all the other countries including the UK were suitable for the Gold Bullion Standard System or the

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Gold Exchange Standard System, marking the loss of the core position of Britain and its currency in the international monetary system. However, the monetary system and monetary relations have strong historic continuity, so the UK and the pound still have strong influence in the international monetary system. In general, during the Gold Exchange Standard System period, the pound and the dollar held close positions and they were in equal competition with alternant winners.

Early Stage of the Dollar Standard System—the Bretton Woods System Before the WW Ⅱ ended, the US and the UK, based on their own interest, put forward the White Plan and the Keynes Plan respectively, which represented the political and economic interest of each of the two country, to change the chaotic situation in the international monetary system. Finally, the US, with its power, forced the UK to give up the international clearing alliance and accept the White Plan. On July 1st 1944, the 'United and allied nations monetary finance conference' was held in Bretton Wo o d s , N e w H a m p s h i r e o f t h e U S , w h e r e t h e International Monetary Fund Agreement and the International Bank for Reconstruction and Development Agreement based on the White Plan (together called the Bretton Woods Agreement) were passed, symbolizing the establishment of the Bretton Woods system. In some documents, the system started from June 1946 and ended in July 1971. During the 25 years when the Bretton Woods system was implemented, the fixed exchange rate system was not the basic feature. In the early stage of the system (from 1946 to 1958, pre-era of free exchange), the characteristics of the

Consequences of the Peace (1919), A Tract on Monetary Reform (1923), A Treatise on Money (1930), Essays in Persuasion (1931), The General Theory of Employment, Interest and Money (1936).

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exchange rate system were closer to the adjustable peg system its designer imagined; in the later phase (from 1959 to 1970, era of free exchange), the exchange rate system was closer to the fixed dollar standard system. In other words, the Bretton Woods system was based on gold in name, but it was a gold-dollar system in essence from scratch. When the double-price gold market was established in 1968, the system became a real dollar standard system. In 1945, the management institutions of the Bretton Woods system (the International Monetary Fund and the International Bank for Reconstruction and Development (World Bank)) were created. The IMF, since its establishment, has had the basic principle of regulating the economic policies of member countries and expanding financing channels for deficits in international payments in order to ensure the normal function of the system.

Double Peg System The Bretton Woods system was actually the GoldDollar standard, to be put in a simple way, a double peg system. On the one hand, the dollar was directly pegged to gold and according to the Bretton Woods System Agreement member countries must accept the official rule that one ounce gold is equal to 35 dollars, that is, the parity price of one dollar is 0.888671 gram of gold. On the other hand, the agreement also specified that the gold content of the dollar was the standard for the currency evaluation and the exchange rates of these currencies against the dollar were based on that. The exchange rates against the dollar were allowed to fluctuate within 1% of its parity price and any change in the parity prices must be permitted by the IMF. Only when there is a fundamental imbalance in the international payments would the official prices of 158

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currencies be allowed to appreciate or depreciate. The aim of such a rule was to make use of the gold as a currency in order to achieve the stability of the global price level and the monetary system. During that period, gold could still be regarded as the standard currency. However, with the dollar in the central position of the monetary relations, currencies of these countries should be adjustably pegged to the dollar which actually became the standard currency. Besides, compared with gold, the dollar was in a relatively weak position and according to the Gresham's Law (the Gresham's Law is an economic principle, also called principle of weak currencies driving away strong currencies, meaning that in the double-standard system, two currencies circulate at the same time and when one of them depreciates, its real value is actually lower than the other. Then the other currency with higher value will be reserved and disappear from the market and circulation. The currency with lower value will be circulating in a large volume.), gold circulating in the market were meant to decrease with a growing amount of dollar, which led to the dominant position of the dollar.

The Triffin Dilemma When the dollar becomes the dominant currency, it is also confronted with a difficult issue. The Bretton Woods system is based on the gold-dollar standard and the dollar is both a national currency and a global currency. As a national currency, the dollar is restricted to American monetary policies and its gold reserve; as a global currency, the dollar supply should meet the needs of the global economic and international trade growth. Therefore, the dollar is facing a dilemma: to meet the needs of the global economic and international trade growth, the dollar supply should increase continuously while such increase will make its exchange with

Gold Parity The ratio of two monetary units calculated on the basis of their legally fixed gold content. According to this meaning, "gold parity" usually takes the place of the term "parity rate," which indicates the quantity of monetary units of another country having the same content of pure gold by weight as the monetary unit of the given country. For example, a pound sterling contains 2.13281 g of pure gold, and the French franc contains 0.160 g; that is, a pound sterling has 13.33 times more pure gold than a franc. Therefore, the parity rate of a pound sterling and a franc sets ￡1 equal to 13.33 francs.

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gold will not be guaranteed. The dilemma was first discovered by the America economist Triffin in the 1950s and thereby is also called the Triffin Dilemma. Triffin pointed out the inner instability and potential risks of the Bretton Woods system, which was later proved correct. The process of the Bretton Woods failure and collapse was one during which the dollar crisis broke and was reversed and broke again and then the whole system collapsed. In the dollar crisis under the Bretton Woods system, the dollar was exchanged at a fixed price for gold and thereby it was also called an 'exchange crisis'. Others called it a crisis of confidence in the dollar because people were doubtful about the convertibility of the dollar and thereby started to dump the dollar assets. After three crises and their salvations, the then American president Nixon had to announce the 'new economic policy' and suspended the exchange of the dollar for gold on August 15th 1971. At that time, the international financial market was extremely chaotic. On December 18th 1971, the Group Ten held a confidential conference in Washington and reached a compromise — Smithsonian Institute Agreement (also called the 'Washington Agreement'). In the agreement, exchange rate adjustment marked a turning point from the international monetary system to the Bretton Woods system and also was an official start of a diversified reserve currency era. However, the repeated dollar crisis which took place in February 1973 put an end to the agreement and also symbolized the complete collapse of the Bretton Woods system and the beginning of the current international monetary system.

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The Coming of the Dollar Standard Age — the Jamaica System The Smithsonian Agreement

After the collapse of the Bretton Woods system, the international monetary and financial relations were in chaotic fluctuations with continuous decrease in the international position of the dollar and exchange rate undulations. In January 1976, the Temporary Committee of the International Monetary System of the IMF reached a consensus on the Jamaica System and in April the same year, the Second Amendment of the IMF Agreement was passed by the IMF committee with the current monetary system gradually coming into being.

System with No System Some people call the current international currency system 'the Jamaica System'. Others think that there is no standard currency or unified exchange rate arrangement and relevant actions of member countries cannot be restricted. Therefore, the current international monetary system cannot really be regarded as a system because it has no system. No matter how people want to define it, there is no doubt that the US and the dollar have played a leading role in the system and thereby it is also called 'post Bretton Woods system'. The Jamaica System made in 1976 has the following contents: (1) the floating exchange rate system is permitted and member countries can make exchange rate arrangement freely; (2) the official gold prices are abolished and gold is not regarded as a currency but is a commodity completely separated from currencies; (3) in the future monetary system, the SDR should be regarded as the main reserve assets and it can be considered to change the dollar standard into an SDR standard.

The Smithsonian Agreement was a December 1971 agreement that adjusted the fixed exchange rates established at the Bretton Woods Conference of 1944. Although the other currencies were still pegged to the dollar until 1973, the main difference from the previous regime was the abolition of the dollar's convertibility into gold guaranteed by U.S. Treasury, making the dollar effectively a fiat currency. The Bretton Woods Conference of 1944 established an international fixed exchange rate system based on the gold exchange standard, in which currencies were pegged to the United States dollar, itself convertible into gold at $35/ounce. A negative balance of payments, growing public debt incurred by the Vietnam War and Great Society programs, and monetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued in the 1960s. The drain on US gold reserves culminated with the London Gold Pool collapse in March 1968. On August 15, 1971, President Richard Nixon unilaterally suspended the convertibility of dollars into gold, thus strategically defaulting on the United States debt. His administration subsequently entered negotiations with industrialized allies to reassess exchange rates following this development. Meeting in December 1971 at the Smithsonian Institution in Washington D.C., the Group of Ten signed the Smithsonian Agreement. The US pledged to peg the dollar at $38/ounce with 2.25% trading bands, and other countries agreed to appreciate their currencies versus the dollar. The group also planned to balance the world financial system using special drawing rights alone.

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Features of the Jamaica System Compared with previous monetary systems, the Jamaica System has its own unique and distinctive features. Firstly, gold receded from circulation, making the current system the only international monetary system with credit currency as the standard currency. Secondly, the legitimacy of the floating exchange rate and the illegitimacy of the controlled exchange rate were specified. However, it is difficult to define the control of exchange rates and thereby countries are not effectively restricted in terms of exchange rate policies. Besides, another distinctive characteristic of the current system is the increasingly evident trend of unified management and group management of currencies and exchange rates. The EMS established at the end of the 1970s, the birth of the Euro in 1999, and the monetary cooperation in East Asia and other regions all demonstrated such a trend. However, global exchange rates were very unstable in the Jamaica System. Around one third of the countries implement an independent floating or managed floating exchange rate regime while the other two thirds implement a peg exchange rate regime. As long as the reserve currencies including the dollar, the yen, the German Marc, the pound and the French Franc are stable, the SDR and the European currency unit will be stable. The floating exchange rate regime is implemented in major industrial countries and the peg exchange rate regime is implemented in developing countries. Most countries, based on their own interest, change the exchange rate independently or with other countries. Therefore, 162

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those developing countries using a peg exchange rate regime have to rearrange their exchange rates without considering their own economic conditions and thus have to take extra foreign exchange risks. Also, after the collapse of the Bretton Woods system, countries in North America and Europe as well as Japan started to loosen regulations on their domestic financial institutions with the opening of the capital account and improved financial liberalization. In the 1970s and 1980s, the circulation scale of cross-border capital grew steadily in these countries and since the 1990s, more countries started the financial liberalization process with the rapid development of emerging economies and economies in transformation, further promoting the real economy and the financial globalization. The scale of cross-border investment and financial transactions increased. Such changes created conditions for the financial crisis when the market infrastructure and insurance measures were not in place and domestic systems were not healthy.

The Financial Crisis and the International Monetary System Since the 1970s, financial crises have taken place frequently. The earliest one was the Latin America debt crisis, attacking the banking system in the region; in the early 1980s, financial crises took place in Chile and Morocco; at the end of the 1980s, the financial crisis hit the American Deposit and Loans Commission; in the early 1990s, financial crises happened in Switzerland, Finland, Norway and some transforming economies; from 1994 to 1995, Venezuela, Brazil and Mexico were attacked by financial crises; in 1997, a financial crisis took place in many East Asian countries; in 1998, the debt crisis in Russia spread even to the remote Brazil. According to statistics by the World Bank, there were 163

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45 systematically major crises and in the 1990s the number rose to 63. Those frequent banking crises and financial crises posed great threats to the world economy, especially to developing economies and small externally-driven economies. The mortgage crisis which started from 2007 was also related to the international monetary system. And it was such a highly liberalized, excessively open system that led to the American debt crisis and its shocks to the global economy. In history, every time when the international monetary system experienced an adjustment, there was a collapse of an international currency and the rise of the international position of another international currency. Therefore, an international monetary crisis can be a disaster to some currencies and can also be a blessing to others. Other than gold, the pound, the dollar, the German Mark, the Japanese yen and the euro experienced changes in their positions in the previous adjustments, some of which fell while others rose. In fact, we should be clear that up till now there has never been a system which can settle all the crises and there were inevitably advantages and disadvantages. A new international monetary system will be playing a leading role in the world economy for a period of time, but it can never be free of problems. The future development of the RMB can also benefit from such experiences. Now all countries want to participate in the new international monetary system and there will be many possible models in its restructuring. However, the international standard currency must meet the requirements of centralization and unification and not much democracy can be realized or else there will be no constraints in practice. Reconstruction and restructuring 164

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will eventually depend on economic and political strength rather than discussions.

Th e P r o b l e m a t i c I n t e r n a t i o n a l Monetary System In March 2009, Zhou Xiaochuan, Governor of the PBOC, wrote an article saying that the break of the financial crisis and its spread made us again think about an old and unsolved problem, that is, what kind of international reserve currency can maintain global financial stability and promote economic development. The Silver Standard, the Gold Standard, the Gold Exchange Standard, the Bretton Woods system were different systems designed to solve the problems and the IMF was also established for that purpose. The financial crisis has shown that the problem is far from being settled and the current international monetary system made the internal defects even worse.

System with Defects The problem now is whether the international institution managing international financial affairs can play the role of a 'guardian' in the world with such rapid financial development. Is such an institution speaking for every country or just for a minority? These are big issues facing the international monetary system. As we know, there are three aspects and functions in the international monetary system: first, making rules of the sources, shapes, numbers and application areas of international currencies and reserve assets used for international settlement and payment; second, making rules of the exchange rates between currencies and the 165

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ways to maintain the rates as well as the appropriate exchange ways and pricing relations; third, making rules of the adjustment mechanism of the international payments to ensure the stable and balanced development of the world economy. The transitional history of the international monetary system over the past century was in essence a process of transition in international monetary shapes and exchange rate systems. The alternation of the international monetary shapes reflected switches in the economic supremacy and world economic patterns. The changes in the exchange rate systems from fixed to floating to orderless reflected the strong will in countries to stabilize the monetary order and the incoordination of interests between different countries. These paradoxes will stay in the changes in the future international monetary system. Now the dollar keeps depreciating in the aftermath of the international financial crisis. The dollar still takes a leading position in the international monetary system with all the benefits and not a corresponding share of responsibility. Therefore, other countries and regions such as emerging markets with China included cannot control risks effectively and are confronted with challenges like crisis transfer, currency mismatch, and dilemma in monetary policies. All these have led to more people thinking about the position of the dollar and restructuring of the international monetary system. The US, as the issuance country of the dollar and as a sovereign nation, needs to assume two functions at the same time, that is, the adjustment of the domestic and external economic imbalances. The current situation is a best example. After the financial crisis began, the US implemented unprecedented expansionary monetary and fiscal policies to save and stimulate its economy, which 166

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made many people worry about fast depreciation of the dollar. If the huge fiscal deficit continued to rise and the Fed continued to implement an easy monetary policy, concerns about the dollar depreciation would deepen because measures the US took to adjust domestic imbalances will worsen global economic imbalances which would trigger the economic recession to get even worse. Besides, the depreciation of the dollar favored the US rather than foreign exchange reserve countries in terms of the wealth redistribution in the international market. This resulted from the system. As mentioned before, the Jamaica system had no standard currency, no constrains on growth, no unified exchange rates, no coordination mechanism for international payments and it was in essence an international laissez-faire system which is also called 'International Monetary Non-system'. The Jamaica system allowed member countries to arrange exchange rates freely and they were allowed to have fixed and floating exchange rate systems, managed floating rate system, as well as peg to one currency or to a basket of currencies system. However, such a system led to the instability of the international exchange rate system because diversified exchange rate systems enhanced the complexity of the system and exchange rate fluctuations and wars happened constantly, increasing international speculative activities and financial risks. Especially under the 'center-periphery' exchange rate system, interest of small countries was often ignored and thereby conflicts between small and large countries were upgraded.

Major Defects in the Decision-making Mechanism In the current international monetary system, the 167

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contribution the US has made is not balanced with the position the country has enjoyed. The US took a dominant position in the Bretton Woods system and 60 years later, its share in the world economy has dropped sharply but the dollar still has the leading position in the international monetary system. This gives the Fed a position similar to the central bank of the world in the way that it had the right to provide liquidity, but it is not assuming corresponding responsibilities. The proportion of the US GDP is about 30% of the world's total while the dollar reserve assets accounts for a stable 60%; the share of the Chinese GDP in the world's total is around 6.85% while the RMB still is not an international reserve currency. Therefore, the major international reserve currency still is the dollar which is also the most important transaction currency in the international foreign exchange market. Furthermore, there are some major defects in the decision-making mechanism. The current international monetary system is based on the interest of several developed countries and there is a lack of equality in participation and decision-making. In the IMF, the voting rights of all the developing countries account for only 39% while the US alone has 16.7%. One IMF rule regulates that any major decision should get a vote of more than 85%, which means that the US has a veto right. Besides, the voting rights for all the European countries account for more than 30%. Therefore, the IMF that plays the role of the world's central bank is not only insufficient in capital and authority but also has unreasonable voting right distribution and structure. Both the US and the European countries as a whole have veto rights. That is to say, any decision not in the favor of the US or Europe will not be passed and the IMF also has no control on the US or Europe, which means the IMF and the World Bank play no function of regulation of the international monetary system and the international economy. 168

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The most realistic threat now to the international monetary system is that the dollar and the euro are mainly sustained by the fictitious economy rather than the real economy. The dollar being the international standard currency is backed by bonds and other financial assets. In fact, the balance of the US bond market is about USD 27.4 trillion while that of the US external debts amounts to USD 13 trillion. The source of the financial crisis is the over-expanded fictitious economy whose instability was spread to the dollar and the whole international monetary system. Similar to the dollar, the euro-priced international bonds amounts to USD 11 trillion and the bigger problems are economic and political frictions in the euro zone which have brought instability to the euro. Because the fictitious economy back the dollar and the euro is instable, the international monetary system where the dollar and the euro are the two major currencies is always fluctuating. What's worse, the US and Europe still seem not to have the intention of weakening the fictitious economy or suspending its expansion. In other words, if the international monetary system is to be stable, either the real economy should take a bigger share in the US or Eurozone economy or there should be new forces bringing in more real economy elements. Without these, there will be no possibility in adjustment or restructuring. However, the US and the EU should lower living standards in order to rejuvenate the real economy and also start competition with developing countries including China, which is as difficult for the US and the EU as weakening the fictitious economy. From the above analysis of the implementation of the international monetary system, its new features, and internal defects, we can clearly see that the current system is confronted with unprecedented challenges. The unstable system is calling for a new one to be born 169

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and no matter which model the new system takes, it will be a result from political and economic power and interest struggles.

Direction of the International Monetary System Reform From the perspective of history, the development of the international monetary system is closely related to the economic and scientific development and is a process of improvement. Human wisdom will enhance their ability to manage themselves and one of its most important expressions is to establish an international monetary system more in compliance with the development of the world economy. The monetary system developed from commodity standard (shells etc.) to gold standard to credit standard (currencies), that is, a process from concrete objects to abstract things. With such development, the international monetary system also went from a system (concrete-object standard) to a non-system (abstractobject standard). Before exploring its reform direction, we should first take a look at how the credit standard represented by paper money could replace the concreteobject standard represented by gold.

The Establishment of the Paper Money Standard System In the veil-of-money concept, exchange currencies are a veil covering the concrete-object economy. According to the concept, currencies are used as universal equivalent to promote commodity trade and when the trade is done, the currency will be useless. Therefore, such a universal 170

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equivalent can be simply a monetary note rather than an object with the same intrinsic value of the traded commodity. Then credit money started to be used on a large scale and the credit money system came into being. From the historic development, we can see that the growth in the gold output was far lower than that of the commodity output and thus not able to meet the needs of increasingly expanded commodity circulation, which seriously weakened the foundation for the Gold Coin Standard. At the same time, the monetary gold supply is unstable and imbalanced and the gold stock is not evenly distributed among different countries. For example, at the end of 1913, the gold reserve in the US, the UK, Germany, France and Russia accounted for two thirds of the world's total. The majority of the gold stock was held by several big powers and it would inevitably lead to the damage of free coining and free circulation of gold, weakening the foundation for gold circulation in other countries. After the WWⅠ , gold was used by belligerent states to purchase munitions and the free transportation of gold and banking bond exchange were suspended, eventually leading to the collapse of the Gold Standard System. From the standpoint of the government, money that is not full bodied can be used to earn seigniorage and thereby countries with solid strength tend to replace metal currencies with paper money. Because of the above reason, the US seized the dominant position in the Bretton Woods system, after the collapse of which the paper money standard was founded. As mentioned before, the current international monetary system is a non-system, in which gold is no longer the standard currency and nor is the dollar after the collapse of the Bretton Woods system. The dollar still has 171

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the leading position which is similar to the standard currency in the system. The current system is actually an international monetary system based on credit currency.

Development of Credit Currency The biggest defect of credit standard is lack of stability, especially in the current international monetary system where such instability has more evident shocks on the world economy. This is reflected in two aspects. First, gold is no longer a currency and the floating exchange rate regime is legalized. Therefore, countries are free to make their own arrangements of exchange rates, which has led to the instability. Secondly, some essential rules are still missing in the current system and the whole international financial market is not effectively regulated, making the international financial market unstable. From a long-term point of view, the international monetary system will eventually develop from a nonsystem to a system. This is just like a large family which initially had an order. Then family conflicts arose and family members started to live separately. However, after a chaotic period, everything will calm down due to their common interests and affection and an improved system will be made to maintain a close relationship between family members. To the international monetary system, the new system will not be the Gold Standard system which was popular a century ago; nor will it be the currently popular Credit Standard system. The improved system may be called super credit standard system and the ultimate goal is to realize the dream of 'one world one currency'. However, it seems that the international monetary system based on credit currency has not come to an 172

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end; instead, it is still in the initial stage and will be confronted with more tests. Therefore, the most important thing to do for China is find out laws, adjusted to them, make use of them so that the RMB could become a 'bellwether' and leading currency in the next credit monetary standard system. What exactly is the law? We already mentioned that the international monetary system dominated by the dollar and the euro will not be able to sustain because the deindustrialization and economic virtualization in the US have made it impossible for the US to back up the system alone. Besides, the economic virtualization in Europe has also made it impossible to support the system. No matter how they try to establish an alliance, threats will continue to develop in the international monetary system. Therefore, the law is that in the credit currency standard system, the balance of the dominant currency will tilt toward the real economy. Let's take a look at how the international monetary system evolved during the past centuries. After the great success of the British industrial revolution, the pound took a key role in the international monetary system because the UK was in the leading position of the world industrial development and the scale and development speed of the real economy was not to be caught up with by any other country in the world. The US had similar experiences except that the US saw its industries (especially the military and hightech industries) rapidly developed during the two world wars, which won the US a leading position in the world's real economic development. Therefore, the dollar became a strong currency with few equal competitors. In terms of Japan which was a defeated nation, since the 1960s, it has started to rapidly develop its industries and become a strong industrial and manufacturing country, after which the yen internationalization began just in time. 173

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With the deepening of the crisis, the US and Europe will eventually realize that only the RMB can bring the real economy in China to the international monetary system. However, in the fight for their own interests, these countries will not want the RMB to be internationalized soon in order to protect the international position and vested interests of their own currencies.

How to Change the International Monetary System Geopolitically, there are three economic regions in the world: the US, Europe, and Asia. In terms of economic aggregate, Asia is the largest with Europe the second and the US the third; in terms of finance, the US is the strongest with Europe the second and Asia the third; in terms of the international currency and international reserve, problems are more evident. The biggest issue facing Asian countries in the international economic exchanges has been both pricing and transfer have to been done in dollar or euro in spite of the large volume of commodity and labor export and increasing inflow and outflow of capital. Therefore, whether the exchange rate is stable or not, such challenges cannot be avoided in these countries which also have to deal with their relations with the US and Europe carefully even when they are confronted with complaints and doubts. Exchange rate has always been a key issue facing Asian countries and in essence it is the discourse power in their foreign trade, international c a p i t a l f l o w, a n d i n t e r n a t i o n a l e c o n o m i c a n d monetary system. Some people suggested that the discourse power of developing countries be enhanced in the international monetary system in the future reform of the international monetary system. In the current system, the voting rights and shares are not reasonably distributed. On the 174

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one hand, the role played by basic votes has actually been replaced by voting rights decided by money. Since its foundation, the total volume of voting rights in the IMF has increased by 37 times while basic votes decreased from the original 11.3% to 2.1% in 2002, losing its real function. On the other hand, fund shares as the foundation for voting rights distribution cannot reflect changes in the current international monetary system. The most noticeable expression is that developed countries still has the dominant position in the decision-making process while the growth in the economic strength of developing countries such as China and Brazil has not been reflected in the fund shares. Therefore, fund shares should be redistributed and basic votes should be expanded with enhanced voting percentage of developing countries so that a financial system that balances the interests of all parties should be established. Other suggested that the role of the SDR should be fully played. In theory, such an idea is great and also in compliance with the initial principle of establishing the SDR. However, in the 30-year practice, the situation of the world economy dominated by several developed countries cannot be easily changed. It is unrealistic to create a new unit of account, means of exchange and payment, and store of value to weaken the rights of developed countries. The creation and distribution of the SDR have been objected and deterred by developed countries represented by the US, which clearly shows the stakes. These suggestions are not fully infeasible, but developed countries (vested interest holders) will not give up their own rights for developing countries. In fact, the IMF is in essence an institution established to guarantee rights of developed countries and essential changes in the system are no different from shooting themselves in the foot.

Special Drawing Right Special drawing rights (SDRs) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF). Not a currency, SDRs instead represent a claim to currency held by IMF member countries for which they may be exchanged. As they can only be exchanged for euros, Japanese yen, pounds sterling, or US dollars, SDRs may actually represent a potential claim on IMF member countries' nongold foreign exchange reserve assets, which are usually held in those currencies. While they may appear to have a far more important part to play or, perhaps, an important future role, being the unit of account for the IMF has long been the main function of the SDR.

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Still others suggested that the Gold Standard should be restored. The consistent depreciation of the dollar has led to huge losses of its investors who crowded into buying gold to retain the value of their assets. Such a situation naturally reminded people of the Gold Standard. However, we should not forget that the Gold Standard was a relatively barbaric monetary system in the human history, making social activities constrained by the unevenly distributed object with limited output. And for a time the humanity was influenced by fetishism. In fact, from the difficult process of the monetary system breaking away from gold, we can see that the restoration of the Gold Standard is not feasible and nor can it help developing countries get rid of the constraints from developed countries and some rich people. China is the largest developing country and also a large real economy and the new international monetary system needs the support of the stable real economy of China. It is also imperative for China to internationalize its currency in order to become one of the strongest countries in the world. China has the world third largest GDP (7% of the world's total), the third largest international trade volume (7.7%) while the RMB accounts for less than 1% in the international monetary system, which is unsymmetrical and imbalanced. When the financial crisis took place, many countries looked to China to promote the world economy. Since the reform of the international monetary system is inevitable, the RMB internationalization proposal should be prepared and implemented as soon as possible so as to be integrated into the international system positively. On September 2nd 2009, Dominique Strauss-Kahn, the then president of the IMF, signed an agreement with vice-governor of the PBOC, in which the PBOC was allowed to purchase no more than USD 50 billion of IMF bond. This was the first time that the IMF had 176

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issued bonds and China was the first purchaser among its member countries. The term was five years and was issued by way of the SDR and its interest was distributed quarterly. From September 24th 2009 to September 25th 2009, Zhu Guangyao, assistant finance minister, expressed the wish of China to enhance the voting rights of all developing countries in the IMF and World Bank to 50% through concerted efforts of the G20 on the G20 financial summit. In fact, through continuous efforts, China is playing an increasingly important role in the international monetary system.

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In his speech titled 'the new millennium monetary system', Mundell (Father of the euro) said: 'people will inevitably want to create a common international currency or restart to use gold or establish a large currency zone' when he referred to the prospect of the international monetary system dominated by the dollar. In 2009 before the G20 financial summit was held, Zhou Xiaochuan, governor of the PBOC, published articles putting forward the suggestion of reforming the international monetary system and establishing a super sovereign currency. Europe has been trying to reform the system and the euro which has been used for 10 years and covering more 16 countries in the euro zone is a result of such efforts. 'There is a visual currency on the internet which is not issued by banks or purchased with real currency. But rather it is the fruit of netizens' online credit and efforts of surfing on the internet.' Some netizens were referring to the visual currency as a super sovereign currency. Then what exactly is the super sovereign currency? And what is its past and today?

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International Monetary Fund

Three Articles by Zhou Xiaochuan published in the spring of 2009 At the end of March 2009 before the G20 summit was held in London, Zhou Xiaochuan, governor of the PBOC, published three articles continuously within a week, inducing debates and discussions on the RMB internationalization. The three articles were very thought-provoking and directly pointed out weaknesses in the international monetary system. The whole world thus heard voices from China. On March 23rd, Zhou Xiaochuan published an article titled Thoughts on Reforming the International Monetary System and analyzed the system from four aspects. First, the breaking-out and spread of the financial crisis reflected the internal defects and systemic risks in the international monetary system; secondly, the ideal target of reforming the international monetary system is to create an international reserve currency which is depegged from a sovereign nation and can maintain long-term stability in its value in order to avoid the internal defects of the sovereign credit currency used as a reserve currency; third, such reform should be founded on the broad picture, focus on details, be proceeded progressively and seek for a winwin result; fourth, the centralized management of part of the reserve by the IMF can strengthen the ability of the international community to fight against crisis and safeguard the stability in the international monetary system especially to enhance the role played by the SDR.

The International Monetary Fund (IMF) is an international organization that was initiated in 1944 at the Bretton Woods Conference and formally created in 1945 by 29 member countries. The IMF's stated goal was to assist in the reconstruction of the world's international payment system post-World War II. Countries contribute money to a pool through a quota system from which countries with payment imbalances can borrow funds temporarily. Through this activity and others such as surveillance of its members' economies and the demand for self-correcting policies, the IMF works to improve the economies of its member countries. The IMF describes itself as "an organization of 188 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world." The organization's stated objectives are to promote international economic cooperation, international trade, employment, and exchange rate stability, including by making financial resources available to member countries to meet balance of payments needs. http://en.wikipedia.org/wiki/International_ Monetary_Fund - cite_note-3 Its headquarters are in Washington, D.C., United States. The Board of Governors is the highest authoritative body which consists of one governor and one alternate governor for each member country. Each member country appoints its two governors. The Board normally meets once a year and is responsible for electing or appointing executive directors to the Executive Board. While the Board of Governors is officially responsible for approving quota increases, special drawing right allocations, the admittance of new members, compulsory withdrawal of members, and amendments

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On March 24th, Zhou Xiaochuan published an article titled Thoughts on the Issue of Deposit Rate, which discussed the factors influencing deposit and analyzed the reasons for high deposit rates in East Asia and oil producing countries as well as low interest rates in the US. The article also briefly introduced changes and adjustments in China's deposit rates and considerations behind them as well as options for adjusting deposit rates. In the end it was pointed out that reforms on the international monetary system should be continued. to the Articles of Agreement and By-Laws, in practice it has delegated most of its powers to the IMF's Executive Board. The Board of Governors is advised by the International Monetary and Financial Committee and the Development Committee. The International Monetary and Financial Committee has 24 members and monitors developments in global liquidity and the transfer of resources to developing countries. The Development Committee has 25 members and advises on critical development issues and on financial resources required to promote economic development in developing countries. They also advise on trade and global environmental issues. 24 Executive Directors make up Executive Board. The Executive Directors represent all 188 member-countries. Countries with large economies have their own Executive Director, but most countries are grouped in constituencies representing four or more countries. Following the 2008 Amendment on Voice and Participation, eight countries each appoint an Executive Director: the United States, Japan, Germany, France, the United Kingdom, China, the Russian Federation, and Saudi Arabia. The remaining 16 Directors represent constituencies consisting of 4 to 22 countries. The Executive Director representing the largest constituency of 22 countries accounts for 1.55% of the vote.

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On March 26th, Zhou Xiaochuan published another article titled Further Discussion on Changing the Macro and Micro Procyclicality, aiming to discuss some procyclicality in the financial system, possible remedies, and how the monetary and fiscal authority can play their professional roles in serious market crisis. The article also introduced macro-economic policies implemented in China's financial reform and fighting against the economic slowdown. With the G20 summit coming, Zhou Xiaochuan, governor of the PBOC made some proposals of reforming the international monetary system dominated by the dollar and confidence and initiative of China in taking part in international affairs was shown. Such an act of China was not to demonstrate its positions or strive for discourse power or to show off. But rather this was to express that China was standing on a higher strategic point to think about deep reasons for the crisis and explore how to prevent such disasters from happening again. When Zhou Xiaochuan was asked whether he published the article in the name of an official or a scholar, Wang Qishan, vice-premier, published an article in the Times in his own name that expressed the standpoints of the Chinese government, which were in compliance with Zhou Xiaochuan's articles.

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Wang Qishan pointed out that China's views on the fund-increment of the IMF, a common concern of the international community, were as follows: China is supportive of the fund-increment and is willing to work with all relevant parties to explore methods of financing and make contributions on condition of its own fund safety and achieving reasonable earnings. To collect fund, China supports the principles of balancing rights and obligations and sharing and voluntary actions. In terms of the scale of fund, different development stages, per capita GDP and the characteristics, formation, and accumulation of foreign exchange reserve as well as different degrees of economic safety dependence for each country should be taken into consideration. It is not realistic or fair to determine the scale of the fund based on the amount of its foreign reserve. Such an opinion is in compliance with what Zhou Xiaochuan wrote about strengthening and reforming the SDR system of the IMF.

Responses from All Parties The three articles by Zhou Xiaochuan have attracted worldwide attention especially from developed countries which reacted strongly to the articles. Joseph Stiglitz, a Nobel Prize winner and professor of ColumbiaUniversity in the US, said: 'No one expected that China, the largest dollar reserve holder in the world, would publicly criticize the international monetary system with the dollar in the center and propose to create a new monetary system'. Reuters from the UK expressed that the stances taken by Zhou Xiaochuan demonstrated that China was not satisfied with the leading role of the US and felt an urgent need to change it. Financial Times commented that Zhou Xiaochuan's suggestions showed the concerns of Beijing on the measures taken by the US to save 183

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its domestic economy and on the negative impacts on China. The newspaper quoted words from Qu Hongbin, chief economist of HSBS China, saying: 'This clearly showed that as the largest holder of American assets, China is worried about the inflationary risks brought by the money-printing actions of the Fed '. The Independent Newspaper of the UK published an article titled 'The Dollar Position Attacked by China' on March 24th 2009 saying that Timasy Geithner, the US Treasury Secretary, named China as a currency manipulator and now Zhou Xiaochuan is fighting back. The newspaper also said that China's call for reform on the IMF was supported by the famous investor George Thoros who said that the IMF should make use of the SDR to protect periphery countries from financial storms in developed countries. Times of the UK said that positions taken by Zhou Xiaochuan demonstrated that China was showing its economic power and posing a challenge on the dollar, which represented the continuously enhanced confidence of China in negotiating with major world economic powers. Some American media think that changing the international reserve currencies would not be easy. On March 23rd 2009 the Wall Street Journal of the US published an article saying that the transition of the international reserve currency from the dollar to a new currency will face huge economic and political barriers. First, the US with a dominant role in the system will not let other countries take the position and its associated advantages. Second, the dollar still is very attractive as a reserve currency from an economic perspective. Economists think that a new international reserve currency will require effective subsidies of costs in the transactions parties' economic activities, which is an advantage. At the same time, a super-sovereign currency 184

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will not be easily accepted by users in countries around the world. In a press release in the White House, Barack Obama, the US president, said that global investors regarded the purchase of the dollar as a safe investment and the US economy was more stable. He also expressed his doubts on Zhou Xiaochuan's suggestion on creating a new international reserve currency to replace the dollar and claimed that there was no need to create a new global currency. On the G20 Summit in early April, the target he hoped to achieve was simply that all rich and developing countries in the world should be determined to take actions against the global economic recession. On a hearing of the financial service committee of the House of representatives, Geithner, the US treasury secretary and Bernanke, chairman of the Fed expressed criticism on suggestions of deserting the dollar and using another currency. Wolker, former chairman of the Fed who helped win the war against inflation in the 1970s, expressed that China's claim whether it was bad holding all the dollar reserve was not appropriate while criticizing inflationary risks caused by the Fed. In his opinion, as a dollar holder, China chose to purchase the dollar and did not want to sell the dollar reserve in order to avoid the RMB depreciation. , commissioner of the EU Economic and Monetary Affairs, said that the position of the dollar would still be irreplaceable. Opposed to the European countries and the US, some emerging markets and international organizations as well as some scholars supported and agreed to the suggestions made by Zhou Xiaochuan. , the Brazilian president, expressed on March 26th 2009 that the proposal of creating a new international reserve currency to replace the dollar was effective

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and appropriate and most emerging markets would agree with it. Russia actually planned to give similar suggestions on the G20 Summit. 'We think that the role played by the IMF should be respected and we should take into consideration the possibility of making the SDR an internationally recognized super reserve currency'. Before China expressed its suggestions, Russia pointed out similar ideas in March 2009. The Kremlin suggested in the publicly released route map of the London financial summit that a new reserve currency be created and issued by an international financial institution to change the current international monetary system dominated by the dollar. Stiglitz, the Nobel Prize winner thinks that to replace the dollar with the SDR was the fasted way and he proposed that a new international reserve currency institution should be established in the long run. Noticeably, Strauss Kein, president of the IMF, expressed that it was reasonable for China to suggest the creation of a new international reserve currency to replace the dollar.

The Past and Present of the Supersovereign Currency History of the Super-sovereign Currency What exactly is the super-sovereign currency? And how about its history? Before the wide media coverage on the issue, most people have no idea of the supersovereign currency, but it does not mean that such currency never existed.

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The super-sovereign currency is a kind of international reserve currency that is depegged from a sovereign nation and can maintain stable value for a long time. Historically, there was such a currency and before WW Ⅱ , gold played a similar role. Before WW Ⅰ , the pound played the role of a key sovereign currency in the international reserve system, but the share of gold accounted for more than 80% in the system. After WW Ⅰ , the dollar's share exceeded that of the pound (in 1929), but gold still took a dominant position and over 90% in some years. The Jamaica Agreement in 1976 announced the demonetization of gold which still played an important role. Currently gold accounts for 10.5% of the world's foreign exchange reserve and among developed countries, gold takes a high proportion in their foreign exchange reserve, such as 78.9%, 71.5%, 72.6%, 66.5% respectively for the US, Germany, France, and Italy. At the same time, the gold settlement is the only commonly recognized way to replace currency settlement. However, because gold is a rare commodity and its supply and demand can not support the normal operation of the world, thus paper currencies came into being and the dollar and the euro gradually replaced gold to be the international reserve. The suggestion of the super-sovereign currency is not first created by China. As early as 1940s, Keins proposed to create an international currency unit 'Bancor' based on the value of 30 representative commodities. Between July 1st and 22nd 1944, representatives from the 44 allied countries in WW Ⅱ held the UN currency and finance conference in New Hampshire of the US, discussing how to regulate the world monetary and financial order after the war. The attendants were divided into two groups and the debates were focused on two economists: Keins representing the UK and 187

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White on behalf of the US. The British economist Keins thought that if the trade deficit of a country was too much, it would damage the global economic growth. He proposed an aggressive way to manage currencies in different countries, that is, to establish the world's central bank and international clearance alliance in order to balance the surplus and deficits of world trade. The international clearance alliance suggested by Keins was in fact a supersovereign international bank which issues its own currency that maintains a fixed exchange rate with currencies around the world. And the currency was named 'Bancor' by Keins. However, the US put forward the White scheme to represent its own interest, in which the core content concerning the international economic and financial system was to build up the dominant position of the US. The US became the strongest world power WW Ⅰ , made a big fortune in the WW Ⅱ , and was in a definitely leading position politically, militarily, economically and technically. In spite of Keins' talent and far-seeing idea of 'Bancor', the idea was not accepted by the US as it was an opponent to White's idea and stood for the interest of the UK, the abdicated leader. And the idea of creating a super-sovereign currency was not accepted by the US either. In 1969, the IMF created a reserve asset and record keeping unit to support the Bretton Woods system, but in the past 40 years, the role of the SDR has not been effectively played.

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super-sovereign reserve currency in the article titled Thoughts on Reforming the International Monetary System. In his opinion, an international reserve currency which is depegged from a sovereign nation and can maintain long-term stability in its value should be created. The SDR has the features and potential of the super-sovereign reserve currency while the expansion of its issuance will help the IMF overcome the difficulties confronted in expenditure, discourse power, and reform on representative rights. This was regarded by the international community as strong dissatisfaction of China with the international monetary system dominated by the dollar and an expression of China's call for more rights. The article also attracts the attention on the SDR. According to the materials provided by the IMF financial plan and implementation division, the SDR was created by the IMF in 1969 as a reserve asset and unit of account, which is also called paper gold. Initially it was established to support the Bretton Woods system and was later called the SDR. At that time, it was defined that one unit of the SDR was equal to 0.888671 gram of gold, which equaled the value of one dollar. The SDR in essence was a supplementary international reserve tool created to make up for the insufficiency of international reserve by the IMF. Its basic role was to serve as an international payment tool and pricing unit of currencies, which was not an international currency in circulation. Even if the SDR can be regarded as reserve assets, its share in the international reserve assets was small, decreasing from only 4.5% in 1971 to2.8% in 1976 and then growing to 4.8% in 1982 before remaining stable. The foreign exchange has accounted for more than 80% in the international reserve for many years. Besides, the SDR is a unit of account based on the dollar whose share was 44%, so the role it is able to play has been limited. 189

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The SDR experienced many rounds of adjustments after its establishment in 1969. Since 1974, the IMF has calculated the value of the SDR based on four different currencies in the form of a standard basket. The four currencies and their share in the calculation were decided by the average export volume in different economic systems in the past five years. Currently, from 2006 to 2010, the four currencies are the dollar, the euro, the yen, and the pound, with a respective share of 44%, 34%, 11% and 11%. That is to say, the current SDR is composed of a basket of currencies including the dollar, the euro, the yen, and the pound. Zhou Xiaochuan's article suggested that the currencies of all major countries should be included in the basket, which in essence was to reestablish a 'global currency' based on credit currencies of all major economic countries and name it 'the SDR'. However, such a reform is a global political action. Which currencies are qualified to be included into the basket? Can GDP be taken into consideration in the proportion of different currencies in the SDR? Who will regulate and recognize how the GDP data in different countries are calculated? Therefore, Zhou Xiaochuan mentioned directly in his article that this needs active political cooperation from all member countries. Now the discourse power of developed countries accounts for 57.9% in the IMF, among which the share and voting right of the US account for 17.64% and 16.732% respectively. Comparatively, China's share and voting right account only for 2.443% and 2.338% respectively. Moreover, more than 30 of the 186 developing countries still have not been given corresponding shares of the SDR. Developing countries have wanted to change the situation for a long time, but it requires 85% vote in the IMF and the US, with a share of 16%, has the right of veto. 190

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China's voice finally received some responses internationally and the need to fight against the global financial and economic crisis and calls from developing countries for reforming the international monetary system have promoted a new round of distribution of the SDR in the IMF. In late July 2009, according to the IMF newly published draft on the SDR distribution, developed countries, with a high share in the IMF, received USD 150 billion of the SDR, among which the US and Japan received USD 42.6 billion and USD 15 billion respectively; developing countries and emerging economies received USD 100 billion of the SDR, among which China, Russia, and India received USD 9 billion, USD 6.6 billion and USD 4.5 billion respectively. Such a distribution has been the largest common distribution by the IMF aiming to supplement the foreign exchange reserve of its 186 member countries in order to provide liquidity globally. Before 1982, the IMF had distributed the SDR twice with a total volume of 21.4 billion which is equal to USD 33.4 billion, but between 1982 and 2009, no distribution was successful. The US congress recently authorized the government to approve the Fourth Amendment of the IMF Agreement. If approval was to be achieved by the US, the voting rights supporting the amendment would exceed 85% and it would come into effect. The IMF thus would be able to put forward, besides distributing USD 250 billion, a one-time special distribution of 21.4 billion shares of the SDR. With increasing reserve in developing countries, their discourse power will also become stronger. Besides fund injection through borrowing, the IMF can also enhance financing by issuing bonds. On July 1st 2009, the IMF passed an official decision to issue USD 150 billion worth of IMF bonds based on the SDR. China, Brazil, and Russia have shown great interest in purchasing and the target for China was USD 50 billion 191

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while that for Brazil and Russia were each USD 10 billion. Such actions all demonstrated the efforts taken by emerging economies to reform the international financial system.

The Euro as a Model When we further discuss the super-sovereign reserve currency and the international monetary scheme, we will see that the idea of including major world economies and their GDP into the foundation for the SDR put forward by Zhou Xiaochuan is quite similar to the European monetary unit ECU before the birth of the euro.

IMF Bond IMF bond refers to bonds issued by the IMF to governments and central banks of its member countries which are issued with SDR as a pricing unit. The interest rates are paid quarterly based on the official SDR interest rates. The bonds can be sold and purchased in official departments but cannot be used privately.

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The ECU was created in 1978 and it was a monetary basket composed of nine currencies in European Communities. When the ECU was created, the share of each member country depended on the weighted calculation of their proportion in the internal trade in the European Communities and their own GDP. This was to determine the percentage and amount of each currencyin the ECU.For example, the shares of Federal Germany, France, Britain, and Italy were 27.3%, 19.5%, 17.5%, and 14% respectively and based on the exchange rates of that day, the comparative prices of each currency could be calculated. The proportion in the ECU of each member country was adjusted every five years. Thus the ECU gradually assumed the functions of pricing and reserve and finally the euro that replaced all sovereign currencies in the euro zone came into being in 1999. The birth of the euro has become a milestone in the international monetary field. It made the supersovereign currency in the modern sense a reality while also making its development, independent of gold and any single country, a model in the world monetary history.

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Unified Monetary System Mundell, Father of the euro, thinks that the future monetary system may return to a new fixed exchange rate regime through monetary union and 'Three Islands of Stability' is the basic framework, that is, Europe, Americas and Asia form a monetary union respectively and then form an alliance. In his mind, as long as the three parties can establish a unified inflationary and seigniorage distribution regime, a three-party alliance can be realized, which is a transition to a world currency. The ultimate goal for international monetary system designers is to establish a unified monetary system, implement an integrated monetary policy, and to build up a unified currency issuance bank. In Mundell's opinion, built on a monetary alliance, a world currency based on the five major currencies (the dollar, the euro, the yen, the pound and the RMB) can be created and the IMF can be restructured into a world central bank issuing currencies. Eventually, flexibility, a global unit of account, globally unified international basic price and all currency zones can be integrated into the world monetary system. When the euro was born, the theory of Optimal Currency Areas (OCA) of Mundell may continue to be the theoretical foundation for a global unified currency. In fact, Mundell has been calling for the creation of a global currency based on the idea of the euro. His remarks for an interview were impressive: 'We need a global currency. Since 2003, I have held a conference on how to create such a currency in Italy each year. We are expecting that at such a critical moment, we can expand a world monetary policy. I talked to some national leaders such as the French president Nicholas Sarkozy, the British premier Brown, both of whom supported such an idea. My suggestion on the schedule 193

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is to hold an IMF conference similar to the Bretton Woods conference during the world expo in Shanghai in 2010 to put forward the world monetary scheme.'

Is Super-sovereign Currency Realistic? Thought-provoking Choice of Time In March 2009, Zhou Xiaochuan, governor of the PBOC, put forward the idea of creating a supersovereign currency in London before the G20 Summit, which led to worldwide discussions on the dollar. However, on July 5th 2009, He Yafei, vice-minister of foreign affairs, said in Rome that the idea of creating a super-sovereign reserve currency was being discussed in the academic field, which did not stand for the Chinese government and the dollar still was the most important reserve currency in the world and would continue to be so in the next few years. At the same time, the former Russian president Medvedev also gave positive comments on the dollar in an interview with Italian media. In the interview article published on the Kremlin website, Medvedev said that the reserve currency position of the dollar and the euro was irreplaceable. In fact, Zhou Xiaochuan was very clear that such ideas of the super-sovereign currency put forward before the G20 Summit were not realistic. Then why did he still say so? The main reason was that China intended to make the super-sovereign currency a tool for participating in the game of large countries. Before the G20 summit in London, the US expressed a 194

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lot of ideas unfavorable for China on various platforms in order to gain more initiative in the meeting. For example, the high deposit rate in some Eastern Asian countries like China was the cause for the financial crisis; China was a currency manipulator in order to stimulate export. Then the action taken by China along with other emerging economies to attack the US by making use of the super-sovereign currency was also a worthwhile effort. The US would definitely oppose the idea of creating a super-sovereign currency because it would damage its interest. The US made use of the dollar's position as the world's reserve currency and issue a large volume of the dollar in order to transfer the costs of its domestic economic stimulus through inflation. Making the US accept the super-sovereign currency is no different from depriving the position of the dollar as a reserve currency and the right of transferring costs. Based on the reason, the US was concerned when China along withother emerging economies struck such an attack.

The Super-sovereign Currency - an ideal rather than a fantasy Many people say that the super-sovereign currency is but a beautiful dream, difficult to be realized. Realistically, its creation will be confronted with enormous resistance because it involves vested interest. However, one thing is sure that it is not a fantasy but a realistic dream. It may take a century to realize the dream. Politically, countries with dominant currencies such as the US are unwilling to give up the benefits of being the issuer of a reserve currency; economically, the only reserve currency transfer happened between the dollar and the pound, whose process went on for decades including 195

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two world wars. Despite all the defects of the dollar, it is still attractive as a reserve currency. However, the reform on the future super-sovereign currency system should be pushed forward in the background of scientific advancement and economic and financial globalization. Its design and implementation should start from the standpoint of a global financial strategy and for China it should be put forward gradually and step by step. The first step includes the internationalization of the RMB and establishing it into a currency as important as the dollar and the euro, which may take 10 to 15 years. The target for this step is to make the RMB one of the leading currencies of the world and to gain its discourse power and decision-making rights. It is reasonable and necessary to change the unreasonable international monetary system, but before a commonlyacknowledged reserve currency plan is reached, a diversified international monetary system with the leading currency as the dollar is the most realistic. That is because the position of a currency in the international monetary system is based on economic, financial as well as political and military strength. In spite of the current financial and economic challenges, once the US economy recovers, comparisons in strength will prove that the central position and rule-making rights of the dollar will experience no fundamental change in the international monetary system. Therefore, in recent years, the international monetary system will not do without the dollar. The rise of the RMB will happen in the context of the dollar still being a leading currency in the international monetary system and the target is to establishing it into a currency as important as the dollar and the euro. That is to say, if the RMB is to change the world monetary system, it should get itself established first.

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The second step is to make the RMB the most important currency in the international monetary system, which may take 30 years. During such a period, regional monetary alliance will be strengthened and 'Three Islands of Stability' will become the basic framework of the international monetary system. In each continent of Europe, Americas and Asia, there will be a corresponding currency zone such as the Euro zone, the dollar zone and the Asian currency zone. There may even be an African currency zone if conditions mature. In the monetary alliance zone, a regional institution with functions of a central bank will be established and it will issue the unified currency and implement unified monetary policies, just like what is happening in the euro zone. The international monetary system will depend on the exchange rates of the regional currencies and national currencies issued by central banks of sovereign nations will be cancelled. The third step is to realize the ideal of establishing a global central bank and putting forward a unified world currency. A general description of the ideal is to establish a super-sovereign global central bank that manages the world's monetary and financial adjustment. Such a central bank should also be a representative governance commission and all member countries must abide by common fiscal disciplines and standards. In the author's opinion, the future world currency can be called Ren Min Bi, which sounds close, simple and supersovereign. It is not like the dollar with a national and regional taste; neither does is sound like World Yuan which is cold. Further research should be done on the standards of the super-sovereign currency.

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When the mortgage crisis broke out, there was a very popular article on the internet titled 'The World Working Together for a World Currency', in which it was written that governor of the world and global bank claimed that the issuing of the world currency is to meet the growing cultural and material demand of the people. Besides, it was also to unite the world's big economies to fight against the worsening economic crisis and from the day on people could exchange for the world currency in banks and start to use it. The world currency would gradually replace national currencies and be used as universal equivalent. It was also predicted that in 2028 all countries would stop using their own currencies and the only currency in circulation would be the world currency. Most readers of the article found it hard to believe, but author of the book was lost in thought. One century ago before the airplane was invented, it was thought that only birds could fly in the air while men could not, but men are actually exploring resources in the space. No one in the world can stop us from dreaming and today's dream could well become reality tomorrow. What exactly will the world currency be like? It may be something unimaginable - electronic money based on identity.

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Periodic Evolvement of Traditional Currencies In traditional currency era, currencies, as universal equivalents, should have existed in the form of objects. There must be an objective intermediate as the foundation for the exchange, be it shell or paper money. With the development of human civilization and expansion of economic scale and trade volume, the form of currency evolved from cows and sheep, shell to paper money. At the same time, the standard currency system also experienced commodity standard, mixed standard and the currency credit standard.

Evolvement of Currency Standards From the stage of commodity currencies, superficially currencies were valuable articles but analyzed carefully the exchange of commodity currencies was not based on the commodities themselves but on its purchase power. That is to say, people accepted commodity currencies not because of their value as a commodity but because of its socially recognized purchase power. In the Gold Coin Standard, money in circulation was gold for all markets and the legal gold content marked and gold quality were the same. Therefore, the Gold Currency Standard is different from credit and is one form of commodity standard. In the Gold Bullion Standard, it was paper money that was in circulation and gold bullions were reserved in currency issuing institutions of different countries. The aggregate legal gold contentof the paper money was larger than gold bullion reserve of currency issuing institutions which promised that all paper money

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holders can exchange for gold freely. In the Gold Exchange Standard, it was also paper money that was in circulation. At that time, only the US still implemented the Gold Bullion Standard and promised that currencies of other countries could be exchanged for the dollar at a fixed exchange rate, indirectly maintaining the gold content of different currencies. There is credit sustaining the Gold Exchange Standard and it is a mixed standard. The purchase power of different currencies totally depends on the promise of the US to the dollar holders in freely exchanging the currency for gold. In the Credit Standard, credit currencies and metal currencies circulated at the same time and had equal value. Credit currencies stood for the purchase credit of metal currencies. However, credit currencies and metal currencies are not the same in that metal currencies provided purchase credit with its own value while credit currencies did that by way of metal currencies. Therefore, the purchase credit of metal currencies is direct and that of credit currencies is indirect. Paper money circulated in the markets without any legal gold content. The purchase power of different currencies depends on the promise of different currency issuing authorities of maintaining the stability of their currencies. Floating exchange rate systems were started among countries and the exchange rates depended on the interest rate parity and purchase parity theory. The evolvement from commodity currencies to credit currencies was in fact guaranteed by currency purchase credit so that commodities could transfer to precious metal, bank credit, and sovereign credit, but in the process the essence of currencies as credit has not changed. Therefore, no matter how the form of future currencies would change, the essential issue would not.

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Today, when the credit of the dollar is questioned by the whole world, some people suggested a return to the Gold Standard which is not based on gold or silver but on other kinds of metal.

Petrodollar Standard The Gold Standard was announced to be ended first in the US. On April 5th 1933, Roosevelt, then the US president, made an order that American citizens should hand in all the gold they had (rare gold and jewelry excluded) and the government would pay at a price of USD 20.67 per ounce. Private gold reserve could end in 10 years in prison and a fine of a quarter million US dollars. From then on, gold started to be depegged from the dollar which became the first paper money controlled and issued without constrains by international bankers. Without gold as a sustaining point, the dollar prices in the international market were very unstable. To stabilize its prices, international bankers chose oil which every country had sufficient supply of as a new sustaining point. First by controlling Saudi Arabia where oil was only allowed to be transacted in dollar, the prices of the dollar were stabilized. In the 1970s, the US reached an unshakable agreement with Saudi Arabia that the dollar was to be the only pricing currency for oil, which was agreed upon by other OPEC member countries. From then on, any country that wanted to do oil transactions had to make the dollar the reserve currency. Then the US took control of OPEC and its member countries had to proceed transactions in dollar which became another sustaining point for the currency. From some point, the dollar now is the 'oil standard'. And the dollar used to purchase oil then returns to the US by way of America's investment in OPEC and oil export countries. Such a process of 'petrodollar backflow' has been perfectly

OPEC OPEC is the Organization of the Petroleum Exporting Countries. It is an oil cartel whose mission is to coordinate the policies of the oil-producing countries. The goal is to secure a steady income to the member states and to secure supply of oil to the consumers. OPEC is an intergovernmental organization that was created at the Baghdad Conference on September 1014, 1960, by Iraq, Kuwait, Iran, Saudi Arabia and Venezuela. Later it was joined by nine more governments: Libya, United Arab Emirates, Qatar, Indonesia, Algeria, Nigeria, Ecuador, Angola, and Gabon. OPEC was headquartered in Geneva, Switzerland before moving to Vienna, Austria, on September 1, 1965.

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completed and the dollar issuance bank (the Fed, controlled by the New York central bank) is able to strictly control the dollar and t h e w o r l d e c o n o m y. The recycling of the petrodollar guaranteed the export of the dollar through a large volume of current account deficit and ensured the capital account surplus so that trade and fiscal deficit could be supplemented, which played a key role in supporting economic growth in the US. After the collapse of the Bretton Woods system, the dollar was depegged from gold, but it still retained absolute advantages over other currencies and the most important reason is that international oil transactions are priced in dollar and so are some raw materials. The price trend of the international oil market was decided by the spot and futures market of the oil. There are five spot markets in the world, namely Northwestern Europe, the Mediterranean Sea, the Caribbean Sea, Singapore and the US. The three futures markets are New York Commodity Exchange, London Commodity Exchange, and Tokyo Commodity Exchange which rose in recent two years. Currently, the international oil trade is mostly priced according to standard oil in major regions. The final settlement price is based on the spot or future price of standard oil a while after the delivery or B/L date plus rise of the premium. The future market price play a major role in the international oil pricing and the dollar is used in the pricing and transactions.

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A New Era Connecting the Past with the Future After the financial crisis broke out in 2008, the international monetary system was confronted with an RMB era. The rise of the RMB is inevitable in history and such a trend cannot be stopped. In fact, many economic policies of China and the US are synchronous, which is actually a representation of their increasingly close relationship. In this round of economic recovery, China and the US will be interdependent and the alliance of the RMB and the dollar will lead the international monetary system to an RMB-dollar era. Now the Americans are aware that without China the financial crisis might never come to an end; the Chinese are also aware that only by rapidly integrating into the international monetary system can they have bigger discourse power and be qualified for exploring the reform of the system and making plans for the future. Or else, all the dream would be in vein and no one would pay attention to the Chinese RMB. More noticeably, the internationalization of the RMB is proceeded with the rapid development of high-technology, which is different from the internationalization of other major currencies. Advantages of a late comer have given us unlimited room for imagination. On the one hand, the RMB will gradually become a global currency; on the other, the development of electronic currencies will unleash the potential of the RMB internationalization and make it fly higher and further.

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This is a new era connecting the past and the future, which marks a turning point of China as a developing country with opportunities. It can be predicted that whatever the future international monetary system may be like, it will be directly linked with the RMB internationalization.

The Conception of One Currency In fact, the expectation of One Currency is not just fantasy of netizens and economists have long researched on the topic. In 1961, Mundell, Father of the euro, published an article in American Economic Review and put forward the theory of Optimal Currency Area, which refers to two geographically close areas that can form a currency alliance that implements fixed exchange rate regime internally and floating exchange rate regime externally. Mundell went further by saying that countries and regions with a high mobility of productive factors especially labor can form an optimal currency zone with a single currency. Based on the theory, in the 1990s, Emerson and Gross, after further research, put forward the idea of 'One market one currency'. In their mind, with the development of globalization, currency competition driven by the market has changed the spacialcomponents of monetary relations and national monetary monopoly was questioned. The choice of currencies in different monetary zones should be decided by the market and the size of the monetary zone should be divided by transaction network. At this time, currencies, as a tool of exchange and value, can start to serve the market and no matter how large the market is and how many sovereign 206

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nations are involved, as long as it is a unified market (the flow of factors are not controlled), a single currency is the best choice. If the economic globalization develops at such a speed, it is not impossible for the world to develop into a unified market and a single world currency is also a possibility. The idea of 'One World One Currency' is not unrealistic. When Zhou Xiaochuan put forward the suggestion of the Super-sovereign Currency before the G20 summit in 2009, the idea was criticized by a lot of people as too early and a utopian. However, the author of the book does not think so. When Marx and Engels were thinking about Socialism and Communism, there was no such a country. However, their thoughts pointed out a path to a bright future for many countries including China. Theories are based on reality but higher than reality, so it can lead the reality and the direction of the future. If a new idea is immediately denied, how can theories develop? When most people are thinking about the reality and a few are looking up at the road ahead, such reasonable ideas should be listened to in spite of different ideas on the future path. Based on the author's conjecture, the RMB internationalization will be fully realized in 30 years with the euro, the dollar and the RMB as leading international currencies. With scientific advancement, global economic and financial integration, the three leading currencies will be put into agenda and the whole world is calling for an era of 'One Currency'. Therefore, it is not too early to talk about the unification of currencies. The author predicts that after the unification of the three currencies, the name of the future currency will become a focus of attention. To name it 'euro', it will

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be too regional and will not be accepted; to name it 'dollar', such a name has been associated with 'money of rich people and developed countries' with regional and national imprints; eventually the most acceptable currency in the world is the RMB as 'money of the people' is the most accurate meaning of a unified global currency. The world economy in the same monetary system is a huge market with rich material products. There are various connections between countries and no country will be able to exist on its own. People will pay for their bills and go shopping with the unified currency called 'people's currency' and how much to be issued will be controlled by the world's central bank called 'People's bank'. Then paper money will be rarely in use and people can use electronic money wherever they go. Financial researchers will no longer research on exchange rates but on the clearing, distribution and allocation of 'people's money'. However, such an ideal can only be realized on condition of world peace and stable development. If the two world wars were to happen again, the world's economic development will be destroyed, not to mention the currency unification. Besides, the improvement and transparency of political, legal and regulatory systems are also necessary conditions.

The Future International Currency Before the 20th century, metal currencies were popular and it was hard for people to imagine that metal currencies would get out of circulation. With the change of time and scientific development, forms of currencies may experience fundamental changes and even 208

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disappear.

Is the Future a World of the Carbon Standard? In 2006, David Miliband, then the Minister of Environment, put forward an individual carbon transaction plan: 'Imagine that in a country with carbon currency standard there would be pounds and carbon points in our bank accounts and when we bought electricity, natural gas, and fuels, we could use carbon points and pounds.' In his conjecture, the government should allocate some carbon points to individuals for buying gas and electricity. When individuals use all their carbon points up, they can buy from those that still have some left. However, such an exciting plan failed because of its complicated operation and management when Brown became Prime Minister and Miliband became Minister of Foreign Affairs. In December 1997, the third Conference of the Parties was held in Kyoto in Japan, where representatives from 149 countries and regions passed the Kyoto Protocol aiming to limit the greenhouse gas emissions for developed countries that led to global warming. The Kyoto Protocol came into effect in 2005 and it specifies in international laws the carbon dioxide emission rights for developed countries in the future development. Since then, carbon has started to be traded as a commodity. The so-called 'commercialization of carbon' refers to control on the greenhouse gas emissions, including the emission rights of carbon dioxide as exchangeable unit for transfer or selling. Therefore, the right of transacting the emission of greenhouse gases becomes the most distinctive commercial feature of carbon transactions. The emission rights for carbon dioxide promote trading parties to advance clean development mechanism, united implementation mechanism, and international emissions

Low-carbon Economy A low-carbon economy (LCE), low-fossilfuel economy (LFFE), or decarbonised economy is an economy that has a minimal output of greenhouse gas (GHG) emissions into the environment biosphere, but specifically refers to the greenhouse gas carbon dioxide. GHG emissions due to anthropogenic (human) activity are increasingly either causing climate change (global warming) or making climate change worse. Scientists are concerned about the negative impacts of climate change on humanity in the foreseeable future. Globally implemented LCEs are therefore proposed by those having drawn this conclusion, as a means to avoid catastrophic climate change, and as a precursor to the more advanced, zerocarbon society and renewable energy economy. In terms of large industrialized nations, mainland France, due primarily to 75% of its electricity being produced by nuclear power, the country has the lowest carbon dioxide production per unit of GDP in the world and it is the largest exporter of electricity in the world, earning it approximately 3 billion euros annually in sales.

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and trading mechanism according to international rules so as to achieve the emission cut target set in the UN Climate Change Framework Convention. In 2006, some developed countries including Japan and the EU were not able to meet the target. Therefore, according to Rule 12 of the Kyoto Protocol, these developed countries should purchase CER (carbon emission reduction) from developing countries that do not shoulder emission cut obligations. The pricing of carbon dioxide by developed countries, purchasing carbon dioxide emission quota, and the establishment of carbon dioxide emission right transaction system together are called 'Carbon Standard' by the EU and Japan. The Carbon Standard promoted the being of an international carbon market.

Carbon Emission Trading Carbon emissions trading is a form of emissions trading that specifically targets carbon dioxide and it currently constitutes the bulk of emissions trading. This form of permit trading is a common method countries utilize in order to meet their obligations specified by the Kyoto Protocol; namely the reduction of carbon emissions in an attempt to reduce (mitigate) future climate change.

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At the end of 2005, carbon dioxide emission right futures in the EU emission trading system got listed on the European Climate Exchange. Such transactions are also going on in the Chicago Climate Exchange. Currently, the French Powernext Carbon is the main spot exchange market for European carbon dioxide emission quota. Based on international laws, carbon transactions are processed according to purchase contracts or ERPA (Emission Reduction Purchase Agreement). One party of the contract pay for greenhouse gas emission quota from the other party and such a quota is used to reduce greenhouse effects in order to achieve the emission target. Among the six greenhouse gases to be cut from emissions, carbon dioxide emission is to cut by the highest degree. Therefore, such a transaction is calculated with each ton of carbon dioxide as a unit and thus called carbon transaction. Basic carbon transaction unit in the Kyoto Protocol includes AAUs specified by the international emission trade mechanism, CERs in the clean development

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mechanism, and ERUs in the united implementation mechanism. Besides, in regional, national, and subnational level transaction systems, there are abatement certificates like the EUAs and GCAS. Carbon transactions are becoming more diversified and once new national and sub-national carbon transaction markets are established, new transaction units appear, which we call 'carbon credit'. After the Kyoto Protocol came into effect, global carbon transaction markets experienced exploding growth and the transaction volume grew from 1.6 billion tons in 2006 to 2.7 billion tons in 2007 by 68.75% with an even more rapid growth of deals' volume. The market value of the global carbon transaction market was 40 billion euros in 2007, representing a growth of 81.8% over the 22 billion euros in 2006. The market value of the global carbon transaction market for the first half of 2008 was equal to that of the whole year of 2007. The global carbon transaction market still remained strong impetus when the American mortgage crisis led to global economic recession and financial crisis. According to estimations of Point Carbon, the transaction volume of carbon dioxide for 2008 amounted to 4.2 billion tons, a growth of 56% and if calculated by the carbon transaction price of 15 euros per ton, the transaction sum was equal to 63 billion euros. After several years' development, the carbon transaction market is becoming increasingly mature and the size of participant countries is expanding with deepened multilevel market structure and increasingly complicated financials. Japan and the EU are active supporters of the Carbon Standard and international carbon market construction, aiming to challenge the dollar standard because carbon transactions are settled in euro in European countries and in yen in Japan, which is to weaken the position of the dollar in local markets. The development of carbon 211

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standard has attracted attention from the US government and is becoming a new focus among the US, Japan and the EU. Today the climate issue is no longer simply concerning the environment because by fighting against climate change, a new global monetary system may be established. Therefore, a lot of countries seem to be confident in the prospect of the system. Take the US for example: it is analyzed that the US may take the opportunity to transform the Oil Standard into the Carbon Standard. The oil is a commodity priced by the dollar and changes in the oil prices are related to the position of the dollar. Without this round of sharp rise and drop, the US may not accept the idea of developing new energies. Maintaining the Oil Standard costs too much and it is not a proper timing to stick to the standard. Therefore, 'the US may transfer its focus to energy saving and emission abatement and make the dollar an international currency for new transactions. ' For China, once the RMB is internationalized, how to hedge against the risks of exchange rate fluctuations should be considered. It is similar to the situation that when the dollar experienced depreciation recently, the international oil price in dollar continued to go up, helping to retain the position of the dollar as the international reserve currency. Research should be done on how to fight against such risks once the RMB is internationalized. Sun Lijian, deputy head of School of Economics of Fudan University, thinks that carbon dioxide emission trading for developing countries will be a new area for China to develop the RMB Standard. In his opinion, carbon emission is just one example and as long as carriers of the RMB Standard can be found it is worth it to operate derivatives. Regulators should enhance their experience rather than give up such attempts just 212

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because the western world had some problems with their mature and complicated derivatives markets. Currently speaking, disadvantages overweigh advantages if the Carbon Standard were to be implemented in China now. In 2009 before the G20 summit was held, Steven Chu, the American Minister of Energy, claimed in a scientific group conference in the House of Representatives that if no compulsory emission abatement measures were taken in other countries, the US would levy carbon tariff, which will stimulate fair competition. Carbon Tariff refers to levying special carbon dioxide emission tariff on high energy-consumption import products. This concept was first raised by the previous French president Chirac, aiming to promote EU countries to levy import tax on countries that do not fulfill the commitments in the Kyoto Protocol. Or else, when EU Emissions Trading Scheme is implemented, enterprises in EU countries especially those in steel industry and high energy-consumption industry will face unfair competition. If Europe, the US and Japan are united to levy carbon tariff on China, made-in-China products will lose its low- cost advantage. Take a simple example, calculated by the carbon emission method the price of electricity will double and the cost of silicon used in solar panel will be over 300 yuan. There will be no advantages for China new energy enterprises over their American counterparts. It can be imagined that once carbon tariff is levied in the US, there will be a disaster and a trade war, which is against certain rules of the WTO. Therefore, China should treat words on the carbon currency in western countries carefully.

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Future Currency Forms Our diligent and wise ancestors established a deeplyrooted concept while looking for various universal equivalents: no matter what you need, you must purchase with money, be it shell, gold or a piece of paper. The forms of currencies experienced diversified, rich and interesting changes in the process of several thousand years. Even now when paper currencies are developed, the exploration of new currency forms is still going on.

WTO The World Trade Organization (WTO) is an organization that intends to supervise and liberalize international trade. The organization officially commenced on 1 January 1995 under the Marrakech Agreement, replacing the General Agreement on Tariffs and Trade (GATT), which commenced in 1948. The organization deals with regulation of trade between participating countries; it provides a framework for negotiating and formalizing trade agreements, and a dispute resolution process aimed at enforcing participants' adherence to WTO agreements, which are signed by representatives of member governments and ratified by their parliaments. Most of the issues that the WTO focuses on derive from previous trade negotiations, especially from the Uruguay Round (19861994).

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For example, according to a report from an American broadcasting company, residents in the Ithaca community in New York can use their own community currency for consumption, which is called 'hour'. They spend 'hour' buying daily articles, paying for restaurant bills and also for movie tickets. In the US, to ensure independence, many communities have their own currencies which they encourage their residents to use and Ithaca is one of them. In Ithaca, people can exchange dollar for 'hour' in any grocery store and 'hour' is calculated by the average income per hour in that area, which is 10 US dollars in Ithaca. For example, a construction worker may get paid for seven hours per day and a barber may get paid by one hour per day. There are five kinds of face value for 'hour', from one eighth to two and altogether 8500 'hours' are in circulation in the community, equal to USD 85,000. Since the use of the special currency 'hour' in Ithaca in 1991, local commercial developments have been promoted, resulting in less reliance on import commodities and increased minimum wages. Officials managing the community currency pointed out that the local currency is the best way for maintaining local circulation of resources. At the same time, he also pointed out that naming a currency unit as 'hour' is a good way to encourage people to think about the value of money. However, 'hour' is now only used in Ithaca

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rather than nationwide in the US. Another example can be found in Japan that to improve social security system and help some lonely senior citizens enjoy the rest of their life, the currency of time is used to a certain degree in some nursing homes, where young and middle-age volunteers are paid by such a currency to take care of old people. When these volunteers grow old, they can spend such money on being taken care of with the same amount of time. In the contemporary society, when people's material life has been greatly satisfied, a lot of crimes have been made to pursue more material wealth. Therefore, money is often imprinted with the word 'awful'. However, the methods of exchanging time for resources in Ithaca and Japan provide people with another perspective of universal equivalent, establishing a relationship concept transcending interest-driven and the negative image of money has gradually blurred. Compared with experimental currency circulating in small areas, electronic money which has already entered our life on a large scale is worth more attention and research because it will be one of the future currency forms. Electronic currency as the newest currency form, since its invention in 1970s, has been used more widely. It is a kind of credit currency based on the development of online credit. In the exchange of financial information through online banking channels, electronic currency, compared with other forms of currency, has advantages of low store, circulation, standardization, application costs and thereby especially good for small-amount of online procurement. Electronic currency, with no technical problems such as store, circulation, and application of intangible currency, has huge potential. The American Mark Twain Bank is the first in the US to provide electronic currency business and had already gained ten thousand such customers before May 1996.

Derivatives A derivative is a financial instrument which derives its value from the value of underlying entities such as an asset, index, or interest rate-it has no intrinsic value in itself. Derivative transactions include a variety of financial contracts, including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards, and various combinations of these. In practice, derivatives are a contract between two parties that specify conditions (especially the dates, resulting values and definitions of the underlying variables, the parties' contractual obligations, and the notional amount) under which payments are to be made between the parties.[10] [11] The most common underlying assets include commodities, stocks, bonds, interest rates and currencies. There are two groups of derivative contracts: the privately traded over-thecounter (OTC) derivatives such as swaps that do not go through an exchange or other intermediary, and exchange-traded derivatives (ETD) that are traded through specialized derivatives exchanges or other exchanges.

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Time Banking Time banking is a pattern of reciprocal service exchange that uses units of time as currency. It is an example of a complementary monetary system. A time bank, also known as a service exchange, is a community that practices time banking. The unit of currency, always valued at an hour's worth of any person's labor, used by these groups has various names, but is generally known as a time dollar in the USA and a time credit in the UK. Time banking is primarily used to provide incentives and rewards for work such as mentoring children, caring for the elderly, being neighborly-work usually done on a volunteer basis-which a pure market system devalues. Essentially, the "time" one spends providing these types of community services earns "time" that one can spend to receive services. As well as gaining credits, participating individuals, particularly those more used to being recipients in other parts of their lives, can potentially gain confidence, social contact and skills through giving to others. Communities therefore use time banking as a tool to forge stronger intracommunity connections, a process known as "building social capital". Time banking had its intellectual genesis in the USA in the early 1980s. By 1990, the Robert Wood Johnson Foundation had invested USD 1.2 million to pilot time banking in the context of senior care. Today, 26 countries have active Time Banks. There are 250 Time Banks active in the UK and over 276 Time Banks in the U.S.

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Only a century ago, people could hardly imagine that now we would be able to pay online and get commodities at home by only clicking the mouse. Similarly, we would not be able to imagine the way people will shop in a century - they probably will not even need to click the mouse but simply use their brain in order to pay. People now pay more and more attention to the arrangement of time and with the rapid development of scientific technology, people living in the cities are calculating their time by second, so looking for more convenient ways of currency services will inevitably be the future trend of the world currency. We can predict that within the next century, the electronic currency will replace paper money and a leap from commodity currency, to gold currency, to paper currency and to electronic currency will eventually be achieved. The electronic currency here refers to a globally unified and super-sovereign currency. The Basel Banking Regulatory Commission (established in 1974 at the suggestion of 10 central bank governors and members of banking regulatory authorities with the main mission of discussing banking regulations) defined the electronic currency as the following: an electronic store of monetary value on a technical device or the internet that may be widely used for making payments. Such a definition emphasizes the direct payment function of electronic currency, but it is not direct transfer from commodity buyers to financial institutions but an online payment method that when commodity buyers and sellers get in touch clearing can be done in real-times and through electronic techniques. People may be wondering how we can transit from a paper currency era to an electronic currency era. Developed countries such as the US, Japan, and the UK have started such tests, among which the Digicash in the US is ready for transaction. Consumers will

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first need to exchange their credit cards or cheques for digital currency in the Digicash company and deposit it into the Digicash bank. Sellers also need to establish ties with Digicash and start their own accounts there. When consumers shop online, they can use the passwords Digicash gives them and withdraw money through emails from the Digicash bank. After the bank confirms the identity of the person withdrawing money, an electronic signature can then be added to the digital currency and transmitted to consumers. Consumers pay sellers with the digital money from the bank and sellers then exchange it for real currency in the bank. It can be seen that Digital actually created a visual circulation form of cash and when people use Digital electronic currency online, it is as convenient as paper money used in real life. Therefore, the Digicash electronic currency system is very attractive with over five million customers and 25 online producers. The British Encyclopedia Publishing House and MIT are users of such a payment. Online consumption has also made great progress in China and online shopping websites including taobao. com, alibaba.com, amazon.com.cn, dangdang.com are very popular. Electronic currency forms such as credit card, IC card, electronic cash, digital cash and electronic purse and cheque already exist, but real electronic currency era has not come because in that era the end of electronic transactions will also be digitalized. At that time, people will no longer use paper money or coins for payment but electronic currency. Therefore, real electronic currency era is when such currency becomes an independent currency in circulation. By then, electronic currency will change our traditional ways of spending money and more importantly make us review our 'economic existence'.

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I have a monetary dream that one day, no matter which country you are from and wherever you go, you will only need to take with you one identity certificate in order to shop, travel, and consume anywhere in the world. The whole world is using the same electronic currency which is not touchable but has the same value of gold and silver. There will be no need for exchange, cash cap to be brought into or out of borders, or complicated procedures. The world will become so simple, efficient and effective and people living in the earth village are harmonious and friendly. Let us all expect such a day to come.

Trade Dependence Tr a d e d e p e n d e n c e i s a l s o c a l l e d 'dependence ratio of trade' and 'foreign trade coefficient', which is an important indicator of a country's openness. Trade dependence = total volume of foreign trade / gross national product (GNP). The change of its proportion means the changed position of foreign trade in the national economy. Trade dependence can also be expressed in the following way: trade dependence = total volume of foreign trade / gross national income. Foreign trade dependence can be divided into the following two categories, that is, export dependence and import dependence. (Export dependence = total export volume / gross national product (GNP); Import dependence = total import volume / gross national product (GNP))

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References

References 1. Dominick Salvatore: The Euro, the Dollar and the International Monetary System, Fu Dan University Publishing House, 2007 2. Zhang Zhengjiang: From the Pound to the Dollar: Transfer of International Economic Dominance, Renmin Publishing House, 2006 3. Zhang Lizhen: Exploration of the RMB Internationalization, Renmin Publishing House, 2006 4. Chen Yawen: Experiences and Effects of the Euro, Economic and Scientific Publishing House, 2006 5. Lu Shiwei: The Dollar Dominance and the International Monetary Structure, China Economy Publishing House, 2006 6. Asian Development Bank: The Monetary and Financial Integration of East Asia, Economic and Scientific Publishing House, 2005 7. Wu Wenxu: On the European Monetary Alliance and the Euro, Southwestern University of Finance and Economics Publishing House, 2003 8. Yūji Kikuchi ( 菊 地 悠 二 ): The Yen Internationalization, Renmin University of China Publishing House, 2002 9. John ﹒ F ﹒ Joan: The History of Money, The Commercial Press, 2002 10. Gu Lishu, Wang Kaiqing: 'The Feasibility and Longevity of the RMB Internationalization', Exploration on Economic Issues, 2009 Issue 03 11. Yu Weifeng: 'Look Back on the RMB Exchange Rate History, Influences, and Trend Analysis', Journal of Hunan College of Finance and Economics, 2008 Issue 03 12. Zhou Jixing: 'Research on the RMB Free Exchange Conditions', Journal of Zhongshan University, 2005 Issue 03

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13. Xu Huiling: 'Necessity and Conditions Analysis of the RMB Free Exchange', Economist, 2005 Issue 11 14. Zhang Hongmei, Liu Xuemei, Yang Yong: 'Revelations and Lessons for the RMB Internationalization from the Euro Internationalization', Industrial Technology Economics, 2008 Issue 12 15. Mei Jian: Research on the Birth of Monetary Competition and Its Influence, Economist, 2004 Issue 11 16. Chen Yulu: Monetary Competition in the East Asia Monetary Cooperation, International Finance Research, 2003 Issue 11 17. Liu Junmin, Wan Minhua: The Best Way to Spend China's Foreign Exchange Reserve Is to Sustain the RMB Internationalization, China Opening Herald, 2009 Issue 02 18. He Guohua: Measure of the Internationalization Degree of the Chinese Finance Market, Statistics and Decision, 2008 Issue 07 19. Yang Qin, Zhao Yong: Monetary Integration in Asia, Times Finance, 2008 Issue 09 20. Lu Zhengwei: 'The RMB Internationalization: Historic Trends and Policy Choice', China Finance, 2009 Issue 10 21. Li Shuang: Ways of the RMB Internationalization, Consume Guide, 2008 Issue 09 22. Han Ying: 'Analysis of the RMB Full Convertibility Conditions', Contemporary Economy, 2008 Issue 12 23. Geng Feng, Wu Jun: Review of the Asian Monetary Cooperation Led by the RMB from the Perspective of Coordinative Policies in the Monetary Integration in Germany 24. Huang Zemin: Advancing the RMB Internationalization Step by Step, International Finance, 2009 Issue 05 25. Ding Yifang: 'the RMB Free Exchange Should be carefully Taken Care of', International Economic Review, 2003 Issue 05 26. Gao Shengzhi: 'Advancing the RMB Internationalization by Learning from the Yen Internationalization', Western Finance, 2007 Issue 12

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References

27. Tong Niancheng: 'On the Monetary Strategy of the RMB Internationalization', Consume Guide, 2009 Issue 08 28. Qiao Guiming: Tests and Policy Choices in the Process of Monetary Replacement of China's Capital Account Opening, International Finance Research, 2003 Issue 11 29. Qiu Zhaoxiang, Su Qin: Monetary Competition, Monetary Replacement and the RMB Regionalization, Financial Theory and Practice, 2008 Issue 02 30. Zhou Nianli, Shen Minghui: New Progress of the RMB Internationalization from the Perspective of Currency Swaps, International Finance, 2009 Issue 03 31. Ma Ronghua: Discussion on the Promotion of the RMB Overseas Circulation Scale Strategy, Journal of Changchun College of Finance, 2009 Issue 01 32. Jia Jian, Ge Zhengcan: Thoughts on China's Currency Swap Agreement, Southwestern Finance, 2009 Issue 04 33. Ma Rentao, Zhou Yongkun: 'Currency Swap: Participation in the International Financial Rescue and Effective Tools in Promoting the RMB Internationalization', China Finance, 2009 Issue 04 34. Ren Yanxia: Thoughts on China's Signing Currency Swap Agreement in Financial crisis, Consume Guide, 2009 Issue 08 35. Yin Yahong: Estimation on the RMB Cash Volume in Circulation in Hong Kong: 1998-2006, Economic Review, 2009 Issue 02 36. Lu Yuntian: the RMB Internationalization in the Financial Crisis, Decision and Information, 2009 Issue 05 37. Ma Ronghua, Rao Xiaohui: Estimation on the RMB Overseas Demand, International Finance Research, 2007 Issue 02 38. Chen Wei: On the Reform Ways of the International Monetary System after the Financial Crisis, Economist, 2009 Issue 05 39. Zhang Yun, Liu Junmin: Evolvement and Reconstruction Principles of the International Monetary System, Shanghai Finance, 2009 Issue 01 40. Li Yang: the International Monetary Reform and Opportunities for China, China

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Finance, 2008 Issue 13 41. Li Han, Ji Qing: Thoughts on the Super-sovereign Monetary Ideas, Commercial Culture (Academic Edition), 2009 Issue 05 42. Ren Liang: Four Technical Difficulties in Implementing Super-sovereign currencies, China Business News, 2009 April 1st 43. Ma Song, Wang Dong: Future Development of Money, Commercial Culture (Academic Edition), 2008 Issue 01

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Postscript

Postscript The RMB is the kind of money that we cannot do without. The RMB internationalization is a topic that the Chinese are both unfamiliar with and expecting. In the process of the RMB internationalization, what changes will enterprises and individuals be confronted with? And how will they be influenced? What preparations should we make and what experiences should we learn from? With these questions, I have done some research and written this book. This book is a dream of my mother and it is also a book written for myself because I have always cherished a dream that the Chinese RMB will one day become the global RMB. In the process of writing this book, I received guidance from my father who used And silver, money of the Republic of China, token money in liberated areas, rouble, Japanese yen, dollar and the five series of the RMB. We went through the Chinese monetary history together and looked forward into its future. Due to my limited knowledge, lack of working experiences in international finance, and rapid development of the RMB international process, some ideas and views in the book are debatable, for which I am seeking forgiveness from readers. To present a whole picture of the monetary internationalization, the book has made a lot of quotations from domestic and international experts. Please contact with me concerning copyrights and your understanding is appreciated here. I also received enormous help from graduate students Zheng Meiling and Sun Jie in collecting and arranging materials and Doctor Zhao Li also offered his precious advice. Hereby I want to extend my thankfulness to them as well as to Yan Li and An Kang for their understanding and support. I especially want to thank Director Wang Yanhao, Editor Chen Yin, and Manager Pan Fei from the PR and strategic department in China Financial and Economic Publishing House for their support. Finally, I want to express my heartfelt thanks to readers for you long-term care.

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Author's Bio Sun Zhaodong is working in the head office of the world's second largest bank by market capitalization and has fifteen years' experience in investment banking and commercial banking. He is also the author of several other best-sellers, including The Mortgage Crisis, The Vietnam Crisis, and The National Bankruptcy, among which The Mortgage Crisis was selected as the most influential 300 books since reform and opening up and was also named in the TOP 10 books of the Year 2008 by CIO Weekly.

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This book is the result of a co-publication agreement between China Financial and Economic Publishing House (China) and Paths International Ltd (UK). ----------------------------------------------------Renminbi: The Internationalization of China’s Currency Author: Zhaodong Sun Translated by: Yong Xie ISBN: 978-1-84464-317-2 Copyright © 2014 by Paths International Ltd (UK) and by China Financial and Economic Publishing House (China). All rights reserved. No part of this publication may be reproduced, translated, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying or otherwise, without the prior permission of the publisher. The copyright to this title is owned by China Financial and Economic Publishing House (China). This book is made available internationally through an exclusive arrangement with Paths International Ltd of the United Kingdom and is only permitted for sale outside China.

Paths International Ltd Published in the United Kingdom www.pathsinternational.com