Reform Of The International Monetary System And Internationalization Of The Renminbi

Ruogu Li

• Publisher: WSPC
• Year: 2015
• ISBN:
  9789814699068
• Topic: Biological Sciences
• Subtopic: Science General
• Index: Biological Sciences

This book argues that only by reforming the international monetary system can we prevent financial crises in the future and the internationalization of the Renminbi, China's national currency, will be an important step in the process.

Just as the old saying goes, "An old building needs to be demolished before a new one can be erected in its place," there will be no construction without destruction. The commencement of the dismantling of the old monetary system is also the beginning of the construction of the new one. Contrary to Western rhetoric, which portrays China as part of the cause of the recent financial crisis, the author contends that China is actually a victim of the current unjust international economic and monetary system. To address the imbalance and break the dollar-dominated international monetary system, the author calls for the internationalization of the Renminbi and diversification of the international monetary system.

Written by one of the foremost financial practitioners in China, this book is thought-provoking and provides a unique Chinese perspective on how the international monetary system should be reformed, what the future system should look like and the role China should play in the process. It is a required reading for anyone interested in understanding China's own vision in its rise in the global political, economic and financial systems.

This book argues that only by reforming the international monetary system can we prevent financial crises in the future and the internationalization of the Renminbi, China's national currency, will be an important step in the process.

Just as the old saying goes, "An old building needs to be demolished before a new one can be erected in its place," there will be no construction without destruction. The commencement of the dismantling of the old monetary system is also the beginning of the construction of the new one. Contrary to Western rhetoric, which portrays China as part of the cause of the recent financial crisis, the author contends that China is actually a victim of the current unjust international economic and monetary system. To address the imbalance and break the dollar-dominated international monetary system, the author calls for the internationalization of the Renminbi and diversification of the international monetary system.

Written by one of the foremost financial practitioners in China, this book is thought-provoking and provides a unique Chinese perspective on how the international monetary system should be reformed, what the future system should look like and the role China should play in the process. It is a required reading for anyone interested in understanding China's own vision in its rise in the global political, economic and financial systems.

Readership: Researchers, economists, finance professionals, analysts, individual investors, monetary and banking authorities and those who are interested in the reform of the international monetary reform, the roles China and its currency, the RMB, are going to play in the process.
Key Features:

• This book is written by one of the foremost financial practitioners in China
• This book provides a unique Chinese perspective on what role it should play in the international monetary system
• This book will be a welcoming antidote to the Western-scholars-dominated narrative on China's economic and financial development

Part One

Evolution of the International Monetary System

The international monetary system has gone through four stages in its evolution: (1) the gold standard (1880–1914); (2) the gold-exchange standard (1925–1933); (3) the Bretton Woods system (1944–1971); and (4) the Jamaica system, also known as the floating exchange rate system (1976–present).

Each international monetary system has its own political and economic background. The history of the international monetary systems is also a history of the rise and fall of economic powers and a history of modern international economic relations. By studying the evolution of international monetary systems and their political and economic background, we can gain insight into changes in and development of the current international monetary system and work to improve it.

Chapter 1

The Gold Standard

The gold standard has been long abandoned. However, as the initial form of international monetary system, it had an extremely important position in the evolution of the international monetary system. And many conflicts and problems in today’s international monetary system have their roots in the era of the gold standard.

1.1 Origin of the Gold Standard

Gold is a basic element in Nature. It was the first metal discovered and used by mankind, much earlier than copper and iron. The use of gold by mankind dates back to the Neolithic Age, 4,000 to 5,000 years ago. As a Chinese saying goes, that which is scarce is precious. Gold is extremely scarce and the cost of its mining and smelting is very high. More importantly, gold is valued as it can be preserved for a long period of time because of its high degree of stability. With the emergence of the commodity economy, gold acquired a unique social role when it began to circulate as currency and became an important means for people to keep their wealth. As Karl Marx wrote in Das Kapital, “Although gold and silver are not by nature money, money is by nature gold and silver”.

From 16th through 18th centuries before the introduction of the gold standard, the new capitalist countries, including the United States and European countries, had adopted a bimetallic system in which gold and silver acted as equivalents. But it was an unstable currency system. In the Elizabethan Age during the 16th century, Thomas Gresham, a financial agent of the Crown, discovered what is now known as Gresham’s Law, which stated that “bad money drives out good” if exchange rate is set by law. At that time, the exchange rates between gold and silver coins in different countries were legally fixed by governments and remained unchanged over a long period of time. But prices of gold and silver fluctuated in response to market supply and demand. As it was more difficult to mine gold than silver and the deposit of gold is much smaller than silver, the relative value of gold inevitably went up against silver, and often surpassed the statutory exchange rate. Therefore, people preferred to smelt gold coins into gold bullions and convert them into silver coins on the market. This way, gold coins could be exchanged for silver at a better rate than official exchange rates. Over time, the number of gold coins (the “good money”) on the market gradually dropped, whereas silver coins (the “bad money”) flooded the market. This created chaos in commodity prices and trading in those countries using the bimetallic standard between 16th and 18th centuries.

The bimetallic standard caused great losses to Britain, and casting silver coins in the 1790s began to phase out. After the Napoleonic Wars, Britain began to issue gold coins. According to the Bank Charter Act of 1844, only the Bank of England was authorized to issue bank notes with the support of an adequate gold reserve. This Act formally established the gold standard in Britain. However, as it was not yet introduced in other countries, the gold standard had not yet become international.

Britain was the first country in the world to industrialize. The Industrial Revolution began in Britain in the 1760s. Driven by the development of modern industry, Britain became the “world’s factory” by the mid-19th century. There was huge global demand for Britain’s industrial products, particularly textiles. After Britain introduced the gold standard, other countries which had close trade relations with it had to follow suit. In 1871, after extracting a huge sum of war indemnity from France, Germany adopted the gold standard by issuing the gold mark as its standard currency. Russia and Japan also adopted the gold standard in 1897.

In the late 19th century, a unified international monetary system — the gold standard, began to emerge among Western countries. During the process, because of Britain’s dominant position in international trade, the British pound sterling became the principal means of payment and the main reserve currency in the international monetary system. The British pound sterling gained recognition in the world and became an international currency equivalent to gold. Gold flowed into Britain in large quantities due to the appeal of Britain’s economic might.

With huge capital, British banking industry registered robust growth and conducted active lending overseas. By the mid-19th century, London had become the financial center of the world.¹ Therefore, the gold standard — which was used before the World War I — was referred to as the “British Pound Standard” by some economists. According to renowned American political economist Robert Gilpin, the international monetary and financial system under the conventional gold standard was organized and managed by Britain. The monetary system under the gold standard was dominated by Britain, next to which were the new financial centers in Western Europe.² It should be noted that the formation of the gold standard was not the result of negotiations among countries. Rather, it was the product of market selection in response to changes in the global economic environment and the economic relations between countries. This stands in sharp contrast with the establishment of the Bretton Woods system after World War II.

1.2 Characteristics of the Gold Standard

The gold standard lasted 35 years, from 1880 to 1914. Under the gold standard, different countries issued small change and bank notes, which could be converted freely to gold coins or gold according to certain proportion. Exchange rates between bank notes of different countries were determined by the ratio of their respective values in gold, and were fixed. For instance, the value of one British pound sterling (GBP) was fixed at 113.00 grains³ of pure gold, while the value of one U.S. dollar (US$) was 23.22 grains of pure gold. Thus, exchange rate between the two currencies was US$ 4.86 to GBP 1.

Under the gold standard, governments of different countries allowed some fluctuation in managing their respective exchange rates, which was kept within limits between the gold-export point (the exchange parity plus the shipping cost) and the gold-import point (the exchange parity minus the shipping cost). If the exchange rate of a particular country surpassed the gold-export point, gold within its territory would be shipped out in exchange for foreign currencies. Once gold was shipped out, demand for its currency would shrink, pressing down its exchange rate. If the exchange rate of that country fell below the gold-import point, gold would flow in pushing up its exchange rate. To keep their monetary systems and international trade running, governments kept their respective exchange rates within limits. Therefore, gold standard was strictly a fixed exchange rate system.

Under such a strict fixed exchange rate system, balance of payments of countries was self-adjusted. Scottish economist David Hume first referred to this system of self-adjustment, known as the price-specie-flow mechanism, in Political Discourses published in 1752. Hume found that, under the gold standard, if a country maintained a surplus in foreign trade, its domestic gold reserve would continuously increase and this would trigger domestic inflation. Rising domestic prices would lead consumers of that country to buy more imported goods, while foreign nationals’ demands for that country’s goods would also decline. This would lead to a drop in trade surplus, a gradual decrease in its gold reserve, and a continuous price decline. Thus the country’s balance of payments would return to equilibrium. The price-specie-flow mechanism worked before World War I mainly because all industrial economies strictly followed the”rules of the game”for the gold standard: the monetary authorities of the trading countries denominated the value of their currencies in terms of gold, and the money supply was restricted by a country’s gold reserve. Free exchange between gold and currencies was permitted and gold could be shipped freely across borders.

1.3 Breakdown of the Gold Standard

The gold standard was dominant from 1880 through 1914. During this period, the capitalist economy further developed, and important progress was achieved in science. This led to the Second Industrial Revolution featuring the use of electricity. The United States and Germany greatly benefited from this industrial revolution, and they saw a boost in their industrial production. But Britain failed to promptly upgrade its industrial capacity and adopt the latest technologies. Thus, Britain’s economic status in terms of industrial output dropped sharply. From 1870 through 1913, Britain’s share of global industrial output dropped from 32% to 14%. Once the number one industrial country in the world, Britain now slipped to number three. The United States’ share of global industrial output rose from 23% to 36% and became number one. Germany gained the second place, surpassing Britain.⁴

The causes for the decline of British economic status were many and complicated, on which in-depth studies have been conducted. English scholar Martin Wiener is well known for his interpretation of England’s decline from a cultural perspective. Wiener believed that the English culture was anti-capitalist, which considered free market economy unfair as it only benefited factory owners, and that the working classes were its victims. Despite the completion of industrialization in Britain after 1870, the British society very much remained what it had been in the pre-industrial age and was not prepared to meet the challenges of modern society. This viewpoint was widely recognized in Britain, but it also caused much controversy.⁵

Cultural factor might have, to a certain extent, hindered Britain’s industrial development after 1870. But I think there were at least three other factors behind Britain’s decline.

First, while other countries had not yet begun to industrialize themselves or lagged behind in industrialization, Britain, the first industrialized economy was naturally the champion leader. However, when capitalist countries, such as the United States and Germany which have bigger territories, entered the stage of industrialization, it was difficult for Britain, an island country with limited land, to maintain its position as the leader of the industrialized countries. In this sense, Britain’s decline was, in fact, a normal result in historical development.

Second, Britain’s decline was due more to the rapid economic development in the United States and Germany. Between 1859 and 1909, U.S. industrial output grew 6 times; between 1870 and 1913, German industrial output grew 4.7 times, while Britain’s growth was only 0.9 times.⁶ Similarly, there are many causes for the rapid growth of the United States and Germany, a main one of which was research and innovation. Take the United States for example: from 1870 to 1913 — in less than half a century — a surprising number of inventions and patents emerged, including many new manufacturing methods and production procedures. Light bulb was invented by Thomas Edison in 1879, the alternating current (AC) was invented by Nikola Tesla in 1894, and the Model T automobile was invented by Henry Ford in 1908. During this period, the U.S. government made major investments in both basic research and applied research. In fact, many of today’s leading American research universities were established with the support of the federal government and state governments during the second half of the 19th century. They include Massachusetts Institute of Technology (founded in 1865), University of California, Berkeley (founded in 1868), Stanford University (founded in 1885), and California Institute of Technology (founded in 1891).

Third, Britain, as the biggest colonial power at the time, controlled a vast market and supplies of raw materials. So even without a very high level of technology, British businesses could still reap huge profits. Therefore, Britain did not have adequate incentive to carry out innovation and responded slowly to technical innovation created in the Second Industrial Revolution.

Factors undermining the stability of the international monetary system were also increasing due to the unbalanced economic and political development of capitalist countries and the increasing conflicts among them, and factors undermining the stability of the international monetary system also increased. Using their economic strength and military force, Britain, the United States, Germany, France, and Russia amassed two-thirds of the global gold reserve by 1913.⁷ The distribution of gold reserves in the world was severely unbalanced, and the basis of many countries’ currencies was seriously weakened. This undermined a key rule of the gold standard, namely, that all countries issued their currencies according to the amount of their respective gold reserves. At the same time, to prepare for war, some countries sharply increased government spending and could only cover the budget deficit by issuing a large number of bank notes. Therefore, rule free exchange between currencies and gold was undermined. After the outbreak of World War I, all the participating countries stopped free exchange between bank notes and gold. Gold export was also prohibited. Thus, all the rules that underpinned the gold standard were violated. The stability of the international monetary system was no longer ensured, and the gold standard collapsed all together.

There was a deeper cause for the disintegration of the gold standard. Currency serves as a lubricant of economic operation, and money supply of an appropriate amount is essential for an economy to grow. Neither excessive nor inadequate money supply is good for the smooth functioning of an economy. The two industrial revolutions accelerated the growth of the world economy, but the supply of gold could not catch up with it. The gold standard thus gradually lost its justification. In this sense, even without World War I, the gold standard would still come to an end anyway.

1.4 Evaluation of the Gold Standard

The advantages of the gold standard, as the first international monetary system, were obvious. First, as the value of different currencies was based on their value in gold, exchange rates between different currencies were relatively stable. Stable exchange rates played an important role in promoting international trade and investment and thus optimized the international allocation of resources. Second, as the issuance of currencies was limited by the amount of the gold reserve, inflation was effectively controlled. A country’s gold reserve came mainly from two sources — gold mining and the balance of payments surplus. Due to limitation in gold mining technology, growth of the money supply was not only slow, but even negative from tim...

Table of contents

• Cover
• Halfitle Page
• Title Page
• Copyright
• Preface
• Contents
• About the Author
• Part 1 Evolution of the International Monetary System
• Part 2 The Current International Monetary System
• Part 3 Global Financial Crisis and the International Monetary System
• Part 4 Reform of the Current International Monetary System
• Part 5 Regional Currency Cooperation
• Part 6 Internationalization of the Renminbi
• Bibliography
• Index