China’s Financial Strategy: Power, Sovereignty and the Limits of Caution
"The only viable general direction for China’s financial strategy is the full marketisation of its domestic financial system combined with limited globalisation of cross-border finance." – Xia Bin
The essay below, by senior establishment economist Xia Bin (夏斌), is an unusually candid, systematic articulation of a broader Chinese instinct about finance—that it is inherently unstable, politically consequential, and useful only if bound by the needs of the real economy. It is introduced by Alicia García-Herrero, who makes a sharp case for the opposing view from a liberal-financial perspective. Alicia is the Chief Economist for Asia-Pacific at Natixis. She is also a Senior Fellow at the European think tank Bruegel, a non-resident Research Fellow at the National University of Singapore’s East Asian Institute, and an Adjunct Professor at the Hong Kong University of Science and Technology. In addition, she serves on the Advisory Committee for Economic Affairs of the Spanish Government and advises the Hong Kong Institute for Monetary and Financial Research (HKIMR). We are very grateful to her for her generous contribution to this newsletter. — Jacob
Xia Bin’s call for “full domestic marketisation paired with limited cross-border globalisation” rightly identifies China’s structural vulnerabilities—currency mismatch, RMB non-convertibility, and exposure to dollar hegemony. Yet his analysis rests on a flawed premise: that finance (“the xū”) must remain subordinate to the real economy (“the root”), serving only as a cautious tool to avoid external shocks. This view underestimates finance’s autonomous strategic value. A developed financial system is not just supportive infrastructure; it is a core instrument of national power, sovereignty, and self-reliance—especially by breaking dependence on foreign currencies.
History demonstrates this truth. Britain’s 19th-century financial supremacy and America’s post-1945 “exorbitant privilege” arose from bold monetary internationalisation, not insulation. Dollar dominance grants the United States seigniorage revenue, sanction leverage, and immunity to external monetary shocks—precisely the autonomy Xia Bin seeks for China. By contrast, his strategy of managed floats, phased capital controls, and RMB “regionalisation” (rather than full internationalisation) perpetuates the very “financial weakness” he diagnoses. Gradualism keeps China tethered to dollar liquidity, foreign reserve accumulation, and external pricing power over commodities and energy. True self-reliance requires the opposite: decisive opening that transforms the RMB into a genuine reserve currency, allowing China to finance its growth on its own terms, recycle surpluses globally, and insulate domestic policy from U.S. Federal Reserve decisions.
Xia Bin’s metaphor—“use the xū to strengthen the root”—is elegant but one-sided. A strong financial sector does not merely “support” the real economy; it generates independent power that strengthens the root in turn. Deep, liquid capital markets attract global savings, lower borrowing costs for strategic industries, and create network effects that reinforce geopolitical leverage. Limited globalisation, by design, caps these benefits. It risks locking China into perpetual “lame giant” status—large in output, yet vulnerable to dollar volatility and capital-flow reversals.
China’s rise demands a bolder vision. Full financial internationalisation is not reckless exposure; it is strategic sovereignty. Only by embracing finance as a primary source of national power—rather than a secondary servant—can China achieve genuine self-reliance and reshape the global monetary order in its favor. Cautious incrementalism may feel safe, but it delays the very financial superpower status Xia Bin himself endorses. The real economy thrives when finance leads, not follows.
— Alicia García-Herrero
Key Points
During periods of great-power transition, financial strategy cannot be reduced to economics alone—policy competition between governments, shaped by differing democratic development, demands analysis of the full spectrum of interactions emerging from interstate competition.
Strategy need not be adversarial: China should pursue a clear, “harmonious” financial strategy that advances its own interests while sustaining globalisation and inclusive global growth.
China’s financial sector faces contradictory demands: economic opportunities require financial globalisation, but external instability means it cannot be rushed. China therefore needs financial globalisation, albeit limited in scope.
Despite impressive achievements, China remains a “weak financial power”—a “lame giant” unable to freely convert its currency, price commodities, or shape the dollar-centred system it depends on.
The only viable path is full domestic marketisation combined with limited cross-border globalisation—domestic reform being the prerequisite for exchange rate flexibility, capital account opening and RMB internationalisation.
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In Traditional Chinese Medicine terms, China’s financial weakness is itself a strategic asset: “using deficiency to ward off harm” shields against external shocks while strengthening the real economy.
The real financial world cannot be captured by mainstream Western textbooks: finance is systemic, innately unstable, dynamic and structurally unequal—analysing it issue by issue, in a “bookish” manner, misses the whole.
China should adopt a managed floating exchange rate: neither a hard peg nor a free float suits a rising but financially weak major economy, and no existing currency bloc fits China’s scale.
Capital account opening must be proactive, gradual and controlled—coordinated with domestic reform, RMB regionalisation and stronger macroprudential regulation, and shifting from administrative to price-based instruments as liberalisation advances.
RMB internationalisation is a defensive necessity, not an aggressive ambition—the flawed dollar-dominated system forces China’s hand. The realistic near-term target is regionalisation, using centres such as Hong Kong as the key offshore hub.
The Scholar
Name: Xia Bin (夏斌)
Age: 74 (May 1951)
Position: Chairman, China Chief Economist Forum (CCEF); Honorary Director and Researcher, Financial Research Institute, Development Research Center of the State Council.
Other: Former State Council counsellor.
Previously: Director, Financial Research Institute, Development Research Center of the State Council (2002–2012); Director-General, Non-Bank Financial Institutions Supervision Department, People’s Bank of China; Deputy Director, Policy Research Office, People’s Bank of China
Research focus: Macroeconomic policy, monetary policy, financial regulation and the development of China’s capital markets.
Education: MA, Graduate School of the People’s Bank of China (1984)
Experience abroad: Research fellow, Nomura Securities Research Institute, Japan
SOME QUESTIONS CONCERNING CHINA’S FUTURE FINANCIAL DEVELOPMENT STRATEGY
Xia Bin (夏斌)
Republished by Guancha on 3 February 2026
Translated by Ameerah Arjanee
Illustration by ChatGPT
I. Financial Strategy in an Era of Great-Power Competition
When human society finds itself at a protracted historical turning point [漫长历史转折], one marked by the rise and fall of great powers, major shifts in national economic strength can no longer be attributed to only a handful of fundamental economic principles (even if ultimately, economic factors remain decisive). Sporadic incidents and the accumulation of contingent factors become impossible to ignore.
In the face of an uncertain future external environment, policy competition among governments, especially between major powers, will determine the course of history. In addition, differences among countries in the strength of democratic forces and the degree of democratic development increase the uncertainty over whether policies emerging from interstate competition will deviate from basic economic principles.
In this sense, the challenge in studying a country’s financial strategy lies in analysing the full spectrum of complex interactions that may emerge from interstate competition.
It may therefore be argued that, in a period of profound transformation marked by major shifts and reconfigurations in the global balance of power, what is urgently required is not merely the mainstream theories of modern economics, but also a guiding theoretical framework that is capable of adapting to changes in the distribution of global economic power while maintaining the international economic order. What is needed is a political economy framework that reflects the dynamics of the rise and decline of major powers [反映大国兴衰更替的政治经济学].
There is a particular analytical requirement when studying the financial strategy of a major economic power that is both undergoing transition and rising to global prominence. That is, it is especially necessary to address the particularity [特殊性] and the tactical nature [策略性] of its financial strategy—that is, how the country can pursue its national economic interests to the fullest extent while adapting to shifts in the global distribution of economic power, and ensure that the trend of globalisation, which underpins global economic growth, is not interrupted.
A strategy does not have to be adversarial. A strategy is a plan devised to secure certain interests, and it can be realised without fundamentally harming others and in a harmonious way. Historically, Britain and the United States before the 1970s illustrate this point: the economic development of both countries served to advance the wider global economy. Today, at a time when the world harbours considerable "uncertainty" and "unease" about the prospect of China becoming the world's leading power by the mid-21st century, China has all the more reason to set out a clear and harmonious financial strategy [清晰的和谐金融战略] for all to see—one that offers a credible answer to the question of how to sustain economic globalisation and promote inclusive growth across the globe.
II. Contradictory Demands on China’s Financial System
China's prospects for future growth rest on four main favourable circumstances: the first is a high savings rate, the second is ongoing industrialisation and urbanisation, the third is globalisation and the fourth is room for institutional reform.
At the same time, the country faces many serious challenges. Broadly speaking, these challenges arise from multiple directions, including geopolitical tension between major powers; issues of territorial integrity and sovereign security; climate change and carbon emissions; domestic income inequality and corruption; issues around democratic reform and soft power; as well as a range of other domestic and international economic, political, and social concerns.
If the analysis is confined solely to the trend in economic growth, the key challenges can be summarised in four aspects: the first is an ageing population, the second is resource and environmental constraints, the third is structural imbalances within the economy, and the fourth is instability accompanying the reconfiguration of the international financial order.
What do these four opportunities and challenges mean for finance? In short, from the perspective of opportunity, the imperative is for China's financial sector to globalise as rapidly as possible. From the perspective of challenge, the imperative is also to accelerate China's financial globalisation. However, in the face of a turbulent and unpredictable future external landscape, China's financial globalisation must under no circumstances be rushed. The country needs to preserve the necessary buffers for “risk insulation” [“风险隔离”] and “shock absorption” [“减震”]. The path towards financial globalisation must be trodden with care.
When all the relevant contextual factors are weighed together, the objective demands on China's financial sector are inevitably contradictory: the sector must globalise, yet that globalisation must remain limited in scope.
III. “Financial Lag” and “Weak Financial Power”
An analysis of China’s future financial environment is, in essence, an analysis of demand. What can China’s existing financial system realistically provide? What are its defining characteristics? These may be distilled into two overarching phenomena: “financial lag” [“金融滞后”] and “weak financial power” [“金融弱国”]. While the former is generally accepted, the latter may invite disagreement.
As early as 2007, I introduced the concept of a “weak financial power”, primarily based on the observation that, from an international comparative perspective, a country’s financial system and its operational mechanisms are unable to secure a dominant position [“上风”] in global financial markets and are instead influenced by other countries. On this basis, it is possible to highlight several key phenomena.
The RMB exchange rate is still not permitted to float freely, and the RMB is still far from being a freely convertible international currency—this is a defining feature of a “weak financial power.” This gives rise to a range of weak institutional mechanisms, including the so-called “original sin” [“原罪”] phenomenon, whereby a country’s macroeconomic policy remains subject to external constraints.
At the national level, there is a pronounced “currency mismatch” [“货币错配”]. In terms of pricing power over bulk commodities and energy, China remains a “lame giant” [“跛足巨人”]. The internationalisation of its financial markets, both in depth and breadth, is still at an early stage, and [the authorities] still dare not allow overseas capital to flow freely in and out of the country. When we also consider a series of domestic administrative controls, the seemingly dynamic “financial development” of China and its “impressive results” remain, in practice, at a preliminary and superficial stage—one of mere self-congratulation [自娱自乐].
IV. Full Marketisation and Limited Globalisation
The preceding analysis covers two dimensions: on the demand side are four major opportunities and challenges, and on the supply side are the realities of China’s “financial lag” [“金融滞后”] and “weak financial power” [“金融弱国”]. Both theory and practical reality point to the conclusion that China has no other alternative. During the strategic transitional phase ahead, the only viable general direction for China’s financial strategy is the full marketisation of its domestic financial system combined with limited globalisation of cross-border finance.
The full marketisation of domestic finance means that, in meeting the challenge of sustaining stable growth, China’s financial system must shift—across market access, capital pricing, micro-level governance and overall financial operations—towards market-driven resource allocation, and it must do so within the shortest feasible timeframe. Limiting the globalisation of cross-border finance means that, on core issues such as the exchange rate, capital management and RMB internationalisation, it may not be possible to adopt the conventions and institutional frameworks of mature, developed economies in a single step. Moving too fast to open up China’s “financial gates” [“金融国门”] and integrate fully into the global financial system would be both strategically wrong and highly dangerous.
More specifically, China's financial strategy has four core components: the RMB exchange rate, capital account management, RMB internationalisation and domestic financial reform.
Among these four elements, domestic reform is the foundation and prerequisite for the other three. Without further domestic financial (including broader economic) reform, it will be difficult to advance any form of financial opening. The full marketisation of the domestic financial system is the fundamental prerequisite for meaningful integration into the global financial system.
The internationalisation of the RMB is a hallmark of a rising economic power and, therefore, is at the heart of China’s financial strategy. It is only by advancing the RMB’s internationalisation in a phased and measured way that greater exchange-rate flexibility and the liberalisation of capital controls can be pursued without losing sight of China’s fundamental economic interests.
RMB internationalisation, however, requires the substantial liberalisation of capital controls as a prerequisite. Capital controls in turn work in coordination with exchange-rate policy, which itself serves a dual role: it is both a lever for driving structural reform and stable development in the domestic economy, and a reflection of the progress made through gradual domestic economic and financial reform. Exchange rate policy is thus a continuously evolving process of adaptation, and it is equally subject to the constraints imposed by the other three elements.
The key to implementing the overall strategy lies in carefully calibrating the pace and sequencing of these core components. For example, advancing the internationalisation of the RMB requires coordination with domestic reforms that allow greater exchange-rate flexibility and liberalise capital controls. At the same time, accelerating RMB internationalisation can reduce the pressure to increase exchange-rate flexibility. A gradual move towards greater exchange rate flexibility requires domestic reform to proceed in tandem, while also easing the pressure to ease capital controls and creating the conditions for further RMB internationalisation, and so on.
“Limited globalisation” [“有限的全球化”] thus refers to an interlocking pattern of development in which exchange rate, capital management, renminbi internationalisation and domestic reform are each advanced gradually and in mutual reinforcement. It is a dynamic process of progressive convergence towards full participation in financial globalisation.
We need to “take one step back” in order to “take two steps forward”. It may be said that “limited globalisation” is an unavoidable choice during the strategic transitional phase. The aim is to maximise opportunity while containing risk, build resilience at home alongside development, lay the groundwork for a strong financial sector, and pave the way for a more ambitious liberalisation in due course.
Borrowing loosely from the language of traditional Chinese medicine, the core intent of the “full marketisation and limited globalisation” [“充分市场化和有限全球化”] strategy may be expressed as follows: “use the xū to ward off harm [与虚避邪]; use the xū to strengthen the root [以虚固本]; strengthen the root to support the xū [固本扶虚]; and use the xū to restraint the xū [以虚制虚].” Here, xū is used primarily as a metaphor for finance, while “the root”, refers primarily to the real economy. [Note: The author is borrowing the traditional Chinese medicine term xū [虚], usually rendered as “deficiency”, and repurposes it as a metaphor for finance or financial weakness. The point is that China’s relative financial weakness can itself serve as a protective buffer against the risks of full financial globalisation.]
Use the xū to ward off harm [与虚避邪]. China is not only a participant and driver of economic globalisation but also a beneficiary. To continue benefiting from economic globalisation, China must participate in financial globalisation. However, under a flawed international monetary system dominated by the US dollar, the global financial system faces multiple risks. As China participates in financial globalisation, it must mitigate the risks and shield itself from the impact of market turbulence on its financial stability. In effect, China’s participation in financial globalisation is a limited, insulated form of participation that is shielded by a “firewall” [“防火墙”].
Use the xū to strengthen the root [以虚固本]. Through limited financial globalisation, China can improve the efficiency of its financial system, support economic restructuring, as well as bolster the strength and competitiveness of its real economy.
Strengthen the root to support the xū [固本扶虚]. Strengthening the capacity and competitiveness of the real economy creates greater demand in the financial sector, which will boost the overall competitiveness of this sector.
Use the xū to restrain the xū [以虚制虚]. Through active participation in financial globalisation to strengthen the real economy, China should improve the systemic competitiveness of its financial sector, deepen financial liberalisation across a wider front, gradually consolidate its position as a “major financial power”, and assume a more proactive role in reforming the international economic and financial order.
V. The Real Financial World Cannot Be Captured by Western Textbooks
Whether viewed from a historical or contemporary perspective, a proper understanding of any financial issue, or of the role of the financial system within the broader economic system, requires a thorough grasp of the following four dimensions.
1. The financial system must be understood as a large, interconnected system.
All financial products derived from money, regardless of how complex their forms or functions, are, at their core, expressions of “trust between people” [“人类之间的一种信任”]. The existence of this trust, and the realisation of its functions, depends first and foremost on a large system of its own. This system has four specific characteristics.
First, it is a four-dimensional system.
Four factors merit consideration to assess the stability and soundness of a financial system: monetary policy, financial regulation, micro-level financial behaviour [微观金融行为] and financial openness (which includes external dimensions such as exchange rates and capital flows). The state of a financial system at any point in time is the product of the interaction between these four factors. Each carries a different weight, and their interaction can give rise to a wide range of complex configurations, which manifest as various forms of financial instability.
Second, the effective functioning of the financial system depends on its proper alignment with the real economy. The following three points warrant attention.
(1) “Financial supression” [“金融抑制”] is harmful, but so is “overdevelopment” [“过度发展”]. Different stages of economic development place markedly different demands on a financial system. For an economy at any given stage of development, the so-called optimal financial model, however widely endorsed, is not necessarily the best fit, nor the only viable one.
(2) Whether a country’s financial system is market-based or bank-based depends partly on its historical path dependency and partly on the structure of its economy at the time. There is no clear winner between the two models. Historically, countries with dominant reserve currencies tended to favour a market-based system, as their financial stability depended on drawing as many other countries as possible into their own market framework. Britain in the 19th century and the United States in the 20th century are prime examples. Germany and Japan, by contrast, despite joining the ranks of developed economies, found themselves locked into the dollar-dominated monetary system and the orbit of the New York financial market, and gravitated instead towards bank-based models.
(3) Likewise, there is no absolute case for or against universal banking [混业经营] versus separate banking [分业经营] [Note: Universal banking, where commercial and investment banking are combined, versus separation of the two.] The appropriate approach depends on the structural equilibrium required across the four financial factors at different stages of economic development, and cyclical shifts in emphasis between the two models may occur over time. The US experience—from the Glass–Steagall Banking Act of 1933, to the Financial Services Modernization Act of 1999, and the Dodd–Frank Act of 2010— stands as a telling refutation of any theoretical bias towards either model, universal banking or separate banking. [Note: The Glass-Steagall Act (1933) separated commercial and investment banking following the 1929 crash; the Financial Services Modernization Act (1999) repealed it; the Dodd-Frank Act (2010) reintroduced significant regulatory restrictions on banks following the 2008 financial crisis.]
The third point is something that mainstream economists are reluctant to acknowledge, yet one that centuries of financial history confirm. It is that the normal functioning of a financial system depends heavily on a country’s political governance framework and the development of democratic forces. The ability of financial policy alone to stabilise economic development must not be overestimated.
Fourth, as a logical extension of this, since the financial system is an organic whole, any signal that emerges within it is a reflection of the whole. Which signals capture the most attention simply varies from one period to the next.
2. Finance is “innately” [“天生的”] unstable and prone to expansion.
There are four reasons for this. First, money has a “public goods” [“公共物品性”] aspect, while its use in finance is “private” [“私人性”]. This combination inevitably leads to the “tragedy of the commons” [“公地悲剧”] and moral hazard. [Note: “Tragedy of the commons” refers to the tendency of individuals to overexploit shared resources for personal gain, ultimately depleting them to everyone’s detriment.] Second, the “public good” character of money and finance rests on a relatively fragile, intangible psychological factor of “generalised trust” [“普通信任”], which results in a fragile risk–return trade-off. Third, asymmetries in responsibility and obligation tend to fuel monetary and financial overexpansion. Fourth, the real economy, the ultimate object of the financial system—is itself subject to inherent cyclical and structural distortions. For these reasons, financial instability and overexpansion are recurring features across different countries and periods.
3. The financial system is a dynamically evolving system.
This is not merely a philosophical observation that “all things are in motion” [一切事物都是运动的], but a judgement grounded in an understanding of the financial system’s “innate” (天生的) instability and expansionary tendency. It is precisely these “innate” characteristics that give rise to economic fluctuations, and it is in response to these that the financial system must be continually reformed and improved.
Recognising this point helps clarify the relationship between systemic reform and established macroeconomic policy. It also serves as a particular reminder to countries in transition that no reform or liberalisation measure starts from a zero point in a nation’s financial history. In pursuing reform and opening up, one must not overlook subtle shifts within the original system—particularly those dimensions undergoing a transition from quantitative to qualitative change [量变到质变]—and the effect these shifts have on the interconnected “essence” [“本质”] of the system as a whole. [Note: The transition from quantitative to qualitative change is a concept from Marxist dialectics, referring to the point at which gradual incremental changes accumulate to produce a fundamental transformation in the nature of a system.]
In other words, the introduction of a new system effectively disrupts the old system’s balance and moves it toward a new equilibrium. It is a way of combining old and new elements. The tendency is to focus on what is new in this “recombination” [“重新组合”] while overlooking whether, and how, the old elements continue to exert influence.
It is also worth noting that reform and opening up are directed by the human mind. Given the inescapability of human cognitive “bias” [认知“偏见”]—or, in the language of George Soros’s “reflexivity theory” [“反射理论”] the way historical facts themselves are coloured by human perception—, all theories to date are at best approximate, imprecise reflections of historical reality and practice. This means that a financial system can only ever be a dynamic, evolving one.
4. Structural inequality is a defining feature of the modern financial system.
Global finance is a world in which multiple currencies and financial systems coexist. Within this overarching system, individual currencies and financial systems occupy different positions and play distinct roles. Because financial systems have self-reinforcing (or self-weakening) features—driven by scale economies, scope economies, or network effects—”core currencies” [“中心货币”] and the financial systems of countries issuing them naturally enjoy a “head-start” [“领先”] and the dominance that comes with being a major power. Such core currencies not only create room for domestic financial expansion beyond their borders, but simultaneously shape the monetary and financial frameworks of countries with “non-core currencies” [“非中心货币”]. This was equally true under the gold standard.
Highlighting this characteristic serves as a warning to countries undergoing economic transition that have a “non-core currency” status. They would do well to proceed with utmost care in formulating external financial liberalisation strategies (mainly exchange rate and capital management policies).
In highlighting these characteristics, the aim is not to lend credence to “conspiracy theories” [“阴谋论”], but to caution well-meaning readers that financial systems and real-world financial issues are complex. It would be naïve to analyse any given financial issue in isolation or in a bookish manner [书呆子式]; a systemic and dynamic perspective is essential. That said, given the limits of human understanding, our grasp of the true nature of finance remains incomplete.
VI. The Case for a Managed Float
A country’s choice of exchange-rate regime is in effect a search for the optimal currency area boundaries that best serve its own interests. Large and small economies, developed and developing countries alike, will approach this choice from different perspectives, and there is no single theoretically correct answer. Economies of different sizes exert entirely different effects on global supply and demand, and a large economy cannot “free-ride” [“搭便车”] within a currency area.
From a historical perspective, major economies have always confronted choices over exchange rate regimes. At different stages of development, the regime adopted—driven by the need to maintain both internal and external balance—has in practice shaped the defining features of the international monetary system of the time. Whether under the gold standard era, the Bretton Woods system, or the present floating exchange rate regime, major economies have tended to occupy what might be described as a “market-maker” [“坐庄”] position in the provision of monetary stability.
By contrast, due to network and scale effects in currency systems, small countries, especially those with a high degree of openness, have limited flexibility in choosing their exchange rate regime. They are effectively positioned within the international monetary and exchange rate framework established by major powers, and they must choose from a narrow set of regimes that are relatively suited to their circumstances. Moreover, under normal market conditions, both speculative capital and international cooperation tend to reinforce the stability of major powers’ “core currencies”. Hence, small countries with “peripheral currencies” [“外围货币”] face not only difficulty in obtaining monetary cooperation but also the challenge of pro-cyclical speculative pressures.
Therefore, for currencies issued by small economies, additional stabilising mechanisms beyond the exchange rate (such as capital account management) are often required to maintain macroeconomic stability. Compared to developed countries, developing countries are disadvantaged by their position in the international division of labour, their imperfect domestic markets, currency mismatches, and the status of their currencies as “weak currencies” [“弱币”]. These factors further complicate their choice of an exchange rate regime. To complement their exchange-rate system, they often implement some degree of capital account control.
Which exchange-rate regime is preferable: fixed or floating? Historically, Western scholars such as Kindleberger and Friedman have taken opposing views, without reaching a clear consensus. In practice, both approaches have been applied in different countries, each with advantages and disadvantages, and their suitability depends on the specific context. In reality, intermediate exchange-rate regimes—a hybrid of fixed and floating arrangements—are commonly implemented. No current theory of exchange rates denies that a country can adopt a target zone regime with moderate fluctuations, nor can any theory claim that a single regime is suitable for all countries at all times. Williamson’s research also indicates that corner solutions, such as currency boards or fully floating regimes, are likewise unable to fully prevent financial crises. [Note: Kindleberger favoured fixed exchange rates, Friedman floating; their debate is a touchstone in exchange rate economics. “Corner solutions” refers to the two extremes of that spectrum — hard pegs and free floats. Williamson, who coined the term, argued instead for intermediate “target zone” regimes with defined fluctuation bands.]
In the next five to ten years, which exchange-rate regime should China adopt? Fundamentally, it should choose a monetary policy framework suited to a rising major economy capable of maintaining stable economic development. Simply pegging to another currency or adopting a fully floating regime would not serve China’s interests. Pegging to another country’s currency does not align with the strategic requirements of a rising major power.
In the long term, there are almost no countries comparable to China in terms of economic scale and structure, and the renminbi is therefore not suited to fully joining any existing international currency bloc. Since the 1990s, China’s economic cycles have grown increasingly independent, and the influence of external volatility has gradually diminished; using another country’s monetary policy as a nominal anchor for China’s own would be detrimental to economic stability. Moreover, China’s macroeconomic management capacity and level of market maturity do not support a fully floating exchange rate regime.
Meanwhile, a substantial body of international research indicates that, given the depth of trade linkages and similarity of economic cycles among Asian economies, Asia stands to benefit in the medium-to-long term from establishing a distinct regional currency area, within which the RMB could play a pivotal role. At the present stage, however, the conditions for the RMB to serve directly as Asia’s key currency are not yet in place.
Therefore, during the strategic transitional period, adopting a managed floating exchange-rate regime is in China’s best interests.
The first advantage is that, although US monetary policy is far from perfect, the international credibility it commands remains unmatched by any other currency (despite short-term depreciation risks during crisis recovery). By maintaining relative stability against the US dollar (important to note: relative), the RMB can “free-ride” [“搭便车”] on the credibility of the dollar area. This allows China to “import” the dollar’s influence while “borrowing a boat to go to sea” [”借船出海”].[Note: Idiom that means using someone else’s resources for one’s own goals]. This gives the international community the opportunity to become familiar with, and begin using, the RMB. In the process, dependence on the dollar can gradually be reduced, allowing the RMB to emerge as an independent, globally accepted currency.
Second, a managed float helps relieve appreciation pressure on the renminbi in a timely fashion. The regime strikes a balance between “managed” [“有管理”] and “floating” [“浮动”], which reflects the real exchange rate appreciation that China’s still relatively high potential growth rate warrants.
Third, adopting this exchange rate regime would provide appropriate conditions and sufficient time for domestic structural adjustment and economic transformation. For a country such as China, both a major economy and one undergoing a complex transition process, the prudent and gradual selection of an exchange rate regime is all the more important.
Fourth, even with the adoption of this regime, the post-crisis context requires China to maintain a clear understanding of the supporting policies necessary for exchange rate reform and to establish appropriate institutional arrangements in a timely manner.
It should be emphasised that the proposed managed floating exchange rate regime is broadly aligned with current policy, though not identical in certain specific aspects.
First, a central exchange rate [中心汇率] should be established for a defined period, although it need not be publicly disclosed. [Note: The “central rate” is the reference rate set by the central bank around which the currency is permitted to fluctuate within a defined currency band.] One-off adjustments may be made at the authorities’ discretion as and when deemed appropriate.
Second, the composition of the “currency basket” [“一篮子货币”] should initially be heavily weighted towards the US dollar, with the weights adjusted as circumstances evolve. Over time, once these adjustments have been implemented to an appropriate level, the concept of a central exchange rate becomes largely redundant, and the regime gradually converges towards the real effective exchange rate (REER) [实际有效汇率]. [Note: The real effective exchange rate (REER) is the weighted average of a currency’s value against a basket of trading partners’ currencies, adjusted for inflation differentials.]
Third, in operating a central rate regime, the currency band should be widened gradually as conditions allow. By progressively and continuously widening the band, the need for discrete one-off adjustments to the central rate is gradually reduced.
Fourth, these operational steps and technical arrangements must be aligned with the process of RMB regionalisation. Only through such alignment can capital account restrictions be eased more rapidly, thereby creating greater room for exchange-rate flexibility.
Fifth, throughout the process of moving towards a more flexible floating exchange rate regime, the RMB, as a rising “weak” [“弱势”] currency, should maintain a mild appreciation bias, or at the very least sustain broad exchange rate stability.
VII. Capital Account Opening: Proactive, Gradual, Controlled
Many international scholars, often more firmly than their domestic counterparts, hold that capital account liberalisation can indeed promote economic development. This view, however, is conditional. Where the necessary prerequisites are not in place, its effect on economic growth becomes uncertain. The relationship between capital account liberalisation and financial crises is not a simple matter of the former “promoting” [“促进”] or “preventing” [“阻止”] the latter, but liberalisation can act as a catalyst [催化作用] when financial crises do occur.
China must press ahead with capital account liberalisation for several reasons. Economic globalisation requires a corresponding liberalisation of the financial system. The major challenges bearing down on China’s economy and financial sector—resource and environmental constraints, and the need to generate returns on the country’s accumulated household wealth— can only be addressed within the global financial market. RMB internationalisation, too, demands further liberalisation of capital controls. And as markets become more liberal, the effectiveness of those controls will continue to erode, which makes liberalisation an unavoidable choice.
The conditions for full liberalisation of capital accounts in China are not yet in place, and simply advancing market liberalisation will not in itself generate efficiency gains in the domestic market. Without proceeding “on its own terms” [“以我为主”], China risks being forced into other countries’ market structures on unfavourable terms, an outcome that would do nothing to improve domestic market efficiency and could well prove counterproductive.
The core principles governing China's capital account liberalisation are therefore a proactive stance [主动性], a phased approach [渐进性] and the retention of control [可控性]. These find expression in five main areas.
First, a degree of control over inward and outward capital flows should be maintained until the RMB’s exchange rate band has been sufficiently widened and that rate has broadly reached its market-clearing level [Note: The rate at which supply and demand for a currency are in equilibrium without government intervention].
Second, capital account liberalisation must be closely aligned with the pace of domestic market reform—spanning factor price reform [要素价格机制改革], services sector reform, restructuring of government functions, tax reform and the full marketisation of the financial sector—so as to keep the externalities inherent in financial markets, particularly those arising from information asymmetries, within bounds that the market can absorb.
Third, capital account liberalisation should be coordinated with the progress of RMB regionalisation. While capital account liberalisation cannot take RMB regionalisation as its sole objective, the two can advance gradually in tandem, with RMB regionalisation as the guiding thread. In the coming years, capital account liberalisation may unfold in a foreign currency-dominated environment or, alternatively, in one where the RMB is gradually taking on a greater role. This may be what sets China’s approach apart from that of other transition economies. As a general principle, any category of cross-border capital transaction permitted in foreign currency should equally be permitted in RMB.
Fourth, capital account liberalisation must be accompanied by stronger macroprudential supervision and greater flexibility in macroeconomic management. As the process of liberalisation advances, the large-scale cross-border flows and arbitrage pressures that follow tend to erode the effectiveness of the quantitative and administrative controls that have historically underpinned China’s macroeconomic framework. Policymakers must therefore be well prepared for a shift towards price-based and indirect instruments (grounded in incentive-based mechanisms rather than administrative controls).
Fifth, different regulatory approaches are warranted for different types of cross-border capital flows at different stages. Inward and outward flows driven by illegal activity or political considerations, in particular, fall outside the scope of standard capital controls and should instead be addressed through anti-money laundering frameworks.
VIII. RMB Regionalisation and the Rise of a Major Power
Were China operating in a world with a stable exchange-rate system and an equitable, well-functioning international monetary order, there would be little need to actively pursue the internationalisation of the RMB as part of its rise to global prominence. The difficulty is that today’s financial world is anything but stable and is beset by problems. In that context, internationalising the RMB is an unavoidable decision in order to shield China’s development from the negative impacts of the modern global financial system.
Of course, achieving full internationalisation of the RMB as a sovereign currency, i.e., making it a major global reserve currency, is a long-term process. Nevertheless, based on long-term trends in domestic and international economic development, starting this process now is an essential move [重要一着棋] for China’s future financial strategic framework. Its significance can be summarised in six points.
First, from China’s perspective, the current pursuit of RMB internationalisation can sustain economic globalisation and safeguard both global and Chinese economic growth.
Stable exchange rates between currencies are a fundamental prerequisite for sustaining economic globalisation. Calls for reform have intensified in response to the deep-seated problems in the US economy and the shortcomings of the international monetary system. Yet under current conditions of dollar dominance, there is no straightforward path to reform. Pursuing a more diversified international reserve system is therefore an unavoidable course for the global economy for a long period to come.
Against this backdrop, it is little wonder that China, as the world’s second-largest economy, commands global attention. Its economy continues to grow rapidly, its trade volumes rank first in the world, and within Asia—a region on its way to becoming the “main driver” [“主要驱动力”] in the global economy—China’s trade has expanded at a remarkable pace. RMB internationalisation would therefore meet a widely felt need among countries that are seeking stable economic development, serve as a boon for the Asian economy, and advance global economic interests at large. This is the primary message China must communicate to the world in pursuing RMB internationalisation.
Second, for China’s economy to maintain balanced and sustained growth, RMB internationalisation is equally necessary.
Since the 1980s, China has been facing capital shortages, which has made an export-oriented strategy and the build-up of foreign exchange reserves essential for the take-off of its economy. What followed was a combination of factors—the euphoria of rising power, inexperience in managing growth, and the sheer momentum of an expanding economy—that drew China, through policy negligence [政策的疏忽] or simple inadvertence, into the global “over-prosperity” [过度繁荣] of the preceding two decades that was the product of misguided US policy. It led to a vast accumulation of dollar reserves, deep structural imbalances and underlying vulnerabilities that would ultimately make growth unsustainable both in China and beyond.
On the other hand, given China’s substantial production capacity and the post-crisis collapse of US consumption, sustaining relatively high growth and realising China’s potential growth rate—thereby contributing more to global economic expansion—will require a measured expansion of the Chinese government’s global policy influence through RMB-denominated foreign investment, buyer’s credit and RMB clearing arrangements [Note: Buyer’s credit refers to loans extended to foreign buyers to purchase Chinese goods and services; RMB clearing arrangements are systems enabling cross-border transactions to be settled directly in RMB]. By channelling excess capacity towards emerging economies in Asia, Africa and beyond, and by nurturing new investment and consumption capacity in these countries, China can help stabilise growth across Asia and the wider world. This is quite similar to the role played by the United States and the dollar economy in the years immediately following the Second World War, and it reflects the needs of global economic development.
Third, pursuing the internationalisation of the RMB can comprehensively improve the efficiency of China’s financial system.
RMB internationalisation requires further opening up of China’s financial sector, which will place strong pressure on this sector to address its current state of “financial lag” and “weak financial power”. History has shown that such pressure can drive reform and opening up in the financial sector, which will lead to improvements in financial efficiency.
Fourth, from the perspective of financial history, the rise of a major power urgently requires the support of an internationalised currency commensurate with its degree of economic openness and international influence.
Historically, the currency of a rising economic power often becomes an international currency. In particular, in the era of fiat money, the rise of a major power is almost impossible to fully achieve without the internationalisation of its own currency.
Fifth, pursuing the internationalisation of the RMB is also essential for managing economic risk.
Against the backdrop of today’s flawed, dollar-dominated international monetary system, the internationalisation of the RMB would help the major economy [that is China] mitigate at least three risks. The first is liquidity risk: the Chinese government is, after all, the “lender of last resort” [“最后贷款人”] for the RMB. The second is the risk of market value swings caused by currency mismatches, because assets denominated in foreign currencies reduce the control of domestic authorities over their own financial markets. The third is pricing power risk [定价权风险]: issuers of currencies whose supply is largely unconstrained enjoy a relative funding advantage and are, in the short term, better able to avoid the risk of pricing power in relevant world-market transactions falling into others’ hands.
Sixth, the internationalisation of the RMB is also a powerful means of addressing the shortcomings of the current international monetary system.
The dollar is currently issued virtually without constraint, and the dollar-dominated international monetary system has serious flaws, which explains the growing worldwide calls for reform. From the perspective of the long-term evolution of the international monetary system, a “supranational currency” [“超主权货币”] would be ideal. However, the road to such a system is likely to be very long. When national self-interest comes into play, it is unclear when—or even whether—such a system might ever be implemented. It may well only remain an ideal, for as Robert Mundell put it: “There is a tendency for the dominant country to reject the world currency. The basic fear is that the global currency represents a threat to the position of its own currency. The counterpart of the conjecture is that actual or potential rivals try to pursue international monetary reform to clip the wings of the dominant power and to redistribute power.”
Therefore, the more realistic choice is to establish multiple international currencies of comparable strength, to create a constrained and balanced system through mutual competition. The RMB has already come to be seen by relevant international organisations and experts around the world as a potential counterweight.
Although RMB internationalisation is both objectively necessary and holds vast potential for development, it cannot be achieved overnight. At present, however, the RMB already meets the basic prerequisites for regionalisation. During the strategic transitional period, the immediate objective of RMB internationalisation should be regionalisation. Regionalisation simply denotes a geographic limitation on the use of an international currency; it does not imply any qualitative difference in the currency’s functions.
How can regionalisation be achieved? In recent years, I have repeatedly stressed that the key lies in implementing three approaches.
First, every possible measure should be taken to channel the RMB into offshore markets, for example through RMB-denominated foreign investment, buyer’s credit, foreign aid, central bank swap agreements, and by raising RMB quotas under Qualified Domestic Institutional Investors (QDIIs) [Note: QDII schemes allow approved domestic institutions to invest client funds in overseas markets.]
Second, as China’s capital account is not yet fully liberalised, the RMB can initially operate offshore like other freely convertible currencies, providing a full suite of services—deposits, loans, payments and settlements, asset management and currency hedging—to build a self-sustaining offshore circulation.
Given that the RMB needs to become regionalised and the capital account remains partially closed, channels between onshore and offshore markets can only be developed gradually and on a limited scale. Strategically, it is therefore feasible to establish an offshore RMB market in locations under Chinese government control, such as Hong Kong, making it a key pillar of the national financial strategy. This is a relatively favourable option, albeit one adopted out of necessity under the framework of “limited globalisation” [“有限全球化”].
Finally, it is equally important to note that, while the internationalisation of the RMB is one measure to address shortcomings in the existing international monetary system, the Chinese government should, from the same strategic perspective, pay full attention to, and support, all other developments conducive to this objective. Such developments include reforms to the International Monetary Fund (IMF), an increase in the RMB’s weighting within the Special Drawing Rights (SDR) basket, efforts in other parts of the world to develop “regional currencies”
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