Trade conflict will prompt China to develop a more independent monetary system

By Wang Peng Source:Global Times Published: 2019/8/14 20:48:40

Illustration: Xia Qing/GT

The China-US trade war began over a year ago, the US' economic bullying has since spread to the financial and currency sectors as the US has designated China as a currency manipulator.

This is not the first time the US has waged a trade war, and China is not its first victim. Looking through history, the US has always gained upper hand and left its opponents with a "lost decade" or decades. In this history, there are lessons to be learned.

China has the confidence and capability to transfer the trade and financial war, which has been imposed by the US, into an opportunity to build a solid financial system and an independent monetary system, thereby safeguarding its monetary sovereignty and financial security. By doing so, China can prepare for long-lasting China-US competition.

China has always placed economic and financial security at the forefront of its concerns. The trade war will lead to a lose-lose scenario. Any trade war "victory" is nothing but a demonstration of one party's ability to bear more pressure. Building a financial system that can endure such stress is key; it will rely on the integrity of a country's monetary sovereignty. Monetary sovereignty is the basis of financial and national security. 

It also means a country is able to form an independent currency-issuing system - both sides of the central bank's balance sheet need to be yuan-denominated.

If foreign exchange reserves take up the majority of its assets while any liabilities are in home currency, it means the country's money-issuance is not independent. Its money supply depends on foreign reserves brought by the trade surplus and foreign direct investment. Money injections, distribution channels and methods are all confined by the scale of foreign exchange reserves.

If a country has an independent monetary system, its central bank will have more tools to counter systemic risks. Unfortunately, most developing countries do not have wholly-integrated monetary sovereignty.

Their currency-issuing mechanisms are pegged to the US dollar to match their export-oriented economies. If they inject money into their circulation systems without US-dollar backing, international capital will recognize it as invalid. 

Any country, including China, needs to build a currency-issuing system separate from foreign reserves, and should have more policy flexibility when economic growth shifts from export-oriented growth to growth driven by market demand.

Many developing countries, during their attempts to build independent currency-issuing mechanisms, have fallen into traps and thus failed. Whether or not China can sidestep the proverbial Caudine Forks is putting the country to test.

There are five policy suggestions proposed here. 

First, improving the budgeting for the operations of state-owned assets. The reality is that state-owned enterprises (SOEs) will act as leading players in the Chinese economy in the medium- and long-term. SOEs have played an important role in China's economic growth. However, some have experienced operating difficulties, turned into zombie companies, or even become local governments' financing platforms. They have occupied a great deal of social resources and capital. Those companies have accumulated seemly huge fixed assets on their accounts without generating profit on the market. This situation, which is eating up the real economy and piling up systemic risks, has to change.

Second, implementing stricter control on local fiscal budgets. Local governments' fiscal situations are optimistic. Some local governments' debts have snowballed to 10 times their annual fiscal revenues. This is not including debt financing through affiliated SOEs. Debt issues could be hidden risks jeopardizing the stability of the yuan. They require determination to reconstruct local financial revenues and expenditures in line with sustainable development.

Third, breaking up the implicit guarantee in financial institutions. The implicit guarantee encourages and pampers institutions to blindly grant loans and expand, creating inefficient assets and eventually harming the currency-issuing mechanism. 

Fourth, establishing a multi-level capital market. The market has faith in the US dollar not only due to US military hegemony, but also due to its convenience and safety. China should learn from the US and better circulate its currency. 

Fifth, setting up a clear goal for monetary policy. Central banks that have independent monetary systems will have a full set of policy instruments. The People's Bank of China needs to have a clear goal, committing to maintain inflation at a certain level. The market will thus have more certain expectations and will build confidence in the central bank's policy effectiveness.

This year marks the 70th anniversary of the founding of the People's Republic of China. Generations of Chinese people have made efforts to regain the pride and prosperity of the Chinese nation. Today, the financial war will prompt China to gain more independent monetary sovereignty, and to safeguard the country's financial security. 

The author is an associate research fellow at the Chongyang Institute for Financial Studies, Renmin University of China.


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