China needs to carry out institutional reforms to internationalize the renminbi ( RMB ) and not blow the opportunity as Japan did with the yen three decades ago, says Chinese economist Miao Yanliang.

“Great powers often collapse under their own weight,” states Miao, the chief strategist at China International Capital Corporation ( CICC )  and a former chief economist at China’s State Administration of Foreign Exchange, referring to the monetary histories of Spain, the Netherlands and Britain between the 16th and early 20th centuries.

A currency’s incentives to expand strengthen the more successful it becomes, he adds, writing in a recent report by CICC, a Beijing-based investment bank.

Decline at peak

However, if incentives outrun fiscal capacity and institutional constraints, “stability can flip into fragility, and the credit architecture becomes prone to self-disintegration,” he warns.

In turn, the weakening of the old centre – a “decline at the peak” – creates an opening for a new one.

“As confidence in the incumbent erodes, global actors begin to search for a new anchor capable of supplying liquidity, safe assets and institutional stability, thereby setting in motion a reconstitution of the monetary order.”

Timing, reform

Essential to the US dollar displacing sterling after World War I, according to Miao, was “timing plus reform”.

Britain’s decision to abandon the gold standard for the overvalued sterling in 1931 was preceded by reforms in the United States.

In addition to the creation of the Federal Reserve system in 1913, the market for US Treasury bonds had expanded rapidly along with improvements in market making, settlement and clearing.     

Moreover, New York rivalled London as an international financial centre by the 1920s, setting the stage for the dollar’s ascendancy under the Bretton Woods framework at the end of World War II.

Sterling’s vulnerability

In short, “the United States capitalized on sterling’s moment of maximum vulnerability and paired it with institutional consolidation and financial deepening,” Miao explains, “thereby positioning the dollar at the core of the international monetary system.”

With the yen’s dollar value more than doubling after the Plaza Accord of 1985, Japan was at “arguably the closest historical moment to mounting a serious challenge to the dollar,” Miao writes. “Yet, it delayed reform and ultimately missed the window for yen internationalization.”

The missed opportunity was not simply a matter of insufficient economic weight, he adds, “it also reflected Japan’s failure to deliver institutional reform within a critical window.”

Too late for Japan

By the time Japan finally got around to reforms in the mid-1990s, it was already too late.

“Worse still, no sooner had reforms begun than Japan’s banking system was hit by a credit crunch and a wave of bank failures,” Miao notes. “The historical window for yen internationalization thus closed quietly, but decisively.”

The lessons from the dollar and yen episodes, he adds, are clear. “Windows for monetary breakthroughs can be brief. A new centre’s genuine ascent requires decisive reform at the right moment: it must seize the opportunity created by the incumbent’s relative decline, while simultaneously rebuilding its own comprehensive capabilities."

Economic power is easy, Miao argues. “Financial system construction is more demanding, requiring sustained accumulation. Institutional credibility is hardest of all, yet it is often the most decisive factor in international monetary competition.”

Is the US dollar now at its “moment of maximum vulnerability” as sterling was in 1931? And if so, can China pair this moment with institutional consolidation and financial deepening as America did?

Critical juncture

The system, according to Miao, is now at a “critical historical juncture” with America’s growing use — and overuse — of the dollar starting to fray the foundations that underpin its status.

“The entry barriers of the international monetary order have, unusually, started to loosen, creating an opening for latecomer currencies to ascend and for the system itself to be reconfigured,” he says. “If the RMB can seize the moment and steadily strengthen its role as an international reserve currency, the global system may evolve from a single-core structure towards a more balanced, multi-centre configuration.”

However, this requires, Miao points out, “functional anchors in financial markets and, ultimately, on institutional credibility sufficient to generate broad international confidence”.

For the RMB, such anchors, he reckons, could reflect the objectives of “expanding opening up” and “boosting China’s strength in finance” – in line with the 15th Five-Year Plan for 2026 to 2030, scheduled to be adopted by the National People’s Congress in March.

“China could pursue a gradual, well-sequenced increase in capital account openness,” Miao says, “while further improving the infrastructure for RMB pricing, invoicing and settlement.”

From usable to trustworthy

With market-oriented reforms, “the RMB can evolve from a currency that is simply ‘usable’ for payments into one that is ‘allocatable and trustworthy’ as an asset, thereby establishing a solid financial foundation for its internationalisation,” Miao offers. “China must seize this strategic window to shape the RMB’s institutional credibility through reform.”

Priorities would include building a buffer against external shocks from cross-border capital flows and floating the RMB to allow for price adjustments to ease pressures.

And as digital financial infrastructure improves, the economist shares, “the RMB can achieve deeper institutional embedding in global payments and settlements, and position itself to take a leading role in the monetary transformation.”

Historical opportunity

“While the emerging cracks in the dollar system provide a rare historical opportunity for the RMB,’ Miao concludes, “its future position will be determined not by the relative decline of the dollar, but by China’s own internal strengthening.”

By accelerating the development of onshore financial markets, implementing a floating exchange rate system and advancing capital account opening, “China can fundamentally enhance the RMB’s credibility and functionality within the global system,” he says. “The goal of RMB internationalization has never been to replace the dollar, but to serve as an additional stabilizing force in a system under strain.

“If China can seize this window, the future international monetary system may evolve from a single-centre structure towards a more balanced, multi-centre arrangement, with the RMB playing a constructive role in this new configuration.”

The Beijing-based Center for  China and Globalization ( CCG ) published a translation of Miao’s two-part essay on January 26 – the same day as Chinese Premier Li Qiang chaired a symposium on the draft outline of the 15th Five-Year Plan. The translation is by CCG research associate Jia Yuxuan and CCG intern Wei Lai. The essay is an excerpt from a report published by CICC on November 28. CCG notes that Miao had reviewed the translation before publication.