What Needs to Happen for the Renminbi to Seriously Compete With the Dollar

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1:15Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal. And I'm Tracy Alloway. Tracy, dollar strength, dollar dominance, conversation is not going away. No. I mean, it's never really gone away. That was our intro for the last episode we did on this topic, which is it seems like every couple of years you get this resurgence about, oh, the end of the dollar, the dollar is going to lose its exorbitant privilege. I remember my dad sending me articles about like, oh, Iraq is invoicing oil in euros like in 1998 or something. Lots of conspiracy theories around that one. But I will say we had that conversation with Paul McNamara.

1:58It was a really good overview of some of the talk that's happening right now and why certain countries, specifically emerging markets like China, might want to get away from the dollar. But I feel like there's more to say. All right. I'm going to make a confession, which is that in all of these conversations, there are certain things that people say, and I just sort of like nod my head. They're like, that's right. That's right. But I don't totally get them. And one of them, and it's not even so much about the dollar per se, but about dollar alternatives. And the big one is like, well, the renminbi cannot be a real dollar alternative until China runs a current account deficit.

2:32And I go, that's right. That's right. But like beyond that, like I actually like do not totally get what that means or what actual constraint China's trade position with the rest of the world means for the future of renminbi internationalization. Well, I think the way I would frame it is one thing we hear is that there isn't a viable alternative to the dollar. There are no other currencies slash country economies that are at the level the U.S. is that could possibly replace the dollar. And so I think we need to talk about why that is and what exactly that means. What does it mean? So I get the idea that, OK, maybe a country doesn't have enough financial assets for savers to buy to put their excess money in.

3:15I get that. But what does it mean that it's not a viable alternative? Right. And I guess the question is like, OK, but what would it take? Yeah. Right? It's like, yes, we can sort of agree this basic premise. Maybe there's some impulse for some countries to move away from the dollar. Also, there are no real alternatives at this point. But maybe at one point there will be. But actually, what would it take for another currency, maybe the renminbi, maybe the euro, to actually become a meaningful global reserve currency? If China woke up tomorrow and put this at the top of its agenda, I don't think it's going to.

3:48But what would that sort of 10-step plan actually look like? That's a great way to sort of frame the conversation. What would it actually look like? So we're going to sort of be having part two to our recent conversation with Paul. Actually, a friend of Paul's. So maybe a similar, different perspective, but sort of like follow on of what would it take for some other currency to be a meaningful global reserve currency. I'm very excited. We're going to be speaking with Karthik Sankaran, a true FX veteran, recently at Corpay. He's been at Eurasia Group, multiple banks, an avid maker of dad jokes and puns on Twitter.

4:22And used to actually cover Paul when he was trading, right? So a perfect guest for this conversation in many respects. And someone who I feel like I've wanted to have on the show for like years and is like in my mind an odd lots guest, even though he hasn't been on the show before. Karthik Sankaran, thank you so much for finally joining us here. Thank you very much for having me. It's an absolute pleasure to be here and honor. What does that mean? Actually, before – I want to get to the alternatives. Just before we do, though, real quickly, I mean you listened to a recent episode with your longtime friend and colleague Paul McNamara in which he said there is some global impulse for countries to stop using dollars but there really aren't many alternatives.

5:02Do you basically agree with that premise? Yeah. I mean, there are, I'd say two things about that. One is I think going to replacement, and that's how this usually gets framed as replacement. I think that's silly. And the way I think about it is, would it make sense to see creeping regional displacement rather than replacement? And I think that's a possibility. And I would argue that the euro has already done that to some extent. in it you know not just in the euro area but also in central and eastern europe you know and i remember when i started my career you know if you wanted to trade this lot this lot you traded dollar polish and if someone asked for a price in march lotty you traded through the legs now it's the other way around you know if someone asked for a price in dollar polish you trade your polish and your dollar so it's taken a long time but and i think that's the this regional displacement idea But what this also brings out, to me at least, is everyone is so excited about their MNB, kind of this BRICS currency and so on.

6:11And one way to frame why I think there is a desire, but it's a very long way from being fulfilled, is that look at what the euro has, which is kind of a solid number, too. We were pretty, you know, kind of like Avis to the dollars, Hertz, at least that's the way the old commercials used to go. But the Renminbi is really, really, really far behind. And one thing, just because I've been introduced as an avid maker of dad jokes. Okay, here we go. First one. Here it is. First one of the evening is at the, or whenever this is played. But, you know, you mentioned a 10-step program for Renminbi internationalization.

6:52and I was reminded that the last person who had a 10-step program that really worked was Genghis Khan. Okay. That's just a mild juggle. That's not going anywhere. Okay. Sorry, I'm going to lose it at the dad jokes. Just to back up a second. Oh, it took me a second to get that one. Actually, sorry, it took me a second to get that. That's a good one. Okay, we're going to have a fun time here. Just to back up and ask this question in a different way, But I mean, there is there is this assumption that China would want to have renminbi internationalization. Should they want that? You know, if you consider China as an export driven economy that exchanges goods in return for U.S.

7:36dollars, which are relatively stable currency, does it make sense that it would want to have a different economic model? What are the benefits that it gets out of that? I mean, I disagree with this, you know, and the stuff that Joe mentioned in the beginning. Does the country at the center of the international monetary system need to run deficits? And I don't think that's necessary, in fact, because you have a model written under the gold standard with a huge exporter of capital. The U.S. until the mid-1960s was the center of the Bretton Woods system and was also a huge exporter of capital. So what that suggests is that it is possible for a surplus country to be the center of the monetary system.

8:25You just have to find a way to get that currency out the door in size, in massive size. And you can do that either through the trade account by running very large external deficits, or you can do it by externing great gobs of capital, either in your currency or that other countries are denominating your currency. So I think that's one way to think about it. But clearly, China is not there and will have a very long time getting there, not just because of the issues with capital account convertibility, but there's a lot of things in the basic way that Chinese financial markets operate that make it difficult even for other people to issue in renminbi in size.

9:14So let's jump into this because I think this is a point that I have not really heard many people make. So people make the point that it's like, okay, one way to get your currency out there into the world is to run a big trade deficit. But as we know, and I'm even thinking back to some of our conversations with Lev Menend about the rise of the shadow banking system and euro dollars, The other way is just for other entities to start issuing your currency or assets that are denominated in your currency. And theoretically, I could issue a renminbi-denominated loan and tell someone I'm going to pay them back in renminbi.

9:53But you made this point with respect, a great thread with respect to Brazil, which is that actually like what we need to see is countries like Brazil being willing to take out renminbi-denominated debt. Can you talk a little bit about the importance of that? I think that's a very powerful thing. Not many people have talked about this element of it. Yeah, and I think there are actually two issues. In some ways, it might actually be a good idea for Brazil to issue Renminbi debt, right? Because you have – and I think this is one of the arguments for a multipolar system more broadly is if you're a country whose terms of trade are driven by what's happening in China, if your business cycle is much more responsive to China, then it makes sense to be able to issue in the Chinese currency.

10:39Because what you don't want to be in the situation that you see emerging markets end up in all the time, they've issued in dollars, the commodity exporters, commodities are priced in dollars, the world slows, China slows, commodity prices tank, the dollar goes up, and they're hosed. I mean, this is like this rinse and repeat cycle in the international financial system. So it might actually make sense for that thread for, I was saying like, I'll get excited when CBRD issues like a huge amount in Panda bonds, but that's difficult. That's really difficult. And there are so many different reasons for that related to the way Chinese financial markets work.

11:22One is if you issue in renminbi, which renminbi do you want to issue in? Do you want to issue in the onshore market, which is deeper, or do you want to issue in the offshore market, where you might have more people able to transact, but it's a much salarer market. If you do end up issuing the onshore market, obviously, and you may not want to, the reputation that Chinese investors have is of being somewhat more excitable. I think we've seen that in the in the equity markets. On the other hand, if you issue offshore, the problem is that China not only has two currencies, CNY and CNH, an offshore currency, an offshore currency, that trade reasonably closely together a lot of the time.

12:16But one of the ways they do that is by having different interest rates. And one of the things the Chinese do periodically is when they're worried about the speculative pressure on their M &B, which they think is coming from offshore players, is they will jack up interest rates on CNH. They will take it to the moon. We've seen it a few times, which might work in deterring the speculators, bring, you know, speculative pressure back down again, get CNY and CNH to converge. But that's really not that comfortable if you've issued in the offshore currency. So, and one of the things that the US has, the dollar has, is incredibly deep derivative markets, for instance.

13:04So if you want to issue, if you issue in dollars and you want to hedge your interest rate risk, you can do it by trading your dollars. Probably one of the most liquid financial futures contracts in the world. I remember financial futures, interest rate futures, are just a, are like a very, very, very small fraction of that. The other issue with issuing onshore is, you know, what's your, and China has this huge domestic debt market. It's the world's second largest debt, domestic debt market. But to a very significant extent, it's composed of entities with opaque finances, right? The CGB market, the Chinese government bond market is a relatively small fraction of the onshore market, just true, you know, which and treasuries are not the entirety of the U.S.

13:53market either. But the opacity of entities issuing domestically is significantly higher. You know, my one line around this is everyone talks about China not having a rule of law. My view is that the real problem is China doesn't have a rule of accounting. That's the real issue. So I was expecting another dad joke. Yeah, I was. Yeah, I was stealing myself. Karthik, so I guess this brings me to the big question, which is how much of this boils down to just capital controls and the fact that China does not have an open economy? And you might expect that one of the requisites for having an international currency would be to have relatively free movement of that currency.

14:34Absolutely. I mean, that's, I think capital controls are a, you know, and that's the obvious, that's the obvious one. And they're trying to tinker with it at the edges, allowing inflows and outflows. But even at those edges, you know, what I was trying to get at was this idea that, you know, you have an offshore renminbi that's much, that's more freely tradable than the onshore renminbi. But there are very sizable disincentives to issuing and sizing the offshore renminbi because of these things like, when it's a smaller market, how do you hedge? So capital controls are a huge part of it. But if you dig deeper into the capital controls issue, I think it raises more questions.

15:16Well, then I sort of want to maybe just go back to a question Tracy asked, which is like, is there a reason China should pursue the internationalization of the renminbi or should pursue having more global central banks hold renminbi as part of their reserve stock? Like, is there some obvious reason why, you know, it's not going to be number one on the agenda, but is there a reason why it should be in the top 10 or top 20 of the agenda? I mean, one of the things that they've said for years is that they want to see a more international internationalism. But I think when they look at the tradeoffs that they might need to make, I don't think they're ready to, you know, take a to take a huge jump.

16:01And I think the the other issue is that we've seen this before. Right. Japan didn't want to. Japan didn't want to either. And, you know, about 30 years ago, people were talking about the extent to which Japan and the yen could act as another reserve currency. The Japanese just decided they simply didn't want to because of the pressure it would put on the profitability of their industrial base. Things are somewhat different from China in the sense that they seem to have a hankering for kind of broad spectrum global power in a way that the Japanese did not have. And maybe having an international currency is part of that.

16:38But to the extent that it happens, it would likely be much more halting. But they've got a really, really long way to go in this regard.

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17:41This is Steve Covino from Covino & Rich. Here to tell you, Toyota's legacy has been standing tall for generations. From pioneering hybrid technology to redefining the standards of safety and efficiency. With each innovation, a commitment to progress. And with the legendary lineup of in-stock trucks, including the ultra-rugged new Tacoma and heavy-duty half-ton Tundra, you can experience the legacy of Toyota for yourself. Visit buyatoyota.com, the official website for deals, to find out more. Toyota, let's go places. So Karthik, just going back to the deficit idea, and I know you kind of spoke to this already, but what if instead of telling China to run a massive deficit, what if China was able to retool its economy in some way?

18:27where, I mean, the reason it runs this big ball of savings that tends to roll around internally is because there isn't that much of a social safety net. There isn't that much of a social welfare in the state. And so people tend to accumulate a lot of savings or maybe rely on their children. But given the one child policy that's been in effect for a long time until recently, that wasn't really viable. What if China just built a social safety net to reduce the excess savings, would that go some way towards retooling the economy in such a way that you could have RMB internationalization? Yeah, I mean, I think so.

19:07I mean, to my mind, it would actually take care of two or three different issues. And one is the underlying growth model in and of itself, right? Because you've kind of, you know, all the low hanging fruit on investment, particularly real estate investment, you know, they're gone. And I've kind of tended to be an optimist about China because I think you kind of need two things. One is a kind of demonstrated capacity for technological convergence and income convergence for the rest of the world, which they've shown. But the other thing you really need is internal convergence between kind of the coast and the interior.

19:48More middle income in the Middle Kingdom. That's my dad joke. Thank you. I like that. Thanks. And, you know, and you kind of look at, you know, works, you know, works about what rural China is like. There's just there's a huge incentive, both socially and economically to do that, to do that. I think the other thing that lower precautionary savings would achieve is that would be a contribution to ending this kind of like really horrible nexus of excess savings, no place to put them, and underfunded mandates for local governments, which then end up having to sell real estate to developers in order to get the money to provide the services the central government won't so there's this really nasty nexus right there that a larger social safety net would also help with it would help with financial stability i think joe this is something that i've never really understood about china that it's ostensibly a socialist country but it actually doesn't have that big of a not much of a safety net i think like anti-unions and weren't there like some stories like they didn't want kids reading marks and stuff like that i don't maybe i may have been i think i read something like that Anyway, I don't want to speculate on things that I don't know.

21:08Well, you know, this is the socialist, the Chinese road to socialism is the Leninist road to capitalism is kind of how you could think about it. There you go. Going back to the U.S. real quickly. So you pointed out that like Japan decided in the end it didn't want to make the tradeoffs that would have required for the for the yen to be a big international currency. And maybe China will not anytime soon choose to make those tradeoffs. But that, of course, brings back to another sort of like other debate that people have. And again, Klein-Pettis and some of these others, it's like, well, is the dollar strength a burden?

21:42And, you know, should we reverse basically, should we try on some level, at least at the margins, to de-internationalize the U.S. dollar that maybe is not so great? I'm curious where you stand on that question. My personal view is that my response to the burden discourse is check your exorbitant privilege. because, you know, I've been around, you know, EM long enough that I think that if you think being able to print dollars to pay your debt is a problem, try owing dollars without having any, right? So that's, you know, that's extreme. But I guess more substantively, I would say that there are lots of reasons I don't think the dollar is a burden.

22:24It certainly is a burden for certain sectors of the U.S. economy that are very exchange rate sensitive and very exposed to kind of catch up growth in other countries. You know, and those regions also fall basically along America's political fulcrum, which is the upper Midwest and Western Pennsylvania. You know, so So I think that adds a political urgency to this debate. That said, the U.S. in total, I think, is a much more interest rate sensitive economy than it is an exchange rate sensitive economy. It's basically it's a much more closed economy than either China or Europe. And if you think that the flip side of dollar centrality leading to dollar strength, which I'm also not convinced is always true, is lower interest rates than otherwise, then you have to ask the question, why are we not doing more with that windfall from low interest rates?

23:26Why did we sink it all in countertops as opposed to doing things like, you know, improving LaGuardia, you know, 15 years ago or building a better BQE? I've only been here five years, so all my analogies are still East Coast analogies. But, you know, and I think finally we're moving in that direction of having a more activist government that uses that potential windfall from issuing currency to do something more in terms of building out essential infrastructure, rather than being, oh, the government always does stupid things. Let's give it to the household. So, you know, then you end up with what happened before 2008.

24:04But that said, the evidence that dollar centrality, which has been true basically since 1945 in one form and since 1970 in one another, always leads to dollar strength, I think is not really true. because in the 50 years since 1971, and Bretton Woods essentially ended, the dollar, I'm an FX guy, the dollar has appreciated for 55 % of that time and depreciated for 45 % of that time. The period of maximum current account deficits by the U.S. is between 2002 and 2008. We were running a current account deficit of close to 6 % of GDP in 2006, The U.S. current account deficit, the largest in terms of rest of the world GDP back then, close to two and a half percent.

24:54And no one wanted to hold dollars. I remember that. I remember, you know, that was when Giselle wanted euros. That's when, you know. So this idea that you have an excessive demand for the safety of U.S. assets that leads to dollar strength is not true. It's not true in the 1970s. It's not true between 2002 and 2008. People want to hold dollars when U.S. interest rates are rising, when you have terms of trade shock like shale, when you have a perceived technological productivity miracle like the Internet boom in 1995 and 2002. Those are strong dollar moments. But the dollar goes up and down all the time.

25:35It's been central. And I think that's not appreciated enough in the Burden discourse. course. So what about ex-US? And, you know, I take the point about maybe, you know, the dollar's centrality doesn't always lead to dollar benefits necessarily. But one argument that has been made, and I think it came up in the episode with Paul, is that the dollar can be a problem for the rest of the world at various points in time. And, you know, we've had Hyun Sung Shin on the show talking about this idea that the stronger dollar basically acts as an economic drag on other economies because of its role in the world and in trade and business activity.

26:16Is there an argument to be made that maybe it would make sense from a financial stability perspective, for instance, to have alternatives to the U.S. currency? Absolutely. I am 100 percent. I am like a total multi-politarian on that front, right? And the reason is this idea, you know, like I was saying earlier, if you think about the global real economy is organized around some hubs and there are spokes, right? And, you know, if you think about Germany or kind of Germany-France as being a hub, what the EU has done and what the Eurozone has done and the extended EU has done has created a financial cycle that kind of parallels the real cycle in the hub, right?

27:03Because if you're borrowing in euros and you're highly exposed to what's happening in Germany or the broader core European economies, when that economy slows, the euro will go down, the ECB will cut rates, unless it's doing something really stupid, which it does periodically. That cannot be excluded. But still, you have this kind of, and to me, that kind of coincidence of real and financial cycles is really important. And a world in which the dollar is the only currency and the most important cross-border liability currency, which is something also I keep harping on, is that the big role is as a liability denomination, not as reserves, not as invoices, none of this stuff.

27:58And that's where the financial stability issues come from. If you are indebted in a currency that tends to strengthen every time the global economy slows, it's bad news for everybody. And that's consumption spark. This is also like, not to diverge, but this is also like what the Bitcoiners never get, The liability aspect, because people are like, oh, right. Sure. Some people may like the idea of like getting paid in Bitcoin, but no one really like wants to like take Bitcoin denominated debt. And that's like, and I understand, I don't want to like have like a big like crypto or Bitcoin tangent, but it really is like this, like this idea of like the liability side is being like really crucial.

28:37and in like you have to ask yourself are you willing to take on debt denominated in this currency and i don't think many people would say yes and that really like sort of like blows up the whole thing yeah and but i mean i think the other thing that the you know this is also i think the liability side is also really important to the broader discourse about this because you see all this excitement as i you know about oh my god they're going to do their trade they're going to their trade in dollars. And yeah, it's interesting because this is your classic economic comparison, right? One of the ways you end an argument with an economist is you're confusing stocks and flows.