Structural conditions for currency internationalization: international finance and the survival constraint

Abstract

This paper examines the relationship between currency internationalization and economic structure. It argues that the hierarchical and asymmetric architecture of the international monetary system imposes a ‘survival constraint’ upon non-center countries that obliges them to generate net inflows of the international center currency to finance their payment commitments. It outlines why management of this constraint has historically been associated with a development approach that prioritizes exports and investment over domestic consumption and illustrates how this development approach creates economic structure subject to path dependence and network effects, which perpetuates the role of non-center countries as users of the international currency and the role of the center country as supplier of the international currency. On this basis, it is argued that currency internationalization cannot be pursued in isolation from broader economic policy, but rather requires economic structural change, political mediation and accommodative balance of payments management. Specifically, raising the international profile of the Chinese renminbi would require rebalancing of the Chinese economy towards domestic demand, whereas the status of the US dollar is intimately intertwined with the international openness of the US economy.

Keywords:

• International currency
• international monetary system
• economic structure
• economic development
• liquidity flows
• survival constraint

Acknowledgements

The author would like to thank Daniel Alpert, Ben Bansal, Hyoung-kyu Chey, Dirk Ehnts, Lawrie Hunter, Tomohiro Kinoshita, Jan Kregel, Soheon Lee, Alisa Schubert Yuasa, Rebecca Simms, Nathan Tankus, Naoyuki Yoshino, the editors and the anonymous reviewers for many helpful comments and suggestions during the preparation of this paper.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1 Conversely, the center country shifts exchange rate risk abroad and provides its financial institutions with a competitive edge internationally, given superior access to center currency funding and lower hedging requirements. A system structured around the center currency thereby directly supports the commercial interests of the center country.

2 For macroeconomic sectoral balances, see Minsky (2008), Pettis (2013b), and Koo (2014).

3 The similarities between the Asian Development Model, the theories of List (1909) and development economics after the Second World War (Chang, 2003; Nurkse, 1954; Sen, 1960) are striking. Lin (2010) provides an attempt to integrate this strand of development economics with more market-focused, liberalist traditions.

4 It is worth bearing in mind that these graphs do not capture intra-sectoral product diversification and provide no indication of net balances. The graphs should consequently be treated as a rough approximation of actual trade patterns only.

5 The author thanks Naoyuki Yoshino for highlighting the relevance of the European Monetary System in this context.

6 Evidence for the continued relevance of these network effects within the context of the internationalization of the Chinese renminbi is presented in Chey (2015): ‘Moreover, when Korean firms use the [renminbi] for trade settlement with their Chinese trade partners, they usually have to handle double exchange risks, both for the [renminbi] and for the dollar, as many still have to continue using the dollar with their other trading partners’.

7 See Westphal, Rhee, and Pursell (1981) on the relatively marginal role foreign direct investment played in the development of the South Korean economy.

8 Exchange rate depreciation and inflation could theoretically decrease the value of US dollar-denominated assets for foreigners in terms of their currencies. However, recent deviations in forex and cross-currency swap markets indicate that demand for US dollars remains strong (Sushko, Borio, McCauley, & McGuire, 2016), while secular stagnation renders inflation an unlikely threat.

9 See Takagi (2011) on the international status of the Japanese yen, and Schenk (2013) on the international status of the British pound.

10 Subacchi (2017) and Prasad (2016) provide comprehensive overviews of the policies and strategies adopted to promote renminbi internationalization.

11 It is worth pointing out that, since China continued to settle exports mostly in US dollars, this strategy also reinforced the centrality of the US dollar.

Additional information

Funding

The financial support of the Japanese Monbukagakusho scholarship is gratefully acknowledged.

Notes on contributors

Stefan Angrick

Stefan Angrick was a Monbukagakusho scholar at the National Graduate Institute for Policy Studies (GRIPS) in Tokyo while working on this paper. He has also held positions with the Asian Development Bank Institute and Keio University, among others. The views expressed here are his own and do not necessarily reflect those of the organizations he has been associated with.