Multipolar International Economy to Lead to a Larger Role for the Euro and, in the
Long Term, for the Renminbi
Rapid growth in emerging-market economies has led to enormous wealth creation and substantial accumulation of their net claims on the rest of the world, raising the profi le of emerging markets in the international financial system as a result. Developing and emerging countries held two-thirds of the world’s $9 trillion of offi cial foreign exchange reserves as of late 2010, compared to only 37 percent of reserves held at the end of 2000. Sovereign wealth funds and other pools of capital in developing countries have become a major source of international investment. Between 2010 and 2025, the collective net international investment position of major emerging markets is projected to rise to a surplus of more than $15.2 trillion (in 2009 dollars) under the baseline scenario presented in GDH 2011, off set by a corresponding deficit in today’s advanced economies.
Even though the role of emerging markets in international finance is growing, there is a great disparity between their economic size and their role in the international monetary system. At present, no emerging economy has a currency that is used internationally—that is, one in which official reserves are held, goods and services are invoiced, international claims are denominated, and exchange rates are anchored—to any great extent. Virtually all developing countries are exposed to currency mismatch risk in their international trade and investment and fi nancing transactions. Addressing these disparities in the international monetary system needs urgent attention, in terms of both the management of the system (here, the International Monetary Fund [IMF] continues to play a leading role) and the understanding of long-term forces shaping the future workings of the system.
International currency use exhibits considerable inertia and is subject to network externalities, rendering currencies already in widespread use the most attractive. For now, the U.S. dollar remains the chief international currency, despite a slow decline in the proportion of global reserves held in dollars since the late 1990s. But the dollar now faces several potential rivals for the role of international currency. At present, the euro is the most credible of those alternatives. Its status is poised to expand, provided the euro area can successfully overcome the sovereign debt crises currently faced by several of its member countries and can avoid the moral hazard problems associated with bailouts of countries within the European Union.
Looking further ahead, as emerging economies account for an ever-growing share of the global economy and participate more actively in cross-border trade and finance, one sees that their currencies—particularly the renminbi— will inevitably play a more important role in the international financial system. A larger role for the renminbi would help resolve the disparity between China’s great economic strength on the global stage and its heavy reliance on foreign currencies. On one hand, China is the world’s largest exporting country and holds the largest stock of foreign exchange reserves by far ($2.9 trillion held as of end 2010). On the other hand, China faces a massive currency mismatch because transactions by its government, corporations, and other entities with the rest of the world are almost entirely denominated in foreign currencies, primarily U.S. dollars. With private entities in China not able to directly address the currency mismatch, the task falls to the government. In moving to address such issues, Chinese authorities have undertaken the internationalizing of the renminbi on two fronts: (1) developing an off shore renminbi market and (2) encouraging the use of the renminbi in trade invoicing and settlement. Such initiatives are beginning to have an effect in laying the foundation for the renminbi taking on a more important global role.
Building on this unfolding reality, GDH 2011 presents three potential scenarios for the future of the international monetary system: a status quo centered on the U.S. dollar, a multicurrency system, and a system with the Special Drawing Right (SDR) as the main international currency. The most likely of the three scenarios is the multicurrency system. Under this scenario, the current predominance of the U.S. dollar would end sometime before 2025 and would be replaced by a monetary system in which the dollar, the euro, and the renminbi would each serve as full-fl edged international currencies. This expected transition raises several important questions. First, how will developing countries, the majority of which will continue to use foreign currencies in trade of goods and assets, be affected by a move to a multicurrency system? Second, can a multipolar economic system—with its dangers of instability— be managed within the existing institutional arrangements, or is a more fundamental reform of the system necessary? Third, what can be done to smooth the transition to multipolarity, short of fundamental reform of the international monetary system?
Over the past decade, emerging economies have led the changing global pattern of currency portfolio allocation