RMB Internationalization: Can the RMB be the next global currency?

This article was originally published in Chinese on Caixin.com

The US dollar has become another victim of Donald Trump’s recent economic policy. The tariff war and Trump’s erratic attitude have left global investors at a loss, but even before this, Trump had threatened to restrict the independence of the US Federal Reserve, creating uncertainty in the markets, a falling dollar as investors sold off some dollar assets.

The depreciation of the US dollar has, as a result, created concern around the centrality of the dollar to the global economy, and there are both short- and long-term possibilities as to how the situation may play out. In the short term, the US dollar will remain the central international currency for a simple reason—there is no substitute. The dollar has dropped in value, but the euro, pound and yen—which experienced sharp depreciations last year—are not strong enough to replace it, and the likelihood of the RMB replacing the dollar in the short term is also slim.

In the long run, the US dollar’s status could be impacted, or at least weakened to some extent, and the key variable here is the development of the RMB. As the legal tender of the world’s second-largest economy, the RMB has the potential to become a central international currency, but whether this potential translates into a larger presence in the global economy depends on a series of major reforms in certain areas of China’s economy.

The rise of USD

To properly understand the dollar’s status and its centrality to the international market, we need to look at how its position came to be.

The capacity and level of development of an economy is the basis for the strength of a country’s currency. According to the Maddison Project Database 2023 (MPD2023), using 2011 dollars as a benchmark, the United States surpassed the United Kingdom in Gross Domestic Product (GDP) based on purchasing power parity back in 1862, a time when the Pound Sterling was the dominant global currency.

By 1880, the United States also surpassed the United Kingdom in terms of GDP per capita, but at that time, the United Kingdom still had a string of colonies spanning the world and London was the global financial centre, so the dollar was still a long way from replacing the pound.

It took until after World War II for the dollar to usurp the pound’s top spot. In 1944, the United States brought together 44 countries from around the world to establish the Bretton Woods system, which stipulated that the value of the US dollar be pegged to gold and the value of other currencies be pegged to the US dollar. This “double-pegged” system was the underlying reason for the dollar’s emergence as the central international currency.

The strength of the old capitalist powers—such as Britain, France and Germany—was hit hard after WWII, and the US economy began to pull away at the top. According to MPD2023, the US GDP was a whopping 27% of global GDP in 1950, and at one point, the US accounted for 75% of global gold reserves. Given such economic strength, it was relatively straightforward for the US dollar to become the international currency.

Over the following decades, with the recovery of Western Europe and the fast ascendence of Japanese and German economies, the comparative strength of the US economy declined and the Bretton Woods system became increasingly difficult to maintain. The system came to an end in 1971 after the US announced the decoupling of the dollar from gold. Although the US wanted to maintain a fixed exchange rate system after this, there was no feasible way to do so, and thus, in 1973, the dollar began to float in the foreign exchange markets and the resulting floating exchange rate regime has since been the mainstay for the currencies of the world’s major economies.

Somewhat paradoxically, the US dollar did not lose its status as the central international currency in the post-Bretton Woods period. Rather with the rise of emerging economies such as China, the dollar’s position was strengthened. Taking China as an example, as of March 2025, the country had about $3.2 trillion in foreign exchange reserves, of which $784.3 billion (as of February 2025) is in US Treasury bonds, clearly showing a recognition of the importance of the dollar despite it no longer being pegged to gold.

Benefits and drawbacks of being a global currency

So, what are the pros and cons of being the global currency? Let’s start with the benefits, which I believe are at least three in number:

• Firstly, a seigniorage (profits) can be collected from issuing currency. This is relatively straightforward, but the pecuniary benefit to the US from seigniorage is actually quite small relative to US GDP.

• Second, it lowers the cost of financing in the US. As other countries raise their holding of dollar assets by increasing dollar denominated foreign exchange reserves and by investing in the well regulated US financial markets, they become net buyers of US assets, which increases the demand for those assets and reduces the financing costs in the US. The prime example of this is United States Treasuries, 30% of which, according to the US Treasury Department, are held by foreign investors. If there were fewer international investors, it would be hard to imagine that the Treasuries could be financed at such a low cost. This is the greatest benefit that the role of global currency brings to the US.

• Thirdly, financial weaponization. The US dollar being the global currency gives the country enormous power in the international financial markets, and the US can use all kinds of financial measures to sanction other countries at any time, with the sanctions on Russia, Iran and North Korea being key examples.

And the downside?

The biggest disadvantage of international central currency status is that the dollar’s exchange rate can end up overvalued, leading to a lack of competitiveness in US manufacturing, a relocation of manufacturing industries to other countries, and the resultant loss of employment opportunities. A key justification given by Trump for the introduction of tariffs is that they will allow for this situation to be reversed, bringing more manufacturing back to the US and reducing the country’s trade deficit.

The fundamental reasoning may well have its merits, but the market’s response was unequivocal. The dollar’s current status is a result of a long historical evolution and the recognition of the system by all parties, an important part of which is the expectation of stability in US economic policy. The willingness of parties to hold dollars will continue only with stability, and Trump’s policies do not imply stability, so it makes sense that investors are looking to reduce their dollar exposure.

The potential internationalization of the RMB

The RMB entered the global markets alongside the rise of China’s economy, and while its use has been growing, it is still a long way from becoming a major international currency. But strong economies will inevitably have strong currencies, it is a natural cause and effect, and as long as China’s economy does not stagnate in the future, its industries continue to upgrade and reforms do not stop, the RMB should continue to expand its position as a global currency.

However, there are at least three things that need to happen in China before the RMB can take on that role.

Firstly, the removal of capital controls.

It is hard to imagine how a currency that is not freely convertible and free to circulate globally can become a global currency. In order for others to feel comfortable using your currency, they need to be allowed to trade in it freely. At the same time, the removal of capital controls would require some reform of China’s tax system. Corporate income tax is still a major source of tax revenue in China, totalling a massive RMB 4,088.7 billion in 2024, roughly 19% of general public budget revenues.

If capital controls were to be lifted, China would face fierce international competition for corporate tax revenue, and if China fails to lower the corporate income tax by then, companies will be inclined to move to wherever tax rates are lower. Therefore, China needs to reform its tax system to rely less on the corporate income tax and shift more towards value-added tax and personal income tax, as European countries are doing today.

Second, China needs to further develop its financial markets and strengthen market regulations that offer sound protection for all investors, domestic or foreign.

If the RMB were to become a central international currency, there would be strong demand for RMB assets from other countries, and an open and vibrant financial market would be a key factor in this, just as the developed US markets are key to the dollar’s dominance.

This is, however, easier said than done. Financial products are among the most complex products ever invented by mankind, and behind every one of them is a long list of contracts, with various rights and obligations intertwined in reams of documents. Investors, especially small- and medium-sized ones, generally have neither the ability nor the energy to understand the details of these products, which means that there is a serious information asymmetry in financial markets.

The fact that money is at stake in financial markets and that there are serious information asymmetries means that, in the absence of effective regulation, they are likely to become something of a sewage dump. Therefore, in order to properly develop the financial market, it is critical to strengthen effective financial regulation and protect the interests of investors so that they can feel at ease investing, while contributing to economic development and sharing its fruits.

On this issue, it would be possible to reference the experience of the US and adopt a two-track regulatory system according to the strength of investors.

For small- and medium-sized investors, regulators should exercise strict supervision, focusing on cracking down on illegal acts such as insider trading and stock price manipulation, raising the cost of violations and taking a relatively prudent approach to financial innovation. For large investors with greater financial heft, their ability to play the market is strong and the degree of information asymmetry is low. As such, regulators can appropriately relax regulatory standards and let players negotiate more in order to reach a deal and promote financial innovation.

Third, measures should be taken to accelerate the transformation of local governments to turn China from a trade surplus country into a trade deficit country.

In the past, I have noted many times that at China’s current economic development stage, the optimal choice is to become a trade deficit country rather than a trade surplus country. At the same time, from a balance-of-payments statement perspective, China needs to use the trade deficit to provide the RMB to global investors.

In order to achieve this goal, China needs to take steps to accelerate the transformation of local governments. The reason being that under the current system, local governments are keen to build the economy by increasing production while providing less than optimal levels of public services. The end result is that more goods and services are produced than what domestic consumers want at the prevailing prices. Either some of the goods and services need to be exported or domestic prices need to fall. While the actions of local governments is not the entire cause of trade surpluses or deflation, their role in the process cannot be ignored.

If local governments still play by the current rules and do not shift their core work to the provision of public services, it will be very difficult for China to become a trade deficit country, let alone a powerhouse of consumption like the US.

To the future

Even with all of this in mind, the RMB still remains the most likely candidate to challenge the hegemony of the US dollar in the future, and steps should be taken to pursue this and promote the internationalization of the currency.

The US has led globalization to an unprecedented degree in the post-war period, and the US dollar has played an active role for a considerable period, creating favorable conditions for global economic prosperity. Now that it looks like Trump is willing to drive progress backwards, this is a major opportunity for the RMB’s internationalization.