Why China Is a Financial Midget; Beijing's economic model will prevent the yuan from replacing the dollar as the world's reserve currency.
The title says it all: "Eclipse: Living in the Shadow of China's Economic Dominance." Arvind Subramanian's new book is a good example of a more aggressive line of argument regarding China--that it's a matter of whether, not when, China will take over economic leadership of the world. But China's road to real financial influence promises to be far longer and rockier than the GDP numbers would suggest.</br></br>The argument for dominance has two prongs. The first is that China's economy will very soon be larger than either the U.S. or the EU. And second, as this happens the yuan will also naturally replace the dollar as the global reserve currency, with profound consequences for international markets.</br></br>On the first issue, there is little debate. China already has a $7 trillion economy, roughly half the size of the U.S. or the EU. If it can continue to grow even at 6% to 7% a year, not even at 10% or 11% as it did through much of the 2000s, then in five years the Chinese economy could easily pass the $15 trillion mark, where the U.S. is today. By the end of this decade, China should already be larger than the U.S. and equal to Europe.</br></br>The future of China's financial role is murkier. Within 10 years the yuan will probably play only a marginally more important global role than it does today. It won't replace the U.S. dollar as the world's reserve currency, and it may not even challenge the Japanese yen or the pound sterling.</br></br>Why? It's one thing to hold the yuan for trade invoicing, but if you're going to hold it as a liquid "safe haven" portfolio investment choice, you need free and unfettered access to deep domestic fixed-income markets. This is what the dollar and euro offer, and essentially so do the yen and other G-10 major currencies.