China needs to address issues stability and liquidity before it can realize its plan to internationalize the yuan and challenge the global dominance of the US dollar, a prominent economist said in a recent forum held in the Philippine capital.

"An international currency that is widely used in private commercial and financial transactions and is held by central banks as reserves has three essential attributes: scale, liquidity and stability," Barry Eichengreen, distinguished professor of economics and political Science at the University of California, Berkeley, said in a forum organized by the Asian Development Bank.

Eichengreen, a former senior policy adviser at the International Monetary Fund, said China has already achieved the first precondition to yuan's success as a global reserve currency - scale. Next only to the United States, China is now the world's second largest economy. Economists have predicted that China will soon overtake the United States as the world's biggest economy.

But Eichengreen notes, "scale while necessary for international currency status is not sufficient." He cited the case of the United States, which back in 1913 was already the world's biggest economy, but even that was not enough for the dollar to dislodge the sterling as the global currency of choice.

The United States back then failed to meet other pre-conditions that will lead to the internationalization of the greenback, liquidity and stability. China, he said, is now in the same position.

China's fast rising economy has encouraged its policy makers to push for the yuan as a global currency reserve by promoting its use in overseas markets. To this end, China has allowed local companies to use the yuan in cross-border trade settlements. It has also permitted foreign investors to invest yuan-denominated funds in China's interbank bond market and signed currency-swap agreements with the Philippines, South Korea, Japan, and Australia.

While China is opening its financial markets, Eichengreen said liquidity remains a challenge. China's bond markets remain small and trading volume is low. Liquidity is a main consideration for central banks when they're considering currencies to hold as a reserve.

Eichengreen also cited the importance of stability, which he said is the most difficult thing to establish given that it has several dimensions political, economic and financial.

Political stability, for instance, will ensure a stable policy environment for investors who will allocate a certain portion of their portfolio to the yuan. Eichengreen suggested that China's regulatory agencies need to be independent "to foster confidence that regulatory decisions are taken with economic stability rather than political considerations in mind."

Banking systems also needed to be strengthened to prevent excess capital inflows, he added.

Eichengreen said that the dollar is the only currency in the world history that managed to transform itself from not being used at all to becoming an international currency in just a span of 10 years owing to the passage of the Federal Reserve Act in December 1913. With the US Federal Reserve acting as the lender of last resort, the Fed started buying and selling dollars and created a liquid market and provided stability. By the 1920s, the dollar has become an international currency and New York eclipsed London as a key financial center.

"The lesson from this is that through concerted policy reform a large country could successfully cultivate a reputation for financial stability and develop a liquid market needed to support the internationalization of its currency and, in principle, it can do that in a short period of 10 years," he said.

The question now, is if China can match the US experience, Eichengreen said.

There are good reasons that China will succeed in its plan to internationalize the yuan, he said, adding that this will also benefit global economy.

"The global economy runs on liquidity and the dollar can't continue to provide the liquidity that an expanding economy needs forever," Eichengreen said.

Emerging economies, like China, will assure that the US economy's share to the global economy will go down, which is why Eichengreen believes that the yuan's internalization will be of interest not only to China but the rest of the world as well.

"Whether China rises to the challenge will have very profound consequence not only for China but to the world," he said.