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China's Yuan: Can it Challenge the Dollar?

China’s economy is now second to only the United States. Can its currency rise to a similar stature? By Angelo Young from International Business Times February 27, 2013 0 0 0 0 0 Shares 3 comments China has long had the ambition of seeing its currency, the yuan, challenge the hegemony of the U.S. dollar. If recent history is any indication, the country is well on its way to achieving that goal. One of main reasons for its progress toward that goal has been Beijing’s willingness to gradually surrender at least some control of the yuan’s value to the world market. For years China undervalued the yuan to make its exports more competitive. It worked, but at the price of provoking major trading partners, like the U.S. and Europe. The issue emerged as a point of contention during the last U.S. presidential race, with Republican candidate Mitt Romney lambasting President Barack Obama for not doing enough to get China to begin valuing its currency more fairly. China has been more than aware of such criticisms, and it has been responding, albeit slowly. In 2009 it began a pilot program of internationalizing its currency by allowing Hong Kong banks to trade the yuan.

) But China isn’t Mexico. a Chinese economic crisis like the one in the mid-’90s that hit Mexico – which was the first developing country to let its currency float freely – would have global repercussions. Then last year. and China-based companies were allowed for the first time to use the yuan for business outside the mainland. Also in 2010. This rapid growth in off-the-mainland yuan deposits caught the attention of the Chicago Mercatile Exchange. Letting the yuan float freely with the ebb and flow of the global currency market could give a boost to economies that depend on exports to China. China eased the yuan back to a managed float after it established a completely fixed currency in 2008 as an emergency response to the American subprime mortgage meltdown. (It took a decade for the country to begin benefiting from the move. the Chinese began allowing Americans to trade in the currency. The downside.or overvalued suddenly sees an overnight adjustment. In addition to the concerns over a deep economic blow that could destabilize the country. however. which announced Monday it would join Hong Kong Exchanges and Clearing Limited (HKG:0388) and start trading CNH futures under contracts of up to three years. foreign companies were allowed to settle direct investments on the mainland using the yuan. .And since then the number of yuan-held deposits in Hong Kong has exploded. as occurred when Mexico allowed its peso to float freely at the end of 1994. Beijing eased the yuan’s trading band against the dollar for the first time in five years – allowing the currency to fluctuate more broadly. from less than 100 billion in the first half of 2010 to about 600 billion in 2013. according to The Financial Times. to that is the initial shock to the economy that can occur when a currency that is artificially under. In January 2011. By October 2011.

One-party regimes. deteriorating governance. when the CCP will reach the upper-limit of the longevity of one-party regimes. has the means to survive for an extended period (though not forever). the organizational decay of one-party regime can be measured by the limited longevity of such regimes. holds that the CCP’s days are numbered.WHY CHINA COULD BECOME A DEMOCRACY Speculating about China’s possible political futures is an intellectual activity that intrigues some and puzzles many. the record longevity of a one-party regime is 74 years (held by the former Communist Party of the Soviet Union). a transition to democracy in China in the next 10 to 15 years is a high probability event. . we may reasonably speculate that the probability of a regime transition is both real and high in the coming 10-15 years. however sophisticated. however. all of the three longest-ruling one-party regimes began to experience system-threatening crisis roughly a decade before they exited political power. and growing alienation of the masses. Leaders get progressively weaker (in terms of capabilities and ideological commitment). such regimes tend to attract careerists and opportunists who view their role in the regime from the perspective of an investor: they want to maximize their returns from their contribution to the regime’s maintenance and survival. those believing that China’s one-party regime still has enough resilience to endure decades of rule can point to the CCP’s proven and enormous capacity for repression (the most critical factor in the survival of autocracies). The conventional wisdom is that the entrenched Chinese Communist Party (CCP). the accounting is complicated by the Kuomintang’s military defeat on the mainland). its ability to adapt to socioeconomic changes (although the degree of its adaptability is a subject of scholarly contention). One-party regimes in Mexico and Taiwan remained in power for 71 and 73 years respectively (although in the case of Taiwan. Among many of the causes of the decline and collapse of authoritarian rule. First. Empirically. To date. suffer from organizational ageing and decay. there is the logic of authoritarian decay. so determined to defend and perpetuate its political monopoly. and its track record of delivering economic improvement as a source of legitimacy. In fact. two stand out. To be sure. If the same historical experience should be repeated in China. where the Communist Party has ruled for 63 years. The result is escalating corruption. To this list of reasons why the Chinese people should resign themselves to decades of one-party rule will be a set of factors singled out by proponents of the theory of predictable regime change in China. Moreover. What stands behind this optimistic view about China’s democratic future is accumulated international and historical experience in democratic transitions (roughly 80 countries have made the transition from authoritarian rule to varying forms and degrees of democracy in the past 40 years) and decades of social science research that has yielded important insights into the dynamics of democratic transition and authoritarian decay (the two closely linked processes). A minority view.

military defeat. de-legitimize autocratic rule.000 (PPP). based on the rich experience of democratic transitions since the 1970s. Recognition of such a crisis convinces some leaders of the regime that the days of authoritarian rule are numbered and they should start managing a graceful withdrawal from power. If such leaders gain political dominance inside the regime. its per capita income could exceed $15. unless they rule in oil-producing countries. Few authoritarian regimes. Most critically. just imagine how impossible the task will become in 10-15 years’ time. such negotiations center on the protection of the ruling elites of the old regime who have committed human rights abuses and the preservation of the privileges of the state institutions that have supported the old regime (such as the military and the secret police). and endemic corruption). If we apply this observation and take into account the probable effect of inflation (although the above PPP figures were calculated in constant terms).Second. a peaceful exit from power managed by the ruling elites of the old regime goes through several stages. Then they negotiate with opposition leaders to set the rules of the post-transition political system. elections are held. thus ushering in a new democratic era. Statistical analysis shows that authoritarian regimes become progressively more unstable (and democratic transitions more likely) once income rises above $1. . which may be caused by many factors (such as poor economic performance. and urbanization rates. rising popular resistance. authoritarian regimes. the more interesting follow-up question is definitely ―how will such a transition happen?‖ Again. the transition in Burma is unfolding according to this script. the likelihood of democratic transitions increases more dramatically. can survive once per capita income hits more than $6. At the moment. If the CCP has such a tough time today (in terms of deploying its manpower and financial resources) to maintain its rule.100 (PPP) today. If this analysis is convincing enough for us to entertain the strong possibility of a democratic transition in China in the coming 10-15 years. the effects of socioeconomic change –rising literacy. As a result.000 (PPP) per capita. they start a process of liberalization by freeing the media and loosening control over civil society. comparable to the income level of South Korea and Taiwan in the mid-1980s on the eve of their democratic transitions. parties representing the old regime lose such elections. we will find that China is well into this ―zone of democratic transition‖ because its per capita income is around $9. Typically. there are five ways China could become democratic: “Happy ending” would be the most preferable mode of democratic transition for China. When per capita income goes above $4. find it increasingly difficult and ultimately impossible to maintain their rule once socioeconomic development reaches a certain level. In most cases (Taiwan and Spain being the exceptions).000 and its urbanization rate will have risen to 60-65 percent. along with the improvement of communications technologies — greatly reduce the costs of collective action. income. Once such negotiations are concluded. unbearable costs of repression. It starts with the emergence of a legitimacy crisis. and foster demands for greater democracy.000 (PPP). which have a relatively easy time ruling poor and agrarian societies. In another 10-15 years.

If the ―Gorby scenario‖ is the one that brings democracy to China. as happened during Tiananmen in 1989. environmental decay. For the last twenty years. took place because the old regime still maintained sufficient political strength and some degree of support from key social groups. In such a scenario. Mexico. it would be the most ironic. except that the trigger of the collapse is not a belated move toward liberalization by reformers inside the regime. ―Tiananmen redux‖ produces a different political outcome mainly because the China military refuses to intervene again to save the party . the regime suffers another internal split. With their enormous popular support. “Gorby comes to China” is a variation of the ―happy ending‖ scenario with a nasty twist. So the sooner the ruling elites start this process. The paradox. crony-capitalism. start a Chinese version of glasnost and perestroika. refuses to offer concessions to the Communist Party since it is now literally in no position to negotiate. the dominant political opposition. Should such a scenario occur in China. The historical record of peaceful transition from post-totalitarian regimes is abysmal mainly because such regimes resist reform until it is too late. including many defectors from the old regime. The same factors that contribute to the ―Gorby scenario‖ will be at play here. and political trends (such as falling economic growth due to demographic ageing. Such a scenario can unfold when the party continues to resist reform even amid signs of political radicalization and polarization in society. such as those in Taiwan. social. Members of the old regime start to defect – either to the opposition or their safe havens in Southern California or Switzerland. but by an unanticipated mass revolt that mobilizes a wide range of social groups nationwide. it means the party has obviously learned the wrong lesson from the Soviet collapse. similar to that between Boris Yeltsin and Gorbachev. the Communist Party has tried everything to avert a Soviet-style collapse. Amid political chaos. among other things. The party’s rule collapses. corruption and rising social unrest) finally forces the regime to face reality. But in the coming decade. a convergence of unfavorable economic. Successful cases of ―happy ending‖ transitions. The manifestations of such a political revolution will be identical with those seen in the heady days of the pro-democracy Tiananmen protest and the ―Jasmine Revolution‖ in the Middle East. Hardliners are discredited and replaced by reformers who. Liberalization triggers mass political mobilization and radicalism. China’s leadership misses the historic opportunity to start the reform now. But the regime by that time has lost total credibility and political support from key social groups. whether the ruling elites start reform before the old regime suffers irreparable loss of legitimacy. In the Chinese case. and Brazil. with the rise of a radical democratizer replacing a moderate reformer. either as a result of elections that boot its loyalists out of power or spontaneous seizure of power by the opposition. is that regimes that are strong enough are unwilling to reform and regimes that are weak cannot reform. the odds of a soft landing are likely to be determined by what China’s new leadership does in the coming five years because the window of opportunity for a political soft landing will not remain open forever. the probability of such a happy ending hinges on. inequality. In the Chinese case. however. the greater their chances of success. “Tiananmen redux” is a third possibility.But for China. like Gorbachev.

adding more risks to financial stability. As China’s capacity to maintain capital control erodes because of the proliferation of methods to move money in and out of China. But even if the party should survive the immediate aftermath of a financial meltdown. The take-away from this intellectual exercise should be sobering. the economy would grind to a halt and social unrest could become uncontrollable. To make matters worse. Environmental collapse in China has already started to alienate the urban middle-class from the regime and triggered growing social protest. “Environmental collapse” is our last regime change scenario. If the security forces fail to restore order and the military refuse to bail out the party. Given the salience of environmental decay in China these days. the party could lose power amid chaos. lost productivity. As we go through the likely causes and scenarios of such a transition. poor regulation. and weak risk management. “Financial meltdown” – our fourth scenario – can initiate a democratic transition in China in the same way the East Asian financial crisis in 1997-98 led to the collapse of Suharto in Indonesia.Growth could stall. record drought. the economic toll exacted on China will most likely damage its economic performance to such an extent as to generate knock-on effects that eventually delegitimize the party’s authority. the probability of a financial meltdown increases further. the economic costs of environmental collapse will be substantial. . The severe degradation of the environment in China also means that the probability of a catastrophic environmental disaster – a massive toxic spill. off-balance sheet activities through the shadow-banking system have mushroomed in recent years.(in most cases of crisis-induced transitions since the 1970s. the probability of a regime change induced by environmental collapse is not trivial. both for the CCP and the international community. The feed-back loop linking environmental collapse to regime change is complicated but not impossible to conceive. In addition. unresponsive. premature capital account liberalization by China could facilitate capital flight in times of a systemic financial crisis. and incompetent on environmental issues. undermining the CCP’s legitimacy and control. water shortage. or extended period of poisonous smog– could trigger a mass protest incident that opens the door for the rapid political mobilization of the opposition. cronyism. corruption. The probability of a collapse induced by a financial meltdown alone is relatively low. the military abandoned the autocratic rulers at the most critical moment). Environmental activism can become a political force linking different social groups together in a common cause against a one-party regime seen as insensitive. Obviously. Should China’s financial sector suffer a meltdown. it should become blindingly clear that we need to start thinking about both the unthinkable and the inevitable. It is a well-known fact today that the Chinese financial system has accumulated huge non-performing loans and may be technically insolvent if these loans are recognized. The Chinese bank-based financial system shares many characteristics with the Suharto-era Indonesian banking system: politicization. in terms of healthcare. few have seriously thought about the probability and the various plausible scenarios of a regime transition in China. and physical damages. To date.