January 16, 2012 7:38 pm

China and the City

Streets of London won’t be paved with renminbi yet

Great power shifts are accompanied by changes in the global reserve currency. The City of London has survived as a financial centre by virtue of its ability to navigate such shifts.

It has not escaped London’s financiers that China has been growing in importance as part of the world’s monetary system since it decided in 2010 to broaden the use of the renminbi among international investors. The first steps have been taken using Hong Kong, a special administrative region of China, as an offshore base. But the broader international market remains up for grabs – not least because it has yet to be created.

In Hong Kong this week, George Osborne staked a claim for the City to a slice of this putative market. Much of what the chancellor of the exchequer said was, frankly, smoke and mirrors. He made a great deal out of some technical agreements with the Hong Kong authorities to investigate clearing and settlement systems, and to develop new products denominated in renminbi. Mr Osborne was similarly hyperbolic about Hong Kong’s decision to extend renminbi settlement hours to encompass the London trading day.

While these initiatives may help London get its foot in the door, they are far from epoch-making. The City remains one of a number of financial centres jockeying for a share of the renminbi market.

This may in any case take quite some time to develop. The moves China has made – while dramatic in the growth they have unleashed – are baby steps. How easily Beijing will stomach the rest of the renminbi’s journey to reserve-currency status is far from clear.

A reserve renminbi would have to be fully convertible, on the capital as well as the current account. But this would imply opening up China to the whims of global capital – precisely what it has been protecting itself against (as its huge foreign currency reserves plainly attest).

In the absence of convertibility there is, of course, a requirement for a foreign exchange market to meet the needs of those importing Chinese goods. Demand for such services is likely to be muted, however. This is because non-Chinese importers will be reluctant to use the currency to settle purchases so long as holders continue to expect the currency to rise.

The reality is that the renminbi market will remain undeveloped so long as foreign holders remain heavily restricted in what they can do with their renminbi. Changing this is a decision over which Mr Osborne has little influence.

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