China in the World Economy

China in the World Economy Lawrence J. Lau, Ph. D. Ralph and Claire Landau Professor of Economics, The Chinese Univ. of Hong Kong and Kwoh-Ting Li Professor in Economic Development, Emeritus, Stanford University Institute of Global Economics and Finance The Chinese University of Hong Kong 16th March 2012 Tel: (852)3710-6888; Fax: (852)2104-6938 Email: lawrence@lawrencejlau.com; WebPages: www.igef.cuhk.edu.hk/ljl

Outline Introduction China in the World Economy The Internationalisation of the Renminbi Concluding Remarks Lawrence J. Lau 2

Introduction China has made tremendous progress in its economic development since it began its economic reform and opened to the World in 1978. China is currently the fastest growing economy in the World averaging 9.8% per annum over the past 33 years. It is historically unprecedented for an economy to grow at such a high rate over such a long period of time. Between 1978 and 2011, Chinese real GDP grew almost 22 times, from US$344.8 billion to nearly US$7.5 trillion (2011 prices) to become the second largest economy in the World, after the U.S. By comparison, the U.S. GDP (approx. US$15.1 trillion) was 2 times Chinese GDP in 2011. Lawrence J. Lau 3

Chinese Real GDP in US$ Since 1952 (2011 Prices) Billions US$ Chinese Real GDP since 1952, in 2011 prices 7,500 7,000 6,500 6,000 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Lawrence J. Lau 4 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Introduction Despite its rapid growth, in terms of its real GDP per capita, China is still a developing economy. Between 1978 and 2011, Chinese real GDP per capita grew 15.5 times, from US$358 to US$5,555 (in 2011 prices). By comparison, the U.S. GDP per capita (approx. US$48,236) was 8.7 times Chinese GDP per capita in 2011. Lawrence J. Lau 5

Real Chinese GDP per Capita in US$ Since 1952 (2011 Prices) 6,000 Real Chinese GDP per Capita since 1952, in 2011 prices US$ 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Lawrence J. Lau 6 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Introduction While many problems have arisen in the Chinese economy within the past decade for example, income disparity--both inter-regional and intra-regional--uneven access to basic education and health care, environmental degradation, inadequate infrastructure and corruption it is fair to say that everyone has benefited from the economic reform and opening since 1978, albeit to varying degrees, and few want to return to the central planning days. The Chinese Government leaders have also demonstrated their ability to confront important challenges and solve difficult problems, for example, the earthquakes, the 2007-9 global financial crisis, and the European sovereign debt crisis. China is one of the very few socialist countries that have made a smooth transition from a centrally planned to a market economy. It is a model for other transition economies Lawrence J. Lau such as Vietnam and potential 7 transition economies such as Cuba, Laos, and North Korea.

Thirty years of Chinese Economic Reform Growth Rates percent per annum Period I Period II 1952-1978 1978-2011 Real GDP 6.15 9.79 Real GDP per Capita 4.06 8.66 Exports 9.99 17.32 Imports 9.14 16.63 Inflation Rates (GDP deflator) 0.50 4.24 1952-1978 1978-2010 Real Consumption Lawrence J. Lau 5.05 8.88 8 Real Consumption per Capita 2.99 7.75

The Shifting Centre of Gravity of the World Economy The centre of gravity of the World economy is gradually shifting from the United States and Europe to Asia, including both East Asia and South Asia. The East Asian economies are partially de-coupled from the rest of the World economy, as evidenced by the strong performance of the Chinese, Indian and other East Asian economies during the 2007-2009 global financial crisis as well as the current European sovereign debt crisis. However, the Chinese and East Asian economies are not large enough to turn the World economy around. The idea of a G-2 consisting of the United States and China is premature. Lawrence J. Lau 9

The Distribution of World GDP In 1970, the United States constituted 35.6% of the World GDP whereas China only constituted 3.2%. By 2010, the United States constituted 23.1% of the World GDP whereas China constituted 9.3%. The East Asian share of World GDP rose from 10% in 1970 to just below a quarter today. Lawrence J. Lau 10

The Distribution of World GDP, 1970, US$ The Distribution of World GDP in 1970, in USD Other Economies 24.2% United States 35.6% Korea, Rep. of 0.3% United Kingdom 4.3% Brazil 1.5% India 2.1% China 3.2% Japan 7.2% Euro Zone 21.7% Lawrence J. Lau 11

The Distribution of World GDP, 1990, US$ The Distribution of World GDP in 1990, in USD Other Economies 20.4% United States 26.3% Korea, Rep. of 1.2% United Kingdom 4.6% Brazil 2.1% India 1.4% Russian Federation 2.4% China 1.6% Japan 14.0% Euro Zone 25.9% Lawrence J. Lau 12

The Distribution of World GDP, 2010, US$ The Distribution of World GDP in 2010, in USD Other Economies 25.9% United States 23.1% Korea, Rep. of 1.6% United Kingdom 3.6% Brazil 3.3% India 2.7% Russian Federation 2.3% China 9.3% Japan 8.7% Euro Zone 19.3% Lawrence J. Lau 13

East Asian Share of World GDP, current prices, 1960-present 28 East Asian Share of World GDP, 1960-present 26 24 22 20 Percent 18 16 14 12 10 Lawrence J. Lau 14 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

China s Share of World GDP, current prices, 1960-present 10 China's Share of World GDP, 1960-present 9 8 7 6 Percent 5 4 3 2 1 0 Lawrence J. Lau 15 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

The Rates of Growth of GDP In the developed economies, the real rates of growth have been declining. In contrast, in the BRIC (Brasil, Russia, India and China) countries, the real rates of growth have been rising. Lawrence J. Lau 16

Average Annual Rates of Growth of Real GDP of Selected Economies 14 12 Average Annual Rates of Growth of Real GDP of Selected Economies 1970-1980 1980-1990 1990-2000 2000-2010 10 8 6 Percent 4 2 0-2 United States Euro Zone Japan China Russian Federation India Brazil United Kingdom Korea, Rep. of -4-6 Lawrence J. Lau 17

Annual Rates of Growth of Real GDP of Selected Economies Annual Rates of Growth of Real GDP of Selected Economies 25 United States Euro Zone Japan China 20 Russian Federation India Brazil United Kingdom Korea, Rep. of 15 10 5 0 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Percent -5-10 -15 Lawrence J. Lau 18

The Rate of Unemployment in Selected Economies 18 16 14 United States Japan Russian Federation Brazil Korea, Rep. of The Rate of Unemployment in Selected Economies Euro Zone China India United Kingdom 12 10 8 6 4 2 0 Lawrence J. Lau 19 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Percent

U.S. Unemployment Rate Seasonally Adjusted 10.5 10.0 9.5 9.0 8.5 8.0 7.5 7.0 6.5 Percent 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 Monthly Rates of U.S. Unemployment, seasonally adjusted Jan-94 Apr-94 Jul-94 Oct-94 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Lawrence J. Lau 20 Jul-11 Oct-11 Jan-12

The Rate of Inflation in Selected Economies Rates of Growth of CPI of Selected Economies 3500 United States Japan Russian Federation 3000 Brazil Korea, Rep. of Euro Zone China India United Kingdom 2500 2000 Percent 1500 1000 500 0-500 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Lawrence J. Lau 21

The Rate of Inflation in Selected Economies (without Brazil) 100 Rates of Growth of CPI of Selected Economies (without Brazil) 80 United States Japan Russian Federation United Kingdom Euro Zone China India Korea, Rep. of 60 Percent 40 20 0-20 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Lawrence J. Lau 22

The Rate of Inflation in Selected Economies (without Brazil and Russia) 35 30 25 Rates of Growth of CPI of Selected Economies (without Brazil and Russia) United States Japan India Korea, Rep. of Euro Zone China United Kingdom 20 15 Percent 10 5 0-5 -10 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Lawrence J. Lau 23

The Distribution of World Trade In 1970, the United States accounted for 14.8% of World trade whereas China only constituted 0.6%. By 2010, the United States constituted 11.3% of World trade whereas China constituted 8.8%. For large economies, international trade tends to be a relatively small percentage of GDP. The East Asian share of World trade is now just above a quarter. More than half of the East Asian international trade is between East Asian countries. Lawrence J. Lau 24

The Distribution of Total International Trade in Goods and Services, 1970 The Distribution of Total International Trade in Goods and Services in 1970 United States 14.8% Other Economies 38.6% Korea, Rep. of 0.4% United Kingdom 7.0% Brazil 0.8% India 0.6% China 0.6% Japan 5.3% Euro Zone 32.0% Lawrence J. Lau 25

The Distribution of Total International Trade in Goods and Services, 1990 The Distribution of Total International Trade in Goods and Services in 1990 United States 13.4% Other Economies 33.3% Korea, Rep. of 1.7% Euro Zone 34.3% United Kingdom 5.8% Brazil 0.8% India 0.6% Russian China Federation1.2% 3.7% Japan 6.9% Lawrence J. Lau 26

The Distribution of Total International Trade in Goods and Services, 2010 The Distribution of Total International Trade in Goods and Services in 2010 United States 11.3% Other Economies 37.5% Euro Zone 26.2% Korea, Rep. of 2.8% United Kingdom 3.8% Brazil 1.3% India 2.1% China 8.8% Russian Federation 1.6% Japan 4.3% Lawrence J. Lau 27

The Rising Share of East Asian Trade in Total World Trade, 1960-present 35 The Rising Share of East Asian Trade in Total World Trade, 1960-present 30 25 20 Percent 15 10 Share of World Exports Share of World Imports Share of Total World Trade 5 0 Lawrence J. Lau 28 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

The Share of Chinese Trade in Total World Trade, 1950-present 12 11 10 9 The Share of Chinese Trade in Total World Trade, 1950-present The ratio of Chinese Exports to World Exports The ratio of Chinese Imports to World Imports The ratio of Chinese Total Trade to World Total Trade 8 7 Percent 6 5 4 3 2 1 0 Lawrence J. Lau 29 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

The Share of Chinese Trade in Total East Asian Trade, 1952-present 45 40 35 TheShare of Chinese Trade in Total East Asian Trade, 1952-present The Ratio of Chinese Exports to East Asian Exports The Ratio of Chinese Imports to East Asian Imports The Ratio of Chinese Total Trade to East Asian Total Trade 30 25 Percent 20 15 10 5 0 Lawrence J. Lau, The Lawrence Chinese J. University Lau of Hong Kong 30 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

The Rates of Growth of International Trade In the developed economies, the real rates of growth of international trade have been declining. In contrast, in the BRIC (Brasil, Russia, India and China) countries, the real rates of growth of international trade have been rising. Chinese international trade grew even more rapidly after its accession to the World Trade Organisation (WTO) in 2001. Lawrence J. Lau 31

Average Annual Rate of Growth of Total International Trade in Goods and Services 20 Average Annual Rates of Growth of Total Real Trade in Goods and Services, in 2000 USD 1971-1980 1980-1990 1990-2000 2000-2010 15 10 Percent 5 0-5 United States Euro Zone Japan China Russian Federation India Brazil United Kingdom Korea, Rep. of Lawrence J. Lau 32

The Share of East Asian Exports Destined for East Asia 53 The Share of East Asian Exports Destined for East Asia 51 49 47 % 45 43 41 39 37 35 Lawrence J. Lau 33 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

The Share of East Asian Imports Originated from East Asia 59 The Share of East Asian Imports Originated from East Asia 57 55 53 % 51 49 47 45 Lawrence J. Lau, The Lawrence Chinese J. University Lau of Hong Kong 34 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11

Market Capitalization of Stock Exchanges Year End 2010 (US$) In terms of market capitalization, the total of all East Asian stock exchanges combined, at year end 2011, is less than the total of all U.S. stock exchanges but greater than the total of all European stock exchanges. This is further evidence of the shifting of the centre of economic gravity of the World. Lawrence J. Lau 35

Market Capitalization of Stock Exchanges Year End 2010 and 2011 (US$ trillion) 2010 2011 U.S.A. 17.3 15.6 Europe 10.9 9.5 East Asia 14.3 12.4 Exchanges: U.S.A.: NASDAQ and NYSE Europe: Athens Exchange, BME Spanish Exchanges, Budapest SE, Cyprus SE, Deutsche Borse, Irish SE, London SE group, Luxembourg SE, NYSE Euronext (Europe), Oslo Bors, SIX Swiss Exchange East Asia: Bursa Malaysia, Hong Kong Exchanges, Indonesia SE, Korea Exchange, Philippine SE, Shanghai SE, Shenzhen SE, Singapore Exchange, Taiwan SE, Thailand SE, Tokyo SE Group Lawrence J. Lau 36 Data source: World Federation of Exchanges

End of Year Market Capitalisation of Selected Stock Exchanges 18,000 16,000 14,000 12,000 End of Year Market Capitalisation of Selected Stock Exchanges, in USD billions Hong Kong Exchanges Tokyo SE Shanghai+Shenzhen SE NYSE London SE USD billions 10,000 8,000 6,000 4,000 2,000 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 Lawrence J. Lau 37 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Technology and R&D In terms of technology and R&D investment, the U.S. is still the undisputed leader of the World with the largest number of patents granted in the U.S. as well as the largest stock of R&D capital. There is a direct relationship between the number of patents granted to the nationals of a given country and the level of its R&D capital stock. Lawrence J. Lau 38

R&D Expenditures as a Ratio of GDP: G-7 Countries, 4 East Asian NIES & China 3.5 3 R&D Expenditures as a Percentage of GDP: G-7 Countries, 4 East Asian NIEs and China U.S. Japan W. Germany U.K. France Canada Italy South Korea Singapore Taiwan China Hong Kong 2.5 Percent 2 1.5 1 0.5 0 Lawrence J. Lau 39 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Patents Granted in the United States: G-7 Countries, 4 East Asian NIEs & China Patents Granted Annually in the United States: G7 Countries, 4 East Asian NIEs and China 1,000,000 100,000 10,000 Number of Patents 1,000 100 10 1 US Japan W. Germany U.K. France Canada Italy Hong Kong South Korea Singapore Taiwan China Lawrence J. Lau 40 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Patents Granted in the United States and R&D Capital Stocks, Selected Economies 1,000,000 Figure 8.4: The Number of U.S. Patents Granted Annually vs. R&D Capital Stocks 100,000 10,000 Number of Patents 1,000 100 10 US Japan West Germany UK France Canada Italy South Korea Singapore China Hong Kong Taiwan 1 Lawrence J. Lau 41 0 1 10 100 1,000 10,000 Billions of 2000 Constant U.S. Dollars

The Internationalisation of the Renminbi: Is the Renminbi (Yuan) Under-Valued? First, we consider the question of whether the Renminbi is under-valued. An under-valued currency is desirable because at some point it will become fully valued and holders of the currency will be able to realise a substantial gain. The currency of a country is considered under-valued if the country runs persistent surpluses in trade in goods and services combined vis-à-vis the entire World. It is considered over-valued if it runs persistent trade deficits vis-à-vis the World. Lawrence J. Lau 42

The Internationalisation of the Renminbi: Is the Renminbi (Yuan) Under-Valued? A bilateral trade surplus, even a persistent one, says nothing about whether a country s currency is under-valued because it may still have a near zero or even negative trade balance vis-à-vis the entire World. Most oil-importing countries have persistent bilateral trade deficits with oil-exporting countries. And that does not necessarily mean the currencies of the oil-importing countries are over-valued relative to the respective oil-exporting countries. Lawrence J. Lau 43

The Internationalisation of the Renminbi: Is the Renminbi (Yuan) Under-Valued? During the past two decades, China has run persistent significant trade surpluses vis-à-vis the United States. (The Chinese official data and the U.S. official data differ because the U.S. data includes as Chinese exports Chinese re-exports through Hong Kong, but the trends are similar.) However, with the World as a whole, China has had essentially balanced trade in goods and services except for the period since 2005 (see the following Charts). Thus, if there were any under-valuation of the Renminbi, it would have to be during this period since 2005 and not before. The Chinese trade surplus vis-à-vis the World reached a peak in 2008 when it began to decline. In 2009, it fell almost 35 percent, and became once again relatively insignificant beginning in 2010. In 2011, the Chinese trade surplus as a percent of GDP has continued its decline ended the year at approximately 2%. Lawrence J. Lau 44 Thus, China has not had a persistent significant trade surplus.

The Monthly Bilateral China-U.S. Trade Surplus of Goods, Billion U.S. Dollars 35 The Monthly Bilateral China-U.S. Trade Surplus of Goods, Billion U.S. Dollars 30 Chinese Official Data U.S. Official Data 25 20 USD billions 15 10 5 0-5 Jan-81 Jul-81 Jan-82 Jul-82 Jan-83 Jul-83 Jan-84 Jul-84 Jan-85 Jul-85 Jan-86 Jul-86 Jan-87 Jul-87 Jan-88 Jul-88 Jan-89 Jul-89 Jan-90 Jul-90 Jan-91 Jul-91 Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

Chinese Monthly Exports, Imports and Trade Balance, US$ USD billions 180 170 160 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 0-10 Chinese Monthly Exports, Imports and Trade Balance of Goods, in U.S. Dollars Exports, fob Imports, cif Trade Balance 46 Jan-92 Apr-92 Jul-92 Oct-92 Jan-93 Apr-93 Jul-93 Oct-93 Jan-94 Apr-94 Jul-94 Oct-94 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12

Monthly Chinese Surplus and U.S. Deficit with the World, Trade in Goods, Bill. US$ 120 Monthly Chinese Surplus and U.S. Deficit with the World, Trade in Goods, Billion US$ 100 Chinese Trade Surplus in Goods U.S. Trade Deficit in Goods 80 60 US$ Billions 40 20 0-20 -40 M1 1979 M7 1979 M1 1980 M7 1980 M1 1981 M7 1981 M1 1982 M7 1982 M1 1983 M7 1983 M1 1984 M7 1984 M1 1985 M7 1985 M1 1986 M7 1986 M1 1987 M7 1987 M1 1988 M7 1988 M1 1989 M7 1989 M1 1990 M7 1990 M1 1991 M7 1991 M1 1992 M7 1992 M1 1993 M7 1993 M1 1994 M7 1994 M1 1995 M7 1995 M1 1996 M7 1996 M1 1997 M7 1997 M1 1998 M7 1998 M1 1999 M7 1999 M1 2000 M7 2000 M1 2001 M7 2001 M1 2002 M7 2002 M1 2003 M7 2003 M1 2004 M7 2004 M1 2005 M7 2005 M1 2006 M7 2006 M1 2007 M7 2007 M1 2008 M7 2008 M1 2009 M7 2009 M1 2010 M7 2010 M1 2011 M7 2011 M1 2012 Lawrence J. Lau 47

The Internationalisation of the Renminbi: Is the Renminbi (Yuan) Under-Valued? The statistics on Chinese trade balances over the past three decades indicate that China has had essentially balanced trade in goods and services combined with the World until 2005. Its trade surplus vis-àvis the World began to rise in 2005, reaching a peak in 2008, and then began to decline rather precipitously, partly in response to the global financial crisis. In contrast, the large U.S. trade deficit with the World existed since at least 1998, long before 2005, when China began to have a significant trade surplus with the World. What this means is that while there is evidence that the U.S. Dollar might have been and continues to be over-valued, there is no evidence that the Renminbi was under-valued prior to 2005. Lawrence J. Lau 48

Case-Shiller US Home Price Index, Chinese Trade Surplus & US Trade Deficit 320 300 280 260 240 220 200 180 160 140 120 100 80 60 40 20 0 95 85 75 65 55 45 35 25 15 5-5 -15-25 -35 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 1997M1=100 Case-Shiller U.S. Home Price Index, Chinese Trade Surplus and U.S. Trade Deficit Case-Shiller Home Price Index (left scale) U.S. Trade Deficit with the World (right scale) Chinese Trade Surplus with the World (right scale) USD billions

The Internationalisation of the Renminbi: Is the Renminbi (Yuan) Under-Valued? In July 2005, the Renminbi was allowed to appreciate and rose 24% in nominal terms and 27% in real terms by the end of 2011. The Chinese trade surplus is expected to continue to decline until it returns to an essentially balanced situation as was the case before 2005. The long-term goal of the Chinese Government is to reduce the Chinese trade surplus vis-à-vis the World to zero. If the current trend continues, the goal of zero annual trade balance can probably be achieved by 2012 or 2013, without necessarily any large adjustment in the nominal Yuan/U.S. Dollar exchange Lawrence rate. J. Lau 50

Chinese Foreign Exchange Reserves and the Yuan/US$ Exchange Rate Chinese Foreign Exchange Reserves and the Yuan/US$ Exchange Rate at the End of the Month Billions US$ 3,600 3,400 3,200 3,000 2,800 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 Foreign Reserves Foreign Exchange Rate Lawrence J. Lau 51 Jan/99 Apr/99 Jul/99 Oct/99 Jan/00 Apr/00 Jul/00 Oct/00 Jan/01 Apr/01 Jul/01 Oct/01 Jan/02 Apr/02 Jul/02 Oct/02 Jan/03 Apr/03 Jul/03 Oct/03 Jan/04 Apr/04 Jul/04 Oct/04 Jan/05 Apr/05 Jul/05 Oct/05 Jan/06 Apr/06 Jul/06 Oct/06 Jan/07 Apr/07 Jul/07 Oct/07 Jan/08 Apr/08 Jul/08 Oct/08 Jan/09 Apr/09 Jul/09 Oct/09 Jan/10 Apr/10 Jul/10 Oct/10 Jan/11 Apr/11 Jul/11 Oct/11 Jan/12 8.4 8.3 8.2 8.1 8.0 7.9 7.8 7.7 7.6 7.5 7.4 7.3 7.2 7.1 7.0 6.9 6.8 6.7 6.6 6.5 6.4 6.3 6.2

The Nominal and Real Yuan/US$ Exchange Rates 9.0 The Nominal and Real Yuan/US$ Exchange Rates (1994 prices) 8.5 8.0 Yuan per U.S. Dollar 7.5 7.0 6.5 6.0 The Nominal Exchange Rate, Yuan/US$ The Real Exchange Rate, Yuan/US$ 5.5 5.0 4.5 Jan-94 Apr-94 Jul-94 Oct-94 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Lawrence J. Lau 52 Oct-11 Jan-12

Trade Surplus (Deficit) as Percent of GDP, Selected Developed Economies & China Trade Surplus (Deficit) as a Percent of GDP of Selected Developed Economies & China 11 10 9 8 7 6 5 4 3 2 Percent 1 0-1 -2 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-3 -4-5 -6-7 -8-9 -10 United States Japan Germany France U.K. South Korea China Lawrence Italy J. Lau 53-11

Trade Surplus (Deficit) as Percent of GDP, Selected Developing Economies & U.S.A. 40 Trade Surplus (Deficit) as a Percent of GDP of Selected Developing Economies & U.S.A. 30 20 10 Percent 0 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-10 -20-30 -40 United States South Korea Singapore Brazil India China Lawrence J. Lau 54

Trade Surplus (Deficit) as Percent of GDP, BRIC Economies and the U.S. 25 Trade Surplus (Deficit) as a Percent of GDP of BRIC Economies & the U.S. 20 15 10 5 0 1978 1979 1980 Percent 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-5 -10 United States Brazil India Russia China Lawrence J. Lau 55

Trade Surplus (Deficit) as Percent of GDP, Oil-Exporting Economies, China and U.S. 75 70 65 60 55 50 45 40 35 30 25 20 15 10 5 0-5 -10-15 -20-25 -30-35 -40-45 Percent Trade Surplus (Deficit) as a Percent of GDP of Oil-Exporting Economies, China and U.S. 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 United States Saudi Arabia Kuwait Russia China Lawrence J. Lau 56

The Internationalisation of the Renminbi What do we mean by Internationalisation of the Renminbi? It can mean many different things: The Renminbi is used as a unit of account in international transactions, e.g., trade between Mainland China and Hong Kong, which may be denominated in Yuan. The Renminbi is used as a settlement currency in international (trade and capital) transactions. (Just because a transaction is denominated in a certain currency does not necessarily imply that the transaction must be settled in that same currency.) Lawrence J. Lau 57

The Internationalisation of the Renminbi The Renminbi is used as a medium of exchange outside of Mainland China, sometimes as an alternative to the local currency of legal tender (e.g., Hong Kong, Macau, Laos). The Renminbi is used as a store of value outside of Mainland China (e.g., Hong Kong). The Renminbi and Renminbi-denominated assets are held by foreign central banks as a reserve currency (e.g., Japan, Nigeria and the central banks of countries with swap agreements with the People s Bank of China). The Renminbi is fully and freely convertible, that is, both current accounts convertible and capital accounts convertible all inbound and outbound capital controls are lifted. Lawrence J. Lau 58

The Internationalisation of the Renminbi The Renminbi has been current accounts convertible since 1994. However, it has not yet become fully capital accounts convertible. There still exist both inbound and outbound capital controls in China. Some categories of capital movements require prior government approval. But individual Chinese citizens can remit up to US$50,000 per person overseas each year, with few questions asked. In Hong Kong, residents can convert HK$ into Renminbi or vice versa up to 20,000 Yuan per individual bank account per business day. More recently, enterprises in Hong Kong are also permitted to establish Renminbi bank accounts which can be used to make and receive payments in Renminbi. Lawrence J. Lau 59

Internationalisation of the Renminbi International trade and other international transactions are normally denominated and settled in a limited number of currencies principally because the citizens of most countries do not wish to accept or hold the currencies of other countries than the few recognised as international reserve currencies (e.g., US$, Euro, Japanese Yen, Swiss Franc, British Pound). (Gold is possibly an exception.) For example, two countries may wish to trade with each other, but neither has confidence in the currency of the other, so that unless the bilateral trade is completely balanced and a straight barter is possible, they will need to use the currency of a third country which both of them trust and are willing to accept and hold. This currency often turns out to be the US$. Without U.S. Dollars, trade between them might not have taken place. Lawrence J. Lau 60

Internationalisation of the Renminbi Most of the international trade, investment and loan transactions of the World today are denominated and settled in U.S. Dollars (except for transactions occurring within the same common-currency areas). The U.S. Dollar is widely used, insofar as international economic activities are concerned, as a unit of account, a medium of exchange, and a store of value. Lawrence J. Lau 61

Internationalisation of the Renminbi Thus, the U.S. Dollar provides a genuinely useful service to the World as a widely accepted international medium of exchange and a store of value. For providing this international liquidity, the U.S. is also rewarded with seigneurage, that is, the ability to mint (print) money (and bonds) and use them to purchase real goods and services around the World, just as the central bank of a country that issues domestic money is rewarded with seigneurage domestically. In other words, the U.S. has the privilege of exchanging real goods and services from other countries with pieces of paper. Lawrence J. Lau 62

The Internationalisation of the Renminbi The World economy has been depending on the United States to supply the international liquidity (international money supply) to support international transactions in trade and investment and for any other purposes. The international transactions balances used by most economies consist of U.S. dollars held as foreign exchange reserves in their respective central banks, which in turn have mostly been earned through trade surpluses with the United States and other economies. The rapid growth of international trade and investment during the past two decades has significantly increased the demand for international liquidity. However, the United States may no longer be willing or able or both to continue to supply the international liquidity post the global financial crisis. For example, it may start running a trade surplus instead of a deficit and therefore reducing the outflow of U.S. Dollars to the rest of the World. The U.S. Dollar, because of the various weaknesses of its economy, is also under pressure to devalue Lawrence and J. Lau has been devaluing vis-a-vis 63 other currencies during the past year.

Internationalisation of the Renminbi More recently, however, whether the U.S. is able to continue to fulfill the role of the principal provider of international liquidity has come into question for two major reasons. First, the potential supply of U.S. Dollars for international transactions purposes depends on the rate of outflow of U.S. Dollars from the U.S., which in turn depends in part on the U.S. running significant trade deficits. However, the United States may no longer be willing or able (or both) to run a large trade deficit post the global financial crisis. To the extent that the U.S. begins to run a smaller trade deficit, or even a trade surplus, the rate of increase of U.S. Dollar balances held by the rest of the World will decline and perhaps even turn negative, other things being equal. (Of course it also depends in part on how fast the U.S. Federal Reserve Board increases the U.S. money supply.) Lawrence J. Lau 64

Internationalisation of the Renminbi Second, the willingness and the need of the rest of the World to continue to accumulate and to hold U.S. Dollar balances has also begun to decline. The willingness has declined because of a not so optimistic outlook for the U.S. economy, especially on the fiscal side, and the expectation of a significant devaluation of the U.S. Dollar in the medium to long term. (Of course, if the U.S. Dollar balances could be inflation-protected long-term, it would be a different matter.) The need has also declined because of the possibility of denominating and settling international transactions in other currencies, including the own currencies of the trading Lawrence partner-countries. J. Lau 65

Internationalisation of the Renminbi Moreover, since 1971, exchange rates of currencies are no longer fixed relative to one another but fluctuate daily. It is, however, not clear that this market system of exchange rate determination has been effective in the reduction of persistent trade surpluses and deficits, especially when compared to the Bretton-Woods system. The exchange rates themselves have in the meantime become excessively volatile and unpredictable, driven by short-term speculative capital flows. The uncertainty of relative exchange rates has become a deterrent to the growth of international trade and long-term cross-border investment, both direct and Lawrence portfolio. J. Lau 66

Internationalisation of the Renminbi Thus, it may have become necessary for the trading countries of the World to devise alternative mechanisms for the denomination and settlement of international transactions other than the use of major international reserve currencies such as the U.S. Dollar. Moreover, there may also be a need to consider new arrangements for individual economies to adjust to persistent trade imbalances, both positive and negative. Lawrence J. Lau 67

The Internationalisation of the Renminbi The critical questions are: Is the current (U.S. Dollar-centric) international monetary system sustainable? (1) Will the supply of international liquidity continue to be adequate without the U.S. continuing to export U.S. Dollars? (2) Will central banks around the World be willing to continue to hold a large proportion of their foreign exchange reserves in a currency that is expected to devalue over time? (3) Are there viable alternatives to the use of the U.S. Dollar as an international medium of exchange and store of value? Lawrence J. Lau 68

Total Foreign Exchange Reserves minus Gold, Selected Countries and Regions 3,500 Total Reserves minus Gold of Selected Countries and Regions 3,000 2,500 China, Mainland Japan Russia Taiwan Prov. Of China India 2,000 USD billions 1,500 1,000 500 0 M1 1985 M7 1985 M1 1986 M7 1986 M1 1987 M7 1987 M1 1988 M7 1988 M1 1989 M7 1989 M1 1990 M7 1990 M1 1991 M7 1991 M1 1992 M7 1992 M1 1993 M7 1993 M1 1994 M7 1994 M1 1995 M7 1995 M1 1996 M7 1996 M1 1997 M7 1997 M1 1998 M7 1998 M1 1999 M7 1999 M1 2000 M7 2000 M1 2001 M7 2001 M1 2002 M7 2002 M1 2003 M7 2003 M1 2004 M7 2004 M1 2005 M7 2005 M1 2006 M7 2006 M1 2007 M7 2007 M1 2008 M7 2008 M1 2009 M7 2009 M1 2010 M7 2010 Lawrence J. Lau 69 M1 2011 M7 2011 M1 2012

Major Foreign Central Banks Holdings of U.S. Treasury Securities 1400 1200 1000 Major Foreign Central Bank's Holders of U.S. Treasury Securities China, Mainland Japan Russia United Kingdom Brazil USD billions 800 600 400 200 0 Lawrence J. Lau 70 Mar-00 Jun-00 Sep-00 Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11

Exchange Rates of Selected East Asian Economies (1/2/2007=100) 180 170 160 150 140 130 Japanese Yen Chinese Yuan Hong Kong Dollar Indian Rupee Indonesia Rupiah Malaysia Ringgit Philippine Peso Singapore Dollar Korean Won New Taiwan Dollar Thai Baht Exchange Rate Index of Selected East Asian Economies (1/2/2007=100) 120 110 100 90 80 70 60 01/02/07 02/02/07 03/02/07 04/02/07 05/02/07 06/02/07 07/02/07 08/02/07 09/02/07 10/02/07 11/02/07 12/02/07 01/02/08 02/02/08 03/02/08 04/02/08 05/02/08 06/02/08 07/02/08 08/02/08 09/02/08 10/02/08 11/02/08 12/02/08 01/02/09 02/02/09 03/02/09 04/02/09 05/02/09 06/02/09 07/02/09 08/02/09 09/02/09 10/02/09 11/02/09 12/02/09 01/02/10 02/02/10 03/02/10 04/02/10 05/02/10 06/02/10 07/02/10 08/02/10 09/02/10 10/02/10 11/02/10 12/02/10 01/02/11 02/02/11 03/02/11 04/02/11 05/02/11 06/02/11 07/02/11 08/02/11 09/02/11 10/02/11 11/02/11 12/02/11 Lawrence J. Lau 71 01/02/12 02/02/12 03/02/12

Exchange Rates of Selected East Asian Economies (7/2/2008=100) 160 150 140 Exchange Rate Index of Selected East Asian Economies (7/2/2008=100) Japanese Yen Hong Kong Dollar Indonesia Rupiah Philippine Peso Korean Won Thai Baht Chinese Yuan Indian Rupee Malaysia Ringgit Singapore Dollar New Taiwan Dollar 130 120 110 100 90 80 70 07/02/08 08/02/08 09/02/08 10/02/08 11/02/08 12/02/08 01/02/09 02/02/09 03/02/09 04/02/09 05/02/09 06/02/09 07/02/09 08/02/09 09/02/09 10/02/09 11/02/09 12/02/09 01/02/10 02/02/10 03/02/10 04/02/10 05/02/10 06/02/10 07/02/10 08/02/10 09/02/10 10/02/10 11/02/10 12/02/10 01/02/11 02/02/11 03/02/11 04/02/11 05/02/11 06/02/11 07/02/11 08/02/11 09/02/11 10/02/11 11/02/11 12/02/11 Lawrence J. Lau 72 01/02/12 02/02/12 03/02/12

The Renminbi as a Settlement Currency If the Renminbi were to be used as a settlement currency by Chinese exporters and importers with their trading partners in East Asia, it would greatly reduce the Chinese demand for U.S. Dollars for international transactions purposes, and the People s Bank of China, China s Central Bank, would no longer need to hold as much foreign exchange reserves for transactions purposes as it does now. Approximately 35% of Chinese trade is conducted with East Asian economies. What this means is that the foreign exchange reserves maintained for the settlement of imports from East Asian economies can be reduced if the settlement currency is going to be the Renminbi itself. Chinese exports to East Asia except Japan amount to more than US$300 billion a year. Similarly, Chinese imports from East Asia except Japan also amount to US$300 billion a year. If imports can be settled in Renminbi, the requirement of foreign exchange reserves Lawrence J. Lau 73 for transaction purposes can be substantially reduced.

The Renminbi as a Settlement Currency Moreover, if other East Asian economies, such as Hong Kong, Indonesia, South Korea, Malaysia and Thailand also use the Renminbi as their settlement currency for trade amongst themselves, it would further reduce the demand for U.S. Dollars for international transactions purposes and hence the proportion of the foreign exchange reserves that the central banks of these economies hold in terms of U.S. Dollar-denominated assets. However, it may also increase demand of these central banks for Renminbi-denominated assets to be held as part of their foreign exchange reserves. Lawrence J. Lau 74

Percent of Chinese International Trade Settled in Renminbi 12 Percent of Chinese International Trade Settled in Renminbi 10 Series1, 8.81 8 Percent 6 4 2 0 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Lawrence J. Lau 75 Dec-11

The Internationalisation of the Renminbi The willingness to accept and to hold a non-local currency depends, but not exclusively, on whether the currency is fully convertible. A person (firm) may be quite willing to accept and to hold a non-local currency, fully convertible or not, if he (it) knows that the next person (firm) he (it) comes across is also likely to accept the currency. There can be wide general acceptance of a non-local currency even in the absence of its full convertibility. Even though the Renminbi is not de jure fully convertible, it has gradually become de facto convertible in many economies in East Asia because of its wide general acceptance. For example, the Renminbi is widely accepted and used in Hong Kong, Macau, Laos, Myanmar, and other border areas even though it is not legal tender in these places. Lawrence J. Lau 76

Total Renminbi Deposits in Hong Kong Billion Yuan 700 Total Reminbi Deposits in Hong Kong (Billion Yuan) 600 500 400 300 200 100 0 Feb Ma Au Nov Feb Ma Au Nov Feb Ma Au Nov Feb Ma Au Nov Feb Ma Au Nov Feb Ma Au Nov Feb Ma Au Nov Feb Ma Au Lawrence J. Lau 77 Nov

Full Convertibility and the Renminbi as a Reserve Currency While it is true that the Renminbi is not fully convertible, it may nevertheless be maintained as part of foreign exchange reserves by an economy as long as there is a credible commitment by the People s Bank of China to convert any Renminbi presented by a foreign central bank into U.S. Dollars or Euros or any other so-called hard currencies. Foreign central banks can hold the Renminbi for potential transactions purposes with China or other economies willing to accept the Renminbi. Foreign countries that hold Renminbi as part of their foreign exchange reserves include Japan and Nigeria. Lawrence J. Lau 78

Concluding Remarks The centre of gravity of the World economy is gradually shifting to Asia (East Asia and South Asia) from North America and Europe. The shift is still on-going. However, it will probably take another 10 years before Chinese real GDP can catch up to the level of the United States real GDP. In the meantime, the U.S. economy will still be the largest in the World. And it will probably be another 30 years from now before Chinese per capita GDP reaches the same level as that of the U.S. The international monetary order is in need of restructuring. There are, however, other alternatives than the use of Renminbi as another reserve currency. For example, a multilateral settlement mechanism similar to what the Bank for International Settlements did for the Western European economies in the 1950s may work within East Asia. The use of Special Drawing Rights (SDRs) and a return to a quasi-gold standard, perhaps within a voluntary regional group of Lawrence J. Lau 79 countries, are other possibilities.

Concluding Remarks Paradoxically, the global financial crisis of 2007-2009 has accelerated the pace of internationalisation of the Renminbi. China will be internationalising the Renminbi gradually and in a planned and orderly manner. It has already made a beginning by allowing the Renminbi to be used on a voluntary basis as an accounting and settlement currency in its international trade with selected countries and regions. In time, perhaps within the next five years, the Renminbi will become effectively fully convertible, in the sense that both inbound and outbound capital controls will be effectively lifted. However, it is possible that shortterm capital flows, which are of little economic benefit to the recipient economies, may continue to be under some form of control. Moreover, convertibility is not equivalent to a freely floating exchange rate. For example, the Hong Kong Dollar is fully convertible but its exchange rate is pegged to the U.S. Dollar. The exchange rate is too important a price to be left to the market. China will probably continue with a managed floating rate system for some time to come. Lawrence J. Lau 80

Concluding Remarks If current trends continue, Chinese real GDP will approach the level of U.S. real GDP in approximately 11 years time--around 2023, at which time Chinese real GDP will exceed US$20 trillion (in 2011 prices) and Chinese real GDP per capita will exceed US$ 14,000. It will take another 20-25 years, until around the middle of the 21st Century, before China reaches the same level of real GDP per capita as the United States, at US$90,000 in 2011 prices (bear in mind that in the meantime, the U.S. economy will also continue to grow, albeit at rates significantly lower than those of the Chinese economy and that the Chinese population will reach a peak around 2035 and then begin to decline slowly). By that time, Chinese GDP will be approximately 4.5 times the U.S. GDP. Lawrence J. Lau 81