Internationalization of the RMB in Latin America: An Overview

Part of the Research Series on the Chinese Dream and China’s Development Path book series (RSCDCDP)


Theoretical research on currency internationalization focuses on supply much more than that on demand. In the last ten years, economic and trade links between China and Latin America underwent a leap-forward development. From the perspective of demand and under the circumstances brought by competitive currency oligopolies and monopolies, the circulation of the RMB in Latin America is influenced by local macroeconomic growth, inflation, exchange rate policies and government management. At the first stage of the internationalization of the RMB, cooperation between China and Latin America is an effective way to expand its influence in Latin America. The research on Latin America is going to provide helpful case support for area selection in terms of the internationalization of the RMB.


RMB internationalization Latin America Currency competition Dollarization 

5.1 Introduction

There is a widely-accepted idea in the nation-state system initiated in the 17th century, which states that national sovereignty as reflected in finance is monetary issuance1; only a single currency can be circulated and used in one country.2 The rise of military powers and tax systems ensure that feature. The state monopolizes its currency and others are excluded. The state persists in its adequate claims for real resources (e.g. goods and services), while on the other hand home currency plays the role of mighty tool to control national economic operations.

Nowadays, world economic globalization promotes interdependency among economic entities. Meanwhile, the competition between main market players has greatly increased as it happens in bigger and deeper market. Marketization competition changed the organization of currency space and obviously omitted state monopoly. When led by states, political borders ruled currency, as it could only be circulated within the borders of the territory of governance. Common currency markets were divided because of circulation territories and currency interest fights between nations, which could hardly be avoided.3 Today, currency space cannot be formed by politics any longer, but rather by an invisible hand, or a currency’s effectiveness and authority (power).4 Currency in one country is no longer monopolized but oligopoly.

Although both exist in imperfect competitive market structures,5 monopoly and oligopoly have different economic implications. Oligopoly has greatly changed the relationship between countries issuing currency and therefore the competitive revenue model. In such a market, the extension of transaction networks increases the importance of currency demanders. Research on currency internationalization pays little attention to currency demanders. There are two possible reasons for this. First, competition in terms of currency internationalization mainly exists between countries issuing currencies, be it competition between international currencies or local ones. The extension of territories for currency circulation can be clearly explained by the issuers’ economic scale, stability, capital market development, etc. The existing literature includes research on the requirements and realization of currency internationalization from the aforementioned perspective and the relationship between strong currencies like the Dollar and the Euro has been thoroughly studied. Second, in the development and maturing process of currency internationalization, demanders have little impact on issuers. This process happens in the changing economic situation of the world along with the rise of issuing countries in global competition, especially in limited regions. To a large extent, it could be correct to analyze the issue from the perspective of the economic strength and influence of issuers, but effectiveness and authority have their specified objects. In the international economic field, no single currency could be put into forced usage by any super-national power, as this field is dominated by the decisions and actions of a country’s public or private market agents.6 With the change of currency competition patterns, the expansion of trade networks, the relationship between currency demanders and economic trade partners are getting more complex. An extreme case in point is the selection of alternative currencies, which will be profoundly affected by the economic development and fundamentals of currency demanders. Meanwhile, there are great differences in the depth and width of economic and trade relations between countries because of imbalances brought about by globalization. Developing countries used to rely mainly on developed ones, especially in the fields of markets, technologies and products. But now developing countries are inter-dependent, thus providing more opportunities for cooperation and the integration of currencies.

In the recent two decades, there was a dramatic economic and trade development between Latin America and China. Since, bilateral trade between Latin America and China has increased at an annual rate of over 30%, surpassing Chinese comprehensive foreign trade growth. China has become the major investor in Latin America. There have been remarkable achievements in terms of cooperation in the fields of natural and energy resources, infrastructure, high-tech, agriculture, etc. Development in the real economy raised new requirements for financial cooperation. China and Argentina signed a currency swap agreement in 2009 and there was motion on a currency swap arrangement with Brazil. At the G20 international economic forum, China cooperated with Latin America on the international financial system reform. Under these circumstances, the possibility for Latin America to become a target region for the internationalization of the RMB has become an important issue for scholars.

Taking Latin America as the major region for currency circulation, this paper is going to explore the possibility of RMB internationalization and regionalization in Latin America so as to add new variables for research on the status of the RMB in different regions. The introduction will be followed by a second part discussing the features of the competition between different currencies, its impact on circulation areas, and the RMB internationalization requirements from the perspective of currency issuers. Part three will focus on the Latin American region and discuss the possibility of expanding RMB circulation in Latin America based on its economic situations and currencies. The final part will be a conclusion on practical implications based on the research.

5.2 International Currency Competition, Currency Circulation and Conditions to Achieve the Internationalization of the RMB

In the era of economic globalization, the RMB is facing fierce international competition. The RMB must qualify in terms of basic international conditions so as to come out at the forefront of competitors. International currency competition means that there will be constraints on the expansion of currency circulation, and the internationalization of RMB is the progress of enhancing its competitive strength, as well as breaking these constraints.

5.2.1 Study on International Currency Competition and Currency Circulation

The research on currency competition could start with market structures, so as to figure out the major features of the competition by exploring different competition models, profit resources and potential influences. More attention should be put on the origin of competitiveness, the conditions for competition and demands in circulation areas for currencies like the Dollar, the Euro and the Yen, although competition among the above three currencies is not the priority of the research. Introduction of the Development and Features of International Currency Competition

Currency competition, as clearly defined by Philipp Hartmann (1998), refers to non-natives accepting and using a currency.7 Currency competition happens when the legal currencies of sovereign states compete with each other, pursuing to expand and stabilize their circulation and trying to achieve monopoly. The international monetary system is naturally an instable oligopoly.8 Therefore, the essence of currency competition lies in the competition between circulation areas.

The development of the international currency system is a process which featured the expansion of circulation areas, which are known in fact as the market of a certain currency. Competition for circulation areas is similar to businesses competing for market shares in commodity markets. Perfect competition among currencies exists in the following two situations9: first, domestic competition among private issuers before the right of issuing currency is handed over to the government; second, international currency competition under the international gold coin standard system before metal coins are replaced by paper money, a credit currency. Thus since the replacement, currencies in the world have started a period of imperfect competition.10 The study of monopolistic competition focused on a market condition featuring low entry barriers, similar but differentiated products, and large numbers of competitors. International currency competition obviously fails to meet the above features, because the main competitors issuing currencies are sovereign states instead of enterprises. The barrier to participate in the international currency competition is quite high, and it depends on various complicated factors, including national will, economic and political strength, national credit, currency stability and transaction networks, etc.

In retrospect of its development path, the international currency system was regarded as perfect competition during the Gold Standard period. The gold was cast and converted freely all over the world, playing the role of global currency. Even bank notes were denominated based on how much gold they could be exchanged for. With the development of the industrial revolution and the foundation of the European colonial system in the UK and other countries, the Pound served as the leading currency in the world for quite a long period. The Bretton Woods system, after World War II, established the monopoly of the US dollar,11 then the only global currency in addition to gold. Large amounts of dollars flew around the world by way of donation, credit, purchase of foreign commodities and labor, so as to meet currency requirements and expand purchasing power. Furthermore, the US dollar had maintained its stability as the hegemonic currency because it could be converted to gold and many countries adopted an adjustable currency system pegged to the US dollar. After the Bretton Woods system and the Jamaica system came the times of economic globalization.12 Starting from the late 1980, the floating exchange rate system was implemented, the capital market was expanded (especially with the IT revolution), the liberalization of trade and investment was progressively impelled, and the regional integration boomingly developed,13 all of which has driven currency competition to become the focus of studies. Economic globalization put an end to worldwide market fragmentation, caused by the separated issuance of currencies by sovereign state, thus making it possible to compete in a relatively unified global market. In 1999, the Euro, officially released by the EU, integrated the different currencies in Europe, thus acting as a new player in currency competition. Since then, the international currency system has entered into a new stage of competition led by the hegemony of the US Dollar in competition with several key currencies including the Euro and the Japanese Yen, which reflects the characteristics of oligopoly.

Under these monopolistic patterns, the government is the only authority to issue currency, and the cost is paid and income is gained by the state. Profits under the monopoly reached their highest level in comparison with other market structures. The appearance of nation-states in the 17th century showed the isolation of the currency market, away from the impacts of other markets in the same country. Meanwhile, it was also in the period of the Bretton Wood system that the US Dollar maintained its monopoly and obtained monopoly income by acting as a medium for international payment and reserves. However, this monopoly also led to the disintegration of the Bretton Woods system. In the 1960s and 1970s, the dollar crisis broke out repeatedly due to the expansion of the US financial deficit, imbalances in international income and payment, and the deteriorated credit of US currency. After that, US dollars couldn’t be converted to gold freely, and the fixed exchange rate system was abolished. With the US Dollar being the single reserve currency in the world, the US faced a tradeoff between maintaining domestic balances and providing global liquidity. No matter what choice the US made, it would definitely have led to economic fluctuations.

Perfect monopoly patterns were rooted in the limits of market entrance. As a part of national power, according to the law, it is strictly forbidden for any private organization and social associations to release currency. Viewed from an international perspective, only the US Dollar was authorized to be pegged to gold, thus playing a role as a settlement and reserved currency. Oligopoly patterns rely on the size of economies. The few oligarchs controlled the international currency market, and competed intensely with each other. Because of the powerful oligarchs and the large scale of initial investments, the original players dominated the initial market, effectively blocking latecomers.

Different from traditional market, the oligopoly of the international currency market plays a more important role and exerts more profound influences.

Leading International Currencies Have a Great Impact on World Economies

Based on the functional analysis framework,14 as well as the theory of international currency and its different roles in circulation, it has been found that key currencies, like the Dollar, the Euro, the Japanese Yen, etc., play an important role in the world currency market.

In terms of exchange mediums and valuation units,15 the Dollar has maintained itself as the leading currency in international trade transactions and the security issuance; meanwhile the impact of the Euro and other currencies keep rising.16 Statistics in Kamp (2006) showed that the proportion of import trade settled in dollars reached as high as 93.6% (Indonesia) around year of 2003, 90.3% (the US) and 82.5% (Indonesia) in export trade; 62.6% of import trade and 61.1% of export trade (Spain) was denominated in Euro. Many international securities and notes are issued in US dollars, euros, yens and Canadian dollars. According to circulation volumes, it’s been discovered that the majority of international securities and notes were issued in euros from 2010 to 2012,17 followed by the US dollar and the UK pound.18 The issuance volume of international securities and notes reflect the demand from foreign countries; the more demand, the more issuance, the more competitive a currency is, and vice versa. By measuring the comprehensive market amount of financial derivatives using the open interest total nominal amount, the important position of the dollar, the euro and the Japanese yen is clearly perceivable. From the status of daily transactions in foreign exchange,19 the dollar maintained 80% of market shares. The above four currencies almost account for 52.31% of total foreign exchange reserves (reserves of fixed currency included).

These international currencies provide the basic liquidity in worldwide economic activities and impact greatly economic operations.20 On the one hand, tempted by huge profits in coin taxes, each player wants to issue more currency, which would result in world economic inflation. On the other hand, inadequate release would lead to a lack of international liquidity, causing economic recession to occur worldwide.

The Intense Competition Between International Currencies

In an oligopolistic market, the economic aggregate of major currency issuers ranks among the top in the world. The currencies they issue have similar functions and are replaceable despite some differences.

In terms of value maintenance, the Dollar is still predominant but faces challenges from the Euro and the Yen, which increasingly complicates the currency competition situation. According to the COFER data21 released by the IMF, there has been a sharp drop in developed economies’ total foreign exchange reserves shares from 2001 to date and a surge in that of emerging and developing economies, from 39.18 to 66.69%. The Dollar, the Euro, the Yen and the Pound are still major international reserve currencies. There was a decline in the status of the US dollar, which share of world reserve currencies dropped from 54.77 to 34.39% in 2011, followed by that of the Yen. The Euro and the Pound have also lost some of their shares, though to a different extent. However, other international reserve currencies have embraced an increase in their shares.22

The Power of International Currency Oligarchs Outweighs Their Responsibilities

In addition to obvious profits like seigniorage, profits that international currency oligarchs obtain from issuing international currencies also include exemption from risks generated by fluctuation in the exchange rate, access to global resource allocation, and immunity to the restraints imposed by the balance of international payment and budget. Moreover, the oligarchs are able to reduce deficit by absorbing foreign capital, leaving other countries to bear the consequences.

Decision-Making on Money Supply of the Oligarchs Is Interdependent and Relatively Stable

Since each of the economies has a large economic scale, one economy’s decision will inevitably influence the others’ currencies. In an oligopolistic market, if one economy adopts quantitative easing policies, the market shares of its currency will significantly increase, which may force other economies to follow suit. This, however, will reduce the profits of each economy. Therefore, whenever an economy adopts a policy, it has to consider and predict the other economies’ reactions and estimate the long-term impacts of such reactions on its profits. Meanwhile, since it is difficult to fathom the behaviors of rivals, currency-issuing economies generally do not easily change the existing market equilibrium. In the light of the strong dependence and restraint between economies against the backdrop of economic globalization, each economy shoulders compelling obligations for the stable development of the international monetary system. That is why there is coordination and cooperation between international currency oligarchs on the improvement and stability of international monetary systems.

Analysis based on the Cournot model on the behaviors of competitors in the oligopolistic situation yields two implications. One is that the price of international currencies is in negative correlation to the currency supply. In other words, greater supplies of an international currency lead to lower prices for that currency, which means less income from seigniorage. This is the economical foundation on which is based the coordination and cooperation between international currency oligarchs. The other is that, with regard to followers, there are two means to expand money supplies (that is, market shares). As indicated by the reaction function, the first way is to reduce marginal costs, such as enlarging economic scales, expanding transaction networks, and reducing costs of issuance and transaction. Any impediment to cost reduction in a certain target area will be disadvantageous to the internationalization of the currency in this area. The other way is to lessen the possibility of being substituted by dominant international currencies by sharpening the currency’s competitiveness, including enhancing stability, improving the yield of relevant assets, strengthening the accessibility to utilization of such assets,23 etc. This implication provides a new perspective for the following study on the internationalization of the RMB.

5.2.2 Conditions for the Internationalization of the RMB

With the rapid development of the Chinese economy, China is constantly improving its role and position in international economic affairs and playing an irreplaceable part in maintaining the stability and growth of global and regional economies. In the meantime, as the international financial crisis has undermined the international influence of developed economies, emerging and developing economies have increasingly appealed to the reform of the international economic system. The reform of the international financial system is mainly decided by the changes in the relative strengths of major great powers. However, there are no fundamental changes in the international economic and financial situations; nor is there significant enhancement in the intervention capacity of emerging markets and developing countries. In this case, the internationalization of the RMB is not only a new subject variable in international currency competition, but a new way to improve China’s power of persuasion and restraint in the international financial governance.

Studies by Chinese scholars24 point out that theoretically speaking, the internationalization of the RMB is of general necessity. However, in reality, whether the RMB as an international currency is in a good position for internationalization needs to be further explored.25 International studies focus on two aspects, namely: comprehensive political and economic strength and influence of currency issuing countries,26 and the functions of currency. With regard to international currencies’ functions as mediums of exchange, potential and rational holders of international currencies seek to minimize relevant transaction costs. Existing studies concentrate on the transaction costs of currency swaps in the hope of unveiling the conditions for lowering such costs and turning a currency into an international currency. Studies related to transaction costs also cover costs of carry,27 information costs,28 search costs,29 etc. Transaction costs are bound up with transaction networks and economies of scale. Once the externality of an international currency comes into being, the currency will be subject to historical inertia. Such a self-reinforcement mechanism of international currencies will set up formidable barriers to the entry of other currencies. From the perspective of store of value, international currencies embody the recognition of the economic strength of the issuing countries and the confidence in their purchasing power. Other relevant studies are done from such angles as economic scale, currency stability, openness, breadth and depth of the financial market, net foreign asset positions of issuing countries, etc.30 Studies on economic scale cover all the functions of international currencies and highlight their importance. As a measurement for prices, a currency is chosen based on factors including exchange rate risk, inflation, national trade scale, robustness of the financial market, price elasticity of the demand for commodities, share of the target markets, herd behavior,31 etc. The official representation of the price measurement function is anchor currency.

According to the findings of existing studies, there are at least four key conditions for currency internationalization, namely: economic scale (including trade scale and openness, economies of scale and transaction networks), currency stability (inflation and exchange rates), the depth, breadth and degree of freedom of a financial market, and the institutional environment (including political status). Economic Scale

China’s thirty-year economic growth and its economic scale that ranks second in the world32 have granted its credit money pay-back value, which helps reduce the impact from fluctuation in the international economy,33 secures the national economic stability and security of international traders holding RMB, and lays a foundation for the internationalization of the RMB. In the meantime, invoicing and settlement of commodities show an actual demand for international currencies. With total imports and exports ranking second in the world in 2011,34 China’s opening-up indexes have exceeded theoretical levels, and are far higher than those of many Latin American economic powers.35 This is the basic driver for the expansion of the circulation area.

The externality of transaction networks is an embodiment of the features of currency as a public good. At present, the RMB transaction network is emerging. The recent decade has seen China actively engage in regional financial frameworks and become one of the capital providers for the Chiang Mai Initiatives, the biggest bilateral currency swap arrangement. The RMB can be used either as a payment currency for bilateral swap arrangements or as invoicing currency for the issuance of local currency bonds by the Asian Bond Fund. The steady progress of China in bilateral currency swaps worldwide indicates that the RMB has become a vehicle currency. Additionally, the RMB has been used in a limited manner in the regional bond market. Continual progress has also been seen in the issuance of RMB bonds in China by international development institutes, investments in bond markets by the Asian Bond Fund and the QFII in China, and issuance of RMB bonds in Hong Kong by mainland financial institutes.36 Consequently, offshore RMB deposits rose by 400 and 90% respectively in 2010 and 2011. Moreover, the RMB cross-border trade settlement pilot project covers 20 Chinese provinces (districts and cities) and will be extended nationwide; overseas settlement of cross-border trade accounts in RMB will also be extended to all countries and regions. An RMB transaction network, which covers neighboring countries of China, including Mongolia, Vietnam, Laos, Cambodia, Nepal and Myanmar, as well as Hong Kong, Macao and Taiwan, is gradually forming, with a growing circulation scale.37 In East Asia, the RMB has become a new settlement currency, ranking right behind the Dollar, the Euro and the Yen. The overseas RMB derivatives market is developing faster. In offshore markets, there have been several kinds of RMB derivatives, of which NDF (Non-Deliverable Forward) is the most active one.38 These new progresses have promoted the offshore use and transaction of the RMB,39 in terms of both geographical scope and business lines and depth. In this way, they enhance the role of the RMB in reducing exchange risks and losses in times of fluctuations in the foreign exchange market. They also boost the economies of scale in RMB use as well as the networks and convenience of transaction, accumulating experience for the internationalization of the RMB. Currency Stability

Currency stability is reflected in two aspects, namely, inflation and exchange rate. From 2000 to 2011, China has maintained an inflation rate lower than 8%, presenting a basically stable state.40 The absence of virulent inflation in China means that total social demand does not exceed total supply and that there is no excessive supply of paper money and credit money. As for the exchange rate, in 2011 one dollar could be converted to 6.46 yuan, down from 8.28 yuan in 2000 (28.17%).41 Internationally, the purchasing power of the RMB is increasing. Its appreciation brings confidence to people around the globe, and this phenomenon will directly facilitate the international expansion of its area of circulation. Breadth, Depth and Openness of the Financial Market

China’s current financial market, which comprises its currency market, capital market, foreign exchange market, gold market and future markets, features multiple trading levels, a rich transaction variety, and diversified trading mechanisms. It plays an essential part in boosting the national economy, improving the formation mechanism of the RMB exchange rate, preventing systematic financial risk and maintaining financial stability. Currency market has become an important platform for macroeconomic control by the Central Bank as well as the major venues where financial institutions adjust fund positions, manage mobility and carry out asset investment. The capital market is expanding its scale, enriching transaction variety, enhancing the market operation mechanism and strengthening its resource allocation function.42 Along with the reform of China’s foreign exchange management system and the improvements in the exchange rate formation mechanism, the foreign exchange market basically combines the foreign exchange retail market and the interbank wholesale market, adopts two mutually complementary transaction means, namely bidding and enquiry, and covers such foreign exchange instruments as spot, forward and swap, thus laying a foundation for the stability of the RMB exchange rate.43

It should be noted that there is a considerable gap between China’s financial market and those of developed countries in terms of transaction variety, pricing mechanism and management mechanism. In order to further develop its financial market, China needs to reinforce its adaptability and self-regulation and address problems like the inadequate development of the bond market, the financial market’s reliance on the Central Bank for more supply of mobility, etc.44

China has steadily advanced the opening-up of its financial market over the recent decade. At present, the current accounts have basically been opened. As specified in the Report of the 18th National Congress of CPC, China will preliminarily boost capital account convertibility.45 With the development of cross-border RMB settlements, the amount of RMB held by overseas entities is increasing. The opening of bond market to overseas investors and financing entities will be sped up. The international board of the stock market will gradually open up. Based on bilateral economic and trade contacts, transactions between the RMB and other currencies held by interbank foreign exchange market will develop steadily. Institutional Environment

Institutional environment refers to the policy environment for the RMB to expand in terms of areas of circulation and the influence of China’s international status. In this section, light will be shed on the changes in China’s international political and economic status. Kenneth N. Waltz argues that the structure of the international system is decided by the distribution of capabilities across units. Countries use comprehensive strength to protect their interest. This comprehensive strength is decided by each country’s score in terms of: population, territory, resource endowment, economic strength, military power, political stability and competence.

First of all, the rise in China’s international economic status is conducive to the expansion of China’s influence in the international political arena. China has evolved into a major investor among developing countries, with a continuously growing domestic market. China and other developing countries have made contributions to the improvement of the international economic order through activities like the G20 and the World Bank reform. China has become an indispensable force that exerts great influence on the world economic situation. Though it enjoys impressive economic strength, China still remains a developing economy in terms of per capita economic strength. Second, China ranks top in the world in terms of military strength. According to the analyses of several international military research institutes, China ranks third, after the US and Russia, in terms of global military power.46 Third, with political stability, China’s governance is making progress. As the UN governance database reveals, the effectiveness of the Chinese government’s governance and the indicators of legal rules in 2011 have significantly improved compared with those of a decade ago. It is by no mean a feat to maintain political stability in a world with diversified values, but the relatively stable international and national environment of this period has created valuable strategic opportunities for China’s economic development.

Analysis on the conditions for the internationalization of the RMB indicates that the RMB, first of all, has been armed with the necessary economic and trade scale. Its transaction network and a financial market are under construction, with sound currency stability. In addition, there has been eye-catching progress in the creation of the institutional environment. However, since export commodities are labor-intensive, with low added value and competitive strengths facing challenges from East Asian countries. In the meantime, there is a great demand for the importation of bulk commodities, the pricing power of which is controlled by big transnational corporations. In this sense, the power to decide currency for invoicing and settlement is constrained. Second, the RMB transaction network is still at its early stage, which means higher currency holding and transaction costs, and hinders the expansion of the RMB’s area of circulation. Third, China’s financial market has not been fully opened up and China is lagging behind the current international currency issuing countries in terms of the development of the financial market and business. Hence, in spite of China’s rapid economic development having created conditions for the internationalization of the RMB, currently China is still in the process of accumulating strength, laying a foundation and constructing a network. Such a process may be divided into three steps, including expansion in the neighboring countries, regional expansion and international expansion. At each step, the RMB can develop at three levels: first as a currency for foreign trade and settlement, then as a financing currency, and lastly as a reserve currency. Currently, there has been evident progress in terms of trade and settlement in RMB in surrounding countries, which is attributed not only to the accessibility of these bordering countries but to the strong demand for RMB owing and the further development of border trade. As to regional expansion, with an increasing influence in Asia, the RMB may become one of the essential anchor currencies in the region and rise to be a dominating currency or a reserve currency in the region. On the other hand, the area of circulation of the RMB has not been expanded to other regions, especially those with huge mutual trading and high economic dependencies, where the RMB’s influence and scale of economic and trade contacts are hysteretic. Latin America is one of such regions. As a target region for the internationalization of the RMB, whether Latin America has the potential of becoming an area of circulation for the RMB is the focus of analysis in the following sections.

5.3 Latin America as an Object of Study

A prominent feature of currency in Latin America throughout its development is the dominant role of the Dollar as a result of currency competition. Whether the RMB will be widely accepted in Latin America will be decided by whether it can replace the current currencies. In addition, domestic currency or international currency in Latin America is determined based on economic and financial development in the region.

5.3.1 Currency Substitution and Dollarization in Latin America

There are two forms of currency substitution.47 One is symmetrical currency substitution. For instance, the Euro replaced the original domestic currencies of the EU members. The other form is asymmetrical currency substitution, also known as “dollarization”. It is quite normal in developing countries for home demand for a desirable foreign currency to far outstrip the foreign demand for the domestic currency. Asymmetrical currency substitution is caused by already high or surging inflation, which leads to the decreasing purchasing power of domestic currencies both at home and abroad. To combat inflation, citizens prefer to hold stable foreign currencies so as to maintain the value of their deposits; some may use a foreign currency as unit of account or medium of exchange. In this way, foreign currencies become the financial “sanctuary” for the public, which is actually a convenient way to resist to their government’s abuse of power to issue money.48 Hence, the occurrence of asymmetrical currency substitution happens on the basis of two preconditions: a strong domestic demand for a foreign currency and a strong enough foreign currency to bear relevant responsibilities.

During the evolution of international monetary systems, every country has been seeking for an exchange rate regime that could secure a stable and prosperous economy. After the collapse of the Bretton Woods System, some countries adopted a policy called hard pegs, which included currency board system, currency union system and dollarization, usually referring to the replacement of the domestic currency with a foreign currency. However, other countries used a policy called soft peg, that is, a more flexible floating exchange rate regime. In the late 1990s, soft peg was deserted in South Asia and Latin America, giving rise to the growing prominence of dollarization.

From the demand side, currency substitution can be understood in two ways. First, in terms of system, currency substitution is the decision of the monetary authority. Second, it can also be seen as market-based monetary reform.49 In the second sense, currency substitution is consistent with monetary competition and reveals the nature of the current international currency situation.

Most studies on currency substitution focus on Latin America, where there are plenty of practices of dollarization,50 and use dollarization as a synonym for currency substitution. However, there are few national empirical studies,51 except Panama.

There are two motivations for the demand for foreign currency assets. One is currency substitution where foreign assets are used as means of payment and unit of account. Currency substitution tends to occur when the public seeks for and uses an alternative currency after high inflation. The other motivation is asset substitution. Based on the comparison between the risks and earnings between domestic assets and foreign assets, unstable prices and long-term recession promote the use of foreign currency assets. In this way, foreign currencies become reserves of value.

Substitution of domestic currency by foreign currency can be classified into three kinds of situations.52

First, there is enormous macroeconomic imbalance and high inflation. This is the case for Chile, Columbia and Peru where the Dollar has substituted domestic currencies.53

Second, there is financial repression and capital control. In Nigeria, Venezuela and many Sub-Saharan African Countries, the launch of policies on financial repression and capital control brought about dollarization.54

Third, dollar is used as anchor currency to stabilize the macro-economy. For instance, Argentina and Ecuador adopted the Dollar as legal tender to cope with grave economic and political crises and to tackle long-standing problems about policies on currency and exchange rate.55

Dollarization is a reliable nominal anchor with which developing countries address currency mismatches and fight inflation. It is able to boost economic stability in the short run. However, dollarized economies may become more vulnerable when confronted with real risks, like Argentine for instance. In the face of huge asymmetric shocks, Argentine doesn’t have effective policy instruments to counter domestic recession and the overvaluation of the real exchange rate.56 To achieve long-term economic growth and development, a dollarized country must first of all clear away structure and system obstacles.57

Currency substitution starts by substituting the domestic currency’s role in value storage, which is probably its weakest part. Next, real estate, automobile and other durable goods begin to be denominated in foreign currencies. Then, transactions are done in foreign currencies, especially the transfer of large amounts of capital. During these processes, the domestic currency remains a unit of account and medium of exchange for non-durable goods.58 It is difficult to eliminate dollarization when it becomes fixed. Public memory about macroeconomic instability and high inflation will stay so long that foreign currency assets (nominal value) will even survive the period of macroeconomic stability.59 It is an important prerequisite for recovering public confidence in domestic currency that macro-economy stays stable for a certain period, securing greater exchange-rate flexibility and mitigating currency devaluation. Meanwhile, prudent rules should be adopted to ensure that costs related to dollarization are completely incorporated into the financing contracts (Table 5.1).60
Table 5.1

Some of the officially dollarized countries




Whether domestic coin was issued 2/

GDP (in billion (of U.S. dollar) 3/

Whether there was a domestic currency



U.S. dollar






U.S. dollar




Kiribati 4/


Australian dollar

No 5/


No 5



Euro 6/




Marshall Archipelago 4/


U.S. dollar




Micronesia 4/


U.S. dollar





1999 5/

Euro 6/




Palai 4/


U.S. dollar






U.S. dollar

Special case 7/


Special case 7/

San Marino



Special case 8/



East Timor


U.S. dollar




Note Excluding member states of the Economic and Monetary Union

Data source Luis I. Jácome and Åke Lönnberg, Implementing Official Dollarization, WP10/106, p. 5, IMF; Annual Report on Exchange Arrangements and Exchange Restrictions, 2009, IMF

The period between 1990 and 2001 witnessed the rapid expansion of dollarization in Latin America. Dollarization was to some extent boosted in both already highly dollarized countries like Bolivia and Uruguay and less dollarized countries including Costa Rica, Dominica, Honduras, Nicaragua and Paraguay. Ecuador and Salvador embarked on their journey to dollarization in September 2000 and January 2001 respectively. By the time Salvador adopted the Dollar as its official currency, the country enjoyed sound macroeconomic fundamentals, low and stable inflation, a growing economy, controllable public debt and foreign debt, and a crisis-free banking system. The move was intended to strengthen the economic connection between the country and the United States and stimulate foreign investment, trade and economic growth.61 Instead of full dollarization, some countries embraced partial dollarization.

Currently, dollarization is mainly adopted by small developing countries. Neither Ecuador nor Salvador is large Latin American countries in terms of population and economy.62 Hence, we cannot apply their experiences to Brazil, Mexico or China.63 Although they have suffered from severe macroeconomic problems between 1980 and 2001, Brazil, Chile, Columbia, Mexico and Venezuela all avoided prominent dollarization. They secured a demand for domestic currencies via effective economic policies, index-based financial instruments and legal restrictions on dollarized transactions. Residents in these countries—except in Venezuela—kept their foreign currency assets abroad. However, their aggregate foreign currency deposits (including offshore savings) were still lagging behind those of highly dollarized countries. Moreover, depositing foreign currencies abroad well blocks the risks brought by domestic banking systems and dollarization. Since 2001, some Latin American countries have become less dollarized. For instance, residents in Argentina are now required to use Peso. While Bolivia, Peru and Uruguay have a slight decrease in foreign currency deposits, there is a sharp fall in Paraguay. In spite of that, there is still a high degree of dollarization in these countries (Table 5.2).
Table 5.2

Degree of dollarization of Latin American countries (Ratio of foreign currency loan to total loan and ratio of foreign currency deposits to total deposits in 2000, 2005 and 2009, %)


Foreign currency loans to total loans (%)

Foreign currency deposits to total deposits (%)





















Source Prepared by the authors on the basis of official figures

Data source Luis Felipe Jiménez and Sandra Manuelito, Latin America: financial systems and financing of investment. Diagnostics and proposals, CEPAL Review, No. 103, p. 50

From the perspective of currency demand, the following factors have an impact on currency substitution in the target area. The first factor is inflation. High inflation tends to eclipse the credit of domestic currencies and strengthen the demand for foreign currencies. The second factor is macroeconomic instability, which refers to a situation where there is financial deficit, public debt, and huge foreign debt, combined with severe external imbalance. Financial liberalization is reinforced along with the devaluation of domestic currencies so as to redress external imbalances and prevent losses in international reserves. Close trade and investment connections are the third factor, which is well explained in the case of Salvador. The fourth factor is effective legal restrictions on the dollarization of countries with low inflation rate and efficient index mechanisms. For highly dollarized countries, restrictive regulations may help promote offshore financial savings, resulting in high of economic adjustment costs. The fifth factor is exchange rate policy. Inflexible exchange rate policies favorable to devaluation will lead to higher degrees of dollarization. The last factor is imperfect systems and financial markets.64

5.3.2 Latin America as a Regional Variable

This section will shed light on the possibility of a new round of currency substitution in Latin America, the target area of circulation for the RMB, based on analyzing the key factors in the area. Analysis on international currency competition has revealed that the Dollar still remains more competitive than other currencies. Objectively speaking, the RMB stands little chance to surpass the Dollar in the short run. However, considering its increasing international expansion, the RMB enjoys enormous prospects in the long term. Hence, studies on the target area of Latin America are also carried out in terms of currency demand, to explore the space65 potential for the international expansion of the RMB based on practices concerning currency. Macroeconomic Stability

Macroeconomic stability plays a decisive role in the adoption of a foreign currency. In this section, the stability of the actual economic growth rates of Latin American countries in the recent ten years is measured with the fluctuation coefficient. To make things simpler, fluctuation coefficient here refers to the ratio of the standard deviation of real economic growth rate (GDP growth rate) to the average value of the actual economic growth rate. The greater the absolute value of the coefficient is, the further the actual economic growth rate of each year deviates from its average value, and thus the more unstable the economic growth (Fig. 5.1).
Fig. 5.1

Indicators of the stability of economic growth of Latin America and other economies (2000–2011).

Note From left to right, the economies are Argentina, Bolivia, Brazil, Chile, China, Columbia, Costa Rica, Cuba, Ecuador, Salvador, Guatemala, India, Latin America and Caribbean (including all income levels), Latin America and Caribbean (developing countries only), Mexico, middle-income economies, Nicaragua, OECD member states, Panama, Paraguay, Peru, Uruguay, upper and middle income economies, Venezuela, and the world. Data source based on the actual GDP growth rate (current price) from the World Development Indicators released by the World Bank in January 2013

As the figure shows, Latin American countries have higher actual fluctuation coefficients than China, India, OECD member states and the middle-income economies. The coefficients of fluctuation of China and India are 0.17 and 0.33 respectively, while those of Venezuela, Uruguay, Paraguay, Mexico and Argentina reach 2.23, 1.78, 1.57, 1.50, and 1.38. The latter group is subject to higher economic fluctuation, which generates strong impact on domestic currencies. Inflation

Inflation is one of the most powerful economic forces capable of damaging citizens’ confidence in domestic currency. During the one decade since 2000, Brazil, Chile, Columbia, Mexico and Peru set targets for controlling inflation, and as a result no double-digit inflation rate was seen (Fig. 5.2).
Fig. 5.2

Inflation in Latin America and other economies in the recent decade (2000–2011).

Note From bottom to top, the economies are Argentina, Bolivia, Brazil, Chile, China, Columbia, Costa Rica, Cuba, Ecuador, Salvador, EU, Guatemala, India, Japan, Latin America and Caribbean (including all income levels), Latin America and Caribbean (developing countries only), Mexico, middle-income economies, Nicaragua, OECD member states, Panama, Paraguay, Peru, the US, Uruguay, Venezuela, and the world. Data source based on the inflation rate (GDP deflator) from the World Development Indicators released by the World Bank in January 2013

Figure 5.3 provides a clear picture of the average inflation rates of some economies between 2000 and 2011. As shown, Venezuela had the highest average inflation rate at 26.19%, followed by Argentina with 12.37%. The average inflation rate of other countries, including Paraguay, Costa Rica, Brazil, and Columbia, all exceeded 8%. China, India, the US and Japan had an average inflation rate of 4.27, 5.67, 2.24 and −1.36% respectively. In spite of generally higher inflation rates, most Latin American countries managed to control them within 10%. Currently, the economic base is so sound that there is no possibility for shaking the citizen confidence in the existing currency and substituting it with another.
Fig. 5.3

Debt service ratio of Latin America and other economies.

Note From left to right, the economies are Argentina, all developing economies, Bolivia, Brazil, Chile, China, Columbia, Costa Rica, Ecuador, Salvador, Guatemala, India, Latin America and Caribbean (including all income levels), Mexico, middle-income economies, Nicaragua, Panama, Paraguay, Peru, Uruguay, and Venezuela. Data source based on data on foreign debt from the World Development Indicators released by the World Bank in January 2013 Debt

Debt to some extent reflects the risks of foreign debt for a country. With a large amount of foreign debt, the principal and interest that a country needs to pay amount to a large proportion of the gross output and gets hold of the share of input for expanded reproduction. In some severe cases, it may place a country on the brink of bankruptcy.

According to international conventions, the main indicators for measuring a country’s risks of foreign debt include the ratio of public and publicly guaranteed debt to exports, the debt-to-GDP ratio, the ratio of short-term foreign debt to total external debt, the total debt service ratio, and the ratio of total debt service to GNI. Take the total debt service ratio as an example to determine the risks of foreign debt in Latin America. Total debt service as percentage of exports of goods, services and income indicates the scale of foreign debt and the solvency of a country. The warning line of this indicator is at 20% for general countries and 25% for developing countries. The danger line is at 30%. When the total debt service ratio of a country exceeds 25%, it means that the country shoulders so great a burden of principal and interest that a debt crisis may break out. As the figure shows, the total debt service ratios of most Latin American countries are lower than 25% and many are higher than the average of developing economies. Several countries go beyond the warning line of 25%, such as Brazil, Columbia, Argentina, Ecuador and Uruguay. Among them, Brazil and Columbia surpass the danger line of 30%. On the whole, Asian countries are “safer”. China has a total debt service ratio lower than 5% and India at around 15%. Financial Market Development

Compared with developed countries, or even with countries that have similar per capita income, Latin America has less developed financial systems and markets. This is mirrored by the absence of a complex system of financial innovation and availability, and the lack of well-developed instruments and markets for transferring and coping with credit exposure and financial risk (including bond securitization, option and other derivatives). As commercial banks dominate financial markets, asset portfolios share most of loan risks; savings and bonds become the main source of financing. The international financial system also contributes in parts. Institutional investors that achieve significant development are only found in a few countries.66

Studies on nominal financial openness are done from the perspective of capital account liberalization. Observation on multiple exchange rates, regulation on current account, regulation on capital account, and whether submission of export earnings is required indicate67 that Latin American countries have higher nominal financial openness than Asian countries between 1995 and 2009. However, it is the other way round when it comes to actual financial openness based on the observation of the activities of market subjects. This means that although Latin American countries started financial liberalization earlier, the import substitution model, which has a strong lingering influence on the activities of market subjects, prevents trade openness from driving financial openness. This provides a different light on the features of the Latin American financial market.

A financial market in want of development paves the way for the decline in confidence in domestic currencies and thus currency substitution. Trade and Investment Relations

Trade and investment relations in Latin America have undergone tremendous changes in the recent decade. China is gaining importance in the trade and investment relations of Latin America.

The following data from the United Nations Economic Commission for Latin America and the Caribbean shows the important status of China in the foreign trade of Latin America (Fig. 5.4).
Fig. 5.4

Latin America and the Caribbean: trade shares of major trade partners (2000–2020)

(This figure is quoted from: Osvaldo Rosales. Improve Economic and Trade Relations between Latin America and China. CEPAL Review, Chinese Edition. China Development Press, 2012. p. 28)

As the figure discloses, over the past decade, the ratio of Latin America’s exports to the US to total exports dropped almost by half, from the former 59.7% to the current 30% or so. Its exports to the EU remain stable. However, its exports to China grew from 1% in 2000 to the current 10% or so, which is close to its current exports to the EU. Of its total exports to the Asian and Pacific countries, 47.26% went to China, its biggest trade partner in the Asia-Pacific region. A similar case is found in terms of imports. It has become an inevitable trend that the status of the US in the imports and exports of Latin America is declining while that of China is rising. Furthermore, as long as there is no big economic impact, the trend will continue.

In terms of bilateral trade between China and Latin America over the years, China had maintained a surplus with most Latin American countries, which allows it to increase foreign exchange reserves through exports and boost the international community’s confidence in China’s economy, as well as generate appreciation expectation of the RMB. However, it is adverse to the expansion of the RMB.

In terms of investment, China ranked 6th in foreign direct investment flow and 13th in stock among countries (regions) around the globe in 2011.68 Since 2009, China’s direct investment in Latin America and the Caribbean has surged. In 2011, China’s foreign direct investment to Hong Kong, the Virgin Islands and the Cayman Islands took up 60%. The latter two have been China’s focus for investment in Latin America over the years. In recent years, China has sped up its investment in other regions of Latin America, including Brazil, Peru, Argentina, Venezuela, Mexico and Ecuador. 90% of investment went to the development of oil and gas and natural resources; the rest was invested in telecommunications, automobile and other industries.

The United States remains an important source of investment in Latin America in recent years,69 despite a decrease between 2006 and 2010 (from 25 to 17%). Investment that came from the Netherlands and Japan rose from 4 to 13% and 2 to 3% respectively. However, there is one significant change: China’s investment in Latin America hit 9% in 2010, making it the third major source of investment in the region following the US and Europe.

Business cycle transmission is another essential perspective for measuring economic relations between economies. According to the 2011 study70 of the Inter-American Development Bank, Sino-Latin American trade relations have greatly changed the international business cycle transmission mechanism of Latin America. A study on five large Latin American countries using the GVAR model shows that, from the mid-1990s to the present, the long-term influence of China’s GDP on Latin American economies has tripled, while that of the United States’ GDP halved. China’s GDP exerts influence not by increasing direct bilateral trade based on the surge in bulk commodity prices, but by affecting the traditional trade partners of Latin America.

This is best demonstrated by international trade settlements. For a long time, international trade has mainly been settled in Dollars. However, the financial crisis of the recent years gave rise to a dollar gap, which resulted in rising financing costs for trade in Dollars. Against such a backdrop, the RMB offers as a new choice for trade settlements between China and other countries.

Trade and investment relations between China and Latin America has been greatly enhanced over the last decade, which has won the RMB wider recognition and adoption in Latin America, boosted people’s confidence in the RMB and expanded its region of circulation. However, it is hard to tell at the moment whether the relations will be so strong as to induce a country to use the RMB as legal tender instead of its domestic currency or the Dollar. Exchange Rate Policies of Latin America

Fixed exchange rate policies tend to give rise to currency substitution or dollarization. According to the latest De Facto Classification of Exchange Rate Regimes and Monetary Policy Framework71 released by the IMF, in addition to the officially dollarized countries, including Panama, Salvador and Ecuador, there are nearly 15 countries that have basically fixed exchange rate policies, including Venezuela and Argentina. Some countries have adopted a crawling peg against dollar, such as Bolivia, Nicaragua and Costa Rica. Columbia, Guatemala, Peru, Uruguay and Paraguay, use a managed float regime, while Brazil, Chile and Mexico employ a completely independent float regime. It turns out that countries with a fixed exchange rate regime either have begun currency substitution or are ready for it. Quality of Institution and Government Governance

De la Torre and Schmulker (2004)72 believe that imperfect institutions leave people in doubts about the execution of contracts and encourage residents to shorten contract terms or conduct transactions offshore in a more secure legal framework. In the Worldwide Governance Indicators (WGI) project initiated by the World Bank in 1996, Kaufmann et al. studied government governance with data from 32 independent sources of 30 organizations and six categories of indicators (Table 5.3).73
Table 5.3

Indicators of state governance in Latin America


Voice and accountability

Political stability

Government effectiveness

Regulatory quality

Rule of law

Control of corruption







































































Data source Worldwide Governance Indicators (WGI), worldbank, 2013

Some Latin American countries, including Venezuela, Ecuador, Cuba and Columbia, have lowering global rankings in terms of institutional quality and governance, which means these countries still need to improve governance. At the same time, ideological factors should also be taken into consideration, because many of these countries have disagreements with the United States. It is not clear whether this factor has affected the development of indicators.

A study on Latin America as a regional variable reveals that, over the recent decade, Latin American countries have sustained stable economic development and a controllable inflation rate and maintained close trade and investment relations with the United States. For some countries, although factors regarding exchange rate policies and governance may influence citizen confidence in domestic currencies, on the whole there is no solid regional economic base for the substitution of domestic currencies or existing currency (mainly the Dollar) with another currency. There are no mature conditions for many Latin American countries to substitute domestic currencies or existing currencies for the RMB. It is inevitable that the expansion of the circulation of the RMB in Latin America will be confined by restrictive conditions in terms of demand.

5.4 RMB Internationalization and Sino-Latin Financial Cooperation

The internationalization of the RMB in international monetary competition is a development process of gradual perfection. With the graduated maturation of the conditions for the internationalization of the RMB and financial markets, the regional and global RMB circulation and its influence will be expanded day by day. In Latin American areas, the internationalization of the RMB must consider the development of the internationalization of the USD. Currently, the conditions for making the RMB a substitutable currency should be further perfected; meanwhile, attention should be paid to the economic developmental status of Latin America itself and opportunities corresponding to the RMB. The realistic choice for the internationalization of the RMB toward Latin America as a regional object is to improve the scale effect and competitiveness of the RMB in Latin America by means of Sino-Latin monetary cooperation and the gradual expansion and deepening of RMB transaction networks, as well as to enlarge the monetary circulation domains. The RMB would then be able to assume the important role of regional public product as long as the right time comes.

5.4.1 Intensifying Financial Cooperation with Latin-American Areas

Regional financial cooperation is an important step for the expansion of RMB recognition and influence. Now, Hong Kong, Macao and the neighboring countries of China are main territorial scopes for RMB circulation. The economic development levels of Latin America make it stand at a very high position among developing countries: its ideologies are presented with diversified features, particularly, USD internationalization features are very distinctive; the regional compensation monetary system and the virtual currency Sucre are also gradually developing, and these features have increased the realistic difficulties for the expansion of RMB circulation in this area.

Under such circumstances, actively undertaking financial cooperation with Latin America is feasible for the promotion of the regionalization of the RMB. This cooperation is divided on two levels: one is the multilateral international field, where China has been boosting the construction and improvement of the international financial order with countries such as Brazil, and seek more financial support and economic development spaces for the developing countries; the other is that of the regional field, where China has been involved in the Inter-American Development Bank and in regional development financial activities. Meanwhile, China is actively accelerating currency swap in bilateral fields, intensifying financial supervision and perfection of mutual assistance mechanisms, and strengthening the all-dimensional and multi-level cooperation with the Central Bank and commercial banks in Latin American countries. Currently, China has conducted currency swaps with Brazil and Argentina, but the contract with Argentina has not been renewed yet upon expiration, and substantial operations have not been done yet in currency swap with Brazil. China has established RMB settlement banks in Hong Kong, Taiwan and Singapore, and the offshore RMB market in London is also rapidly developing. Although a leapfrog development has been realized in Sino-Latin trade relation, institutional arrangements for RMB-related businesses have not been put into place in Latin American. Therefore, financial cooperation with Latin American countries is still at its start, development orientation and tasks have been clearly defined, but more political wisdom is still required for substantial acceleration.

5.4.2 Strengthening Trade Investment Relations with the Latin American Region

Currently, trade investment relations with Latin American regions keep growing rapidly, which will be helpful to the accumulation of scale advantages and cost advantages in terms of taking the RMB as a pricing and settlement currency. But the problems are very distinctive as well and mainly reflected on the following aspects: first, trade protectionism and trade frictions in Latin American regions are very distinctive. Countries like Argentina, Chile, Mexico and Brazil, etc., are among the countries with the most anti-dumping lawsuits against China every year. Second, trade imbalances remain a major concern of Latin American countries. Except for some individual countries, China still maintains a trade surplus with most Latin American countries. Third, Latin American countries are dissatisfied about trade structure. China imports many resource products, while it imports less other products due to the industry competitiveness in Latin American countries. Fourth, trade convenience and investment convenience in Latin American countries is not high enough; on the contrary there exists many trade investment barriers, which have impeded the steps of Chinese enterprises going out. Currently, China and Latin America still lack a cooperation mechanism like the Sino-African cooperation mechanism. China and Latin American countries should consider the overall situation of the Sino-Latin trade relations, should seek common points while reserving differences, and should explore pragmatically to set win-win resolutions and solve these problems. From the unilateral Chinese perspective, some measures should be put on the agenda and more efforts should be offered for support; for example, support the usage of the RMB for settlement, pricing and direct investments between enterprises; support domestic commercial banks to provide buyers of RMBs credit for overseas importers; and invest and assist the use of the RMB as contract object, etc.

5.4.3 Expanding RMB Transaction Networks in Latin American Regions

The expansion of RMB transaction networks reduces circulation and transaction costs and improves the scale economy of currencies. However, the expansion of transaction networks is not a subjective stipulation, but a result of market choices. The following strategies and tactics should be considered in order to expand the transaction networks of the RMB: first, gradually reduce regulations on RMB capital accounts transactions, gradually realize complete convertibility, and boost the extensive acceptance of the RMB; second, accelerate RMB circulation growth in Latin American regions, realize settlement, pricing and other functions of the RMB where possible, and gradually increase RMB utilization frequency; third, issue RMB bonds and launch other financial products priced in RMB on local Latin American markets, and allow overseas citizens to use overseas RMB for investments in domestic securities market, and so on; fourth, enhance the liquidity of the RMB, reduce the carrying, holding and information costs of the RMB, increase the maximum amount of RMB to be carried by citizens traveling to Latin America, support RMB Union Pay cards in Latin America, and vigorously promote the cooperation of bank card businesses in various Latin American countries, etc., while endeavoring to be one of the most important medium currencies in initial exchange demands from foreign exchange traders, and reduce search costs; fifth, accelerate the generation of the route trust equalization or lock-in effect of the RMB by providing long-term and sustainable transaction conveniences. The regional status of the RMB will be gradually stabilized as long as a lock-in effect is achieved, and it might be possible to carry forward conditional currency substitution on this basis.

5.4.4 Improving RMB Stability

The fundamental element for the establishment of the RMB’s regional status is the stability of the RMB itself and its capability to create monetary confidence. Enhancing China’s political, economic and financial stability will benefit the intensification of stability in the internationalization process of the RMB. Yet stability is more difficult to realize than scale and liquidity.74 Preparations should be made to face stricter challenges on future political, economic and social developments in China. In the long run, there are certain conflicts between the objectives of RMB stability and competitiveness. The stability objective takes domestic currency appreciation as a feature, and is helpful to price stability but bad for economic growth. The competitiveness objective takes domestic currency depreciation as a feature, and is helpful to export and economic growth, but might aggravate the pressure on domestic inflation. The orientation of the exchange rate target could be determined shortly.

An important concern for the holding of RMBs and relevant assets is the maintenance of its value and appreciation, as well as whether or not the most extensive and safest choices can be offered to the investors. If the answer is positive, then the RMB will be competitive in international trade settlements, investments and reserves. The assets return rate and richness of assets varieties, the capacity of the financial market to attract and dissolve risks, the growth of RMB itself and the prospects for economic growth in China are closely related to each other, particularly in terms of the depth and breadth of industrial development. An ideal state is the continuous expansion of the Chinese import market to help the exportation of the RMB. Foreign countries holding RMB could purchase products needed from China, and hence establish a smooth RMB export and backflow mechanism. Therefore, the sustainable development and stable growth of the Chinese economy will be the most fundamental factor in determining the expanded circulation domains of the RMB in Latin American regions.


  1. 1.

    Fred Hirsch, Money International, London: Penguin, 1969.

  2. 2.

    In fact, currency cross-region circulation was common before modern national state.

  3. 3.

    Zhang Yuyan, Zhang Jingchun, “Nature of Currency and the future selection of RMB-Also on Asian Currency Cooperation”, in “Contemporary Asia-Pacific Studies”, pp. 9–43 Press 2, 2008.

  4. 4.

    Benjamin J. Cohen, The Geography of Money, Cornell University Press, 1998, p. 5; C. A. E. Goodhart, “What is the essence of Money?”, Cambridge Journal of Economics, Vol 29, Issue 5, 2005. The latter pointed out that the right size of relative power was the determinant.

  5. 5.

    There are four types in market structure, and they are perfect competition, perfect monopoly, monopolistic competition, and oligopoly. The feature of oligopoly market is, rare manufacturers control the market structure of produce and sale of some industry. The less the manufacturers are, the harder to get in or out the business, the stronger interdependence between them. The reasons could be economy size, advanced technology, bigger investment, and government special permission. The typical industries are petroleum, automobile, steel, etc.

  6. 6.

    Jiang Boke, Zhang Qinglong, Currency Internalization: Academic Review of its Terms and Impact, NEW FINANCE, p. 6, volume 8, 2005.

  7. 7.

    Philipp Hartmann, Currency Competition and Foreign Exchange Markets: The Dollar, the Yen and the Euro, Cambridge University Press, 1998.

  8. 8.

    Zhang Yuyan, Zhang Jingchun, “Nature of Currency and the future selection of RMB-Also on Asian Currency Cooperation”, in “Contemporary Asia-Pacific Studies”, pp. 9–43 volume 2, 2008.

  9. 9.

    The Perfectly Competitive Market defines the four assumptions including Prices Established, Product Homogeneity, free flow of resources and complete information. Without any of them, the market is imperfectly competitive.

  10. 10.

    Pan Liquan: “Oligopoly international Currency System and Strategic choice in RMB internationalization”, Volume 1, 2007.

  11. 11.

    After World War I, with the gradual rise of the United States, Monroe Doctrine and Pan American Doctrine have become the major guiding ideology. Joined with more than 20 Latin American countries, the US has become the center of Economic Community to construct “the Dollar Bloc”, and the US dollar currency area has been taken into shape.

  12. 12.

    Qifted a few characteristics of monopolistic competition, but the barriers block heavily, long-term cost curve remained unchanged approximately.

  13. 13.

    Yu Wanlin, Zhu Yan: “Analysis on alternative mechanism of monetary in currency competition”, in “Finance and Economy” Volume 9, 2005.

  14. 14.

    Chinn, M, Frankel, J, 2005. “Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?” in G7 Current Account Imbalances: Sustainability and Adjustment, ed. By Richard Clarida, Chicago: University of Chicago Press.

  15. 15.

    See Footnote 14.

  16. 16.

    Due to limited data and few literature on studies of settlement currency, the outstanding literatures in recent years are from Goldberg (2005) and Kamps (2006). Goldberg indicated, the Dollar is the leading currency in settling import and export business. Generally speaking, Eurozone countries will impose 1/3 export settlement by the Dollar, and 40% in import, similar situation will occur in UK, which share 26% in export currency settlement and 37% in import. Goldberg, Linda S., and Cedric Tille, ‘Vehicle Currency use in International Trade’. NBER Working Paper 11127. NBER, 2005; MA. Goldberg, Linda S., ‘Trade invoicing in the Accession Countries: Are They Suited to the Euro?’ NBER Working Paper 11653, 2005. Kamps made correction and improvement on the theory of Goldberg and Tille (2005), calculating the market share of various currencies in 42 countries for settlement in import and export, which clearly brought an intuitive understanding on competitiveness. Kamps, A., “The Euro as invoicing Currency in International Trade”, pp. 43–50, ECB Working Paper Series, No. 665, 2006.

  17. 17.

    BIS, Securities statistics and syndicated loans, Dec, 2012; BIS Quarterly Review, December 2012.

  18. 18.

    Peter Kenen, The Euro versus the Dollar: Will There Be a Struggle for Dominance? [J]. Journal of Policy Modeling, V24, Issue 4, pp. 347–354, 2002.

  19. 19.

    BIS, Triennial Central Bank Survey, Report on global foreign exchange market activity in 2010, Monetary and Economic Department, December 2010.

  20. 20.

    Ye Fang, Du Chaoyun: “Currency Competition under the present international monetary system—Analysis on Dual Oligopoly Model”, in “Shanghai Finance”, Press 4, 2012, pp. 45–49.

  21. 21. Calculation based on foreign exchange reserves of identified currencies.

  22. 22.

    It is worth mentioning that reserves in unidentified currencies are not taken into consideration, including the foreign exchange reserves of non-IMF members and unpublished foreign reserves of IMF members. Recent years have seen an increase in the share of reserves in unidentified currencies in the total reserves of developing economies, from 44.4 to 61.3% in 2011.

  23. 23.

    Ye Fang & Du Chaoyun. “Currency Competition under the Current International Currency System—Analysis based on the Duopoly Model”. Shanghai Finance. 4 (2012). In the paper, the Hotelling model is applied to discuss the stability of international currencies. Current studies on RMB internationalization expose that stability is a higher goal to attain.

  24. 24.

    Current studies focus on four aspects. First, the mutual dependence and mutual influence between China’s economy and world economy render RMB internationalization an essential way to protect economic development environment. See Wang Yuanlong. “Study on Several Problems about RMB Internationalization”. Finance & Trade Economics. 7 (2009). Bin, Xia. China’s Development and International Financial Order”. Theoretical Horizon. 1 (2011). Second, it is necessary for the RMB to acquire the power of international currency in order to improve the quality of China’s international financial discourse power. See Zhang Yihao, Pei Ping, & Fang Xianming. “International Financial Discourse Power and China’s Strategy”. World Economics and Politics. 1 (2012). Third, RMB internationalization will effectively address appreciation pressure and high saving rate. See Ma Guangming. “On the Unequal Appreciation Pressure on the Currencies of Developing Countries—Discussion on the Necessity of REM Internationalization”. Economic Review. 4 (2009). Zhang Qunfa. “Dollar Hegemony and REM Internationalization”. Economic Survey. 2 (2008). Fourthly, RMB internationalization is the inevitable choice in order to accommodate to the regional transfer of international production efficiency and get over monetary system mismatch. See Li Xingong. “Regional Transfer of International Production Efficiency and Monetary System Mismatch: RMB Internationalization.” Shanghai Finance. 3 (2009).

  25. 25.

    Especially whether currency demanders accept the “landing” of international currency. Relevant discussions will be presented in the later sections.

  26. 26.

    C. F. Bergstern, The Dilemma of The Dollar: The Economics and Politics of United States International Monetary Policy, New York University Press, 1975; B. J. Cohen, The Geography of Money, Cornell University Press, 1998; R. A. Mundell, ‘The International Financial System and Outlook for Asia Currency Collaboration’, The Journal of Finance, 2003, 58(4):3–7; G. S. Talvas, “internationalization of currencies: the case of US dollar and its challenger Euro”, International Executive, 39(5) 581–597, 1997.

  27. 27.

    A. Swoboda & R. A. Mundell. Monetary Problems of the International Economy. University of Chicago Press, 1969. In the book, it is pointed out traders have the demand for reducing the large amount of various kinds of cash that they are forced to hold, which generates higher transaction costs. Currencies with high mobility and low transaction cost are most likely to become international currencies.

  28. 28.

    Karl Brunner and Allan MeltZer, “The Use of Money”, The Ameriean Economie Review, 1971(December), (61), pp. 784–805; Mckinnon, R, ‘Private and official International Money: TheCase for the Dollar’, Essays in intemational Finance, Prineeton University. 1969, Issue 74.

  29. 29.

    Chrystal, Alec, K, “Demand for international media of exchange”, The American Economic Review 67(5):840–850, 1984. It analyzed that in the interbank exchange market, the indirect transaction via vehicle currency will produce the least search costs. Thus in the preliminary period of trading, it was the most important currency to act as vehicle currency: Matsuyama, yotakiand Matsui. “Toward a Theory of Intemational Curreney”, Review of Eeonomic Studies, 6(2):283–320, 1993, by utilizing the search models of money, It was discovered several factors to determine the international currency selection, like giant economic scope, the extent of openness, the degree of economic integration, etc.

  30. 30.

    Sun Haixia: “Studies on the condition of currency Internationalization—Three functions of International currency”, Ph.D. Thesis in Fudan University, 2011.

  31. 31.

    See Footnote 30.

  32. 32.

    China’s economic scale had already ranked second in the world in 2010, 3.4 times of that of Brazil which ranked first among Latin American countries. Its percentage of the world economic scale increased from around 2% in early 1990s to 12.2% in 2012 (predicted figures). Based on data from IMF, World Economic Outlook, Oct, 2012. Many economists predicted that with the current growth rate, China will catch up with or exceed the US in terms of economic scale and become the largest economic power in the world. See Brzezinski, Zbigniew. The Grand Chessboard: American Primacy and Its Geostrategic Imperatives. Translated by Hu Angang, and Zou Zhizhuang. Shanghai: Shanghai People’s Publishing House, 1998.

  33. 33.

    Bergstern calls it the independence standard of international currencies. Bergstern, C. F. The Dilemma of the Dollar: The Economics and Politics of United States International Monetary Policy. New York University Press, 1975.

  34. 34.

    China’s total trade is more than five times of that of Mexico, the highest among Latin American countries. According to the data on international balance of payment from the US Department of Commerce in 2012, China has surpassed the US to be the largest trading country in the world. Data is quoted from WTO, Statistics Database Online, Sep, 2012.

  35. 35.

    Chai Yu. “Study on Trade Openness of Latin American Countries”. Journal of Latin American Studies. 4 (2011).

  36. 36.

    Under the framework of the Executives' Meeting of East Asia-Pacific, ABF2 issues local currency bonds in eight countries, with seed money adding up to 2 billion dollars. According to BIS statistics, it reached about 1.5 billion dollars in the middle of 2011. See EMEAP, “Local Currency Bond Markets and the Asian Bond Fund 2 Initiative”, 14 July 2011, BIS. By the end of November 2011, the RMB bonds issued in Hong Kong had exceeded 100 billion yuan; issuers include 78 transnational enterprises and international financial institutions. See “RMB Bonds Issued in Hong Kong Exceeds 100 Billion Yuan.”, December 15, 2011. An HSBC research report believes that RMB deposits in Hong Kong will hit 1 trillion yuan by the end of 2012 and 3.2 trillion yuan by the end of 2015. In the meantime, the proportion of RMB deposits to total deposits in Hong Kong will increase from 9 to 30%. See “RMB Business Slacks, Hong Kong Banks Attract Deposit”. China Business News. August 10, 2012. Factors like changes in RMB appreciation expectation and decline in trade have caused fluctuation in RMB deposits in Hong Kong since the end of 2011. Swift (Society for Worldwide Interbank Financial Telecommunication) points out that RMB has replaced Russian ruble and Danish krone and become the 13th international payment currency in the world. Swift stated that in January 2013, international payment in RMB had increased by 171% year on year and its proportion to total payment reached a record high of 0.63%. The development of offshore RMB trading centers in Hong Kong, Singapore and London has significantly boosted the increase in payment in RMB. See “The Wall Street Journal”, March 12, 2013,

  37. 37.

    Some Chinese scholars have probed into the scale of circulation. See Jing, Li, Tao, Guan, & Fan, He. “Cross-border Circulation of RMB and its Influence on China’s Economy”. Management World. 2004 (9). However, the real situation is hard to clarify.

  38. 38.

    Since the RMB cannot be converted freely, NDF allows transactions on RMB forward exchange rate without using RMB for settlement; major convertible international currencies are used for quotation and delivery instead. Since 1996, RMB NDF has been applied in Hong Kong, Singapore, Japan and Taiwan. It was not active at the beginning. However, along with RMB appreciation, the daily turnover surged. Other products include non-deliverable options, non-deliverable swap, etc. Expectations for the appreciation of the RMB exchange rate in terms of these products impose certain pressure on the official exchange rate.

  39. 39.

    According to the RMB Globalization Index launched by Standard Chartered in November 2012, RMB use in the international trade has increased by 50% in 2012. In the face of the waning of global demand, instability of global finance, and lack of RMB appreciation expectation, the RMB Globalization Index still goes up by 50% in 2012. The index covers three markets which dominate the offshore RMB business: Hong Kong, London, and Singapore. It measures business growth in four key areas: deposits (denoting store of wealth), Dim Sum bonds and Certificate of Deposits (as vehicles for capital raising), trade settlement and other international payments (unit of international commerce) and foreign exchange (unit of exchange). See

  40. 40.

    Since 2010, there has been a slight increase in the inflation rate of China, surpassing the medium-income countries, Latin American countries and the world average. This is one of the reactions of the Chinese government’s economic stimulus package. Calculate based on the World Development Indicators (WDI) of the World Bank. Inflation is measured by the annual growth rate of the GDP implicit deflator.

  41. 41.

    Based on the World Development Indicators (WDI) of the World Bank.

  42. 42.

    By the end of 2012, there had been 2494 listed countries in Shenzhen and Shanghai. Investors had opened more than 200 million accounts, with total market value up to 2.18 trillion yuan. Stock value of the capital market in Chinese mainland ranked third in the world and first in Asia. Latest ranking from the World Federation of Exchanges. Jiefang Daily. November 8, 2012.

  43. 43.

    From 2007 to 2011, trading in foreign exchange market in China grew annually by 40.3%. By the end of 2011, trading in foreign exchange market in China hit 14.2 trillion dollars, with an average daily trading of 58.1 billion yuan, four times of that in 2006. Shanghai Securities News. February 15, 2012.

  44. 44.

    According to Edward Shaw’s standards, there are three indicators for financial deepening, namely, financial stocks (reflecting the financial development of a certain point in time), financial flow (reflecting the financial development of a certain period of time), and financial asset price (reflecting the development with various prices in the financial market). Measuring China’s financial deepening in the recent decade with the first indicator, that is, M2 as percentage of GDP, reveals that the percentage of China, the UK and Japan are higher than that of the US who boasts a full-fledged financial market. It shows that people are willing to hold financial assets which feature high mobility instead of physical assets. This is the representation of financial deepening. On the other hand, it also indicates that the capital efficiency of currency is so low that people choose to deposit their money in the banking systems in the face of financial depression and underdeveloped financial market. Capital efficiency can be improved through methods like expanding direct financing, including raising IPO limit, increasing issuance of corporate bonds, expanding local government financing and promote trust finance. See The Economic Observer, January 23, 2011.

  45. 45.

    According to IMF’s standards in classification of capital account transactions, RMB capital accounts with partial, basic and full convertibility amount to 75% of all the capital accounts. For more details, visit IMF websites and see RMB Capital Accounts Equipped with Conditions for convertibility”, Beijing Business Today, November 26, 2012.

  46. 46.

    Such as the world military strength rankings of Jane’s Defense Weekly and Global Firepower.

  47. 47.

    J. Benjamin Cohen, The Geography of Money, Cornell University Press, 1998, p. 94.

  48. 48.

    Cohen, J. Benjamin. The Geography of Money, Cornell University Press, 1998, p. 94.

  49. 49.

    For the former: R. Lamdany and J. Dorlhiac, ‘The Dollarization of a Small Economy’, Scandinavian Journal of Economics, 89(1), pp. 91–102, 1987; For the latter: M. Melvin, ‘The Dollarization of Latin America as a Market-Enforced Monetary Reform: Evidence and Implications’, Economic Development and Culture Change, 36, pp. 543–557, 1988.

  50. 50.

    Giovanini, Alberto, and Turtelboom, Bart, “Currency Substitution”, NBER4232, Dec 1992. Calvo and Vegh believe that currency substitution is the last stage of dollarization. See G. A. Calvo and C. A. Vegh, “Currency Substitution in Developing Countries: an Introduction”, Revista de AnalisisEconomico, 7(1), pp. 1–38, 1992.

  51. 51.

    Luis I. JácomeandÅkeLönnberg, “Implementing Official Dollarization”, WP10106, IMF. For study on Panama, see Moreno-Villalaz, J. L., “Lessons from the Monetary Experience of Panama: A Dollar Economy with Financial Integration,” Cato Journal, Vol. 18, No. 3 (Winter), pp. 421–439, 1999 and Goldfajn, I. and G. Olivares, “Full Dollarization: The Case of Panama,” Economia, Vol 1, No. 2 (spring), pp. 101–155, 2001.

  52. 52.

    Duma, Nombulelo, ‘Dollarization in Cambodia: Causes and Policy Implications’, WP11/49, IMF, 2010.

  53. 53.

    Galindo, A., L. Leiderman, 2005, “Living with Dollarization and the Route to Dedollarization,” Inter-American Development Bank Working Paper No. 526, New York.; Herrera, L., and R. Valdés, 2005, “De-dollarization, Indexation and Nominalization: the Chilean Experience,” The Journal of Policy Reform, Vol. 8, No. 4, 281–312, December; Kokenyne, A., J. Ley, and R. Veyrune, 2010, “Dedollarization,” IMF Working Paper No. 188, 2010; Reinhart, C., K. Rogoff, and M. Savastano, 2003, “Addicted to Dollars,” NBER Working Paper 10015.

  54. 54.

    Reinhart, C., K. Rogoff, and M. Savastano, 2003, “Addicted to Dollars,” NBER Working Paper 10015.

  55. 55.

    Andrew Berg, Eduardo Borensztein, ‘Full Dollarization:The Pros and Cons’, Economic Issures 24, IMF, 2000.

  56. 56.

    Dollarization may aggravate economic crisis. The prominent currency mismatch further weakens balance sheet effects. In 2002, the currency board of Argentina collapsed which resulted in severe political and economic consequences and undermined the country’s passion for a super-fixed exchange rate regime. It was the same case with Uruguay in the same year. See Morris Goldstern, Managed Floating Plus, IIE, 2002, p. 41.

  57. 57.

    The cost of official dollarization includes but not limited to (i) seigniorage loss; (ii) limited or lack of capacity to provide banks in need with lender-of-last-resort (LOLR) assistance; (iii) failure to buffer impact with exchange rate; (iv) lack of capacity to lower the value of financing commitments denominated in domestic currency by means of large-scale exchange rate devaluation or inflation. On the contrary, official dollarization have the following benefits: (i) domestic inflation gets closer to international inflation; (ii) it dissolves currency risks and lowers domestic interest rate; (iii) stable inflation and lower interest rate give rise to better investment environment; (iv) there is no so-called “original sin”. When currency mismatch on the balance sheet is gone, the national risks will be reduced. See Jácome, Luis I. and Lönnberg, Åke. Implementing Official Dollarization, WP10106, IMF.

  58. 58.

    Calvo, Guillermo A, and Vegh, Carlos, Currency substitution in developing countries: an introduction, WP/92/40, IMF.

  59. 59.

    Annamaria Kokenyne, Jeremy Leyand Romain Veyrune, Dedollarization, WP/10/188, IMF.

  60. 60.

    Robert Rennhackand Masahiro Nozaki, Financial Dollarization in Latin America1, WP/06/7, IMF.

  61. 61.

    AndrewSwiston, Official Dollarization as a Monetary Regime: Its Effects on El Salvador, WP/11/129, June 2011; Hinds, M., 1999, Prepared Testimony for U.S. Senate Banking Committee, Hearing on Official Dollarization in Emerging-Market Countries. Available on the internet at:; Hinds, M, 2002, “Why Dollarize? The Case of El Salvador,” Presentation at Summit of the Americas Center, March. Available on the internet at: At that time, two thirds of Salvador’s export go to the United States, with an annual remittance of 2 billion dollars.

  62. 62.

    In 1904, Panama became the first Latin American country to use dollar as official currency.

  63. 63.

    Morris Goldstern, Managed Floating Plus, IIE, 2002, p. 34.

  64. 64.

    Robert Rennhack and Masahiro Nozaki, Financial Dollarization in Latin America, WP/06/7, IMF.

  65. 65.

    In addition to its geographical sense, here space also refers to market thickness. Only when the market is thick enough can new traders and new transactions be admitted. Here, relevant countries are assumed to have been equipped with the capacity for currency substitution.

  66. 66.

    Luis Felipe Jiménez and Sandra Manuelito, Latin America: financial systems and financing of investment. Diagnostics and proposals, CEPAL Review, No. 103, pp. 45–71.

  67. 67.

    Chai Yu. Trade Openness of Latin America. Journal of Latin American Studies. No. 4, 2011. Yu Chai & Shengang Li. “Economic Openness of Latin America” (draft), December 2012. This is a subproject of the major CASS project “Economic Trends of Latin America and Path Choice for Sino-Latin American Economic and Trade Cooperation”.

  68. 68.

    World Investment Report 2012, UNCTAD.

  69. 69.

    This figure is quoted from: Osvaldo Rossles. Improve Economic and Trade Relations between Latin America and China. CEPAL Review, Chinese Edition. China Development Press, 2012. p. 34.

  70. 70.

    AmbrogioCesa-Bianchi, M. Hashem Pesaran, Alessandro Rebucci, Xu Teng Teng China’s Emergencein the World Economy and Business Cyclesin Latin America, IDB-WP-266, Inter-American Development Bank, September 2011.

  71. 71.

    IMF, De Facto Classification of Exchange Rate Regimes and Monetary Policy Frameworks, Data as of April 31, 2008.

  72. 72.

    Augusto de la Torreand Sergio Schmukler, “Coping with Risks Through Mismatches: Domestic and International Financial Contracts for Emerging Economies”, International Finance, 7:3, 349–390, 2004.

  73. 73.

    The six categories are (1) Voice and Accountability, which measure political rights, civil rights and human rights; (2) Political Instability and Violence, which measure the possibility of violence threat on government or a change of government, including terrorism. (3) Government Effectiveness, which measures the competence of bureaucracy and quality of public service. (4) Regulatory Quality, which measures the occurrence rate of policies adverse to the market. (5) Rule of Law, which measures the quality of contract execution, police and the court, including judicial independence and crime rate. (6) Control of Corruption, which measures abuse of power for personal gain, including petty and serious corruption (the privileged stratum captures state power).

  74. 74.

    For example, the United States has become the largest economic entity in the world in about 1870, but it only exceeds the United Kingdom on three indicators in 1920, and becomes a real international currency. Refer to The Economist, March 24, 2013.

Copyright information

© Social Sciences Academic Press and Springer Nature Singapore Pte Ltd. 2019

Authors and Affiliations

  1. 1.Institute of Latin AmericaChinese Academy of Social SciencesBeijingChina

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