Gaining Currency: The Rise of the Renminbi.

• Author: Dorn, James A.

Gaining Currency: The Rise of the Renminbi

Eswar S. Prasad

New York: Oxford University Press, 2017, 321 pp.

When China began its journey from a centrally planned economy to a socialist market economy in late 1978, it had virtually no footprint in the global economy. Today it is the world's largest trading nation, and its currency, the renminbi (RMB, also known as the yuan), has become an international medium of exchange, albeit on a small scale compared to the dollar, euro, yen, and pound.

In his new book, Eswar Prasad, former head of the IMF's China Division and currently Tolani Senior Professor of Trade Policy in the Dyson School at Cornell University, tells the story of the rise of the RMB and considers its future as a "safe haven" currency (i.e., one investors can turn to during a financial crisis).

Although the RMB has achieved official reserve status and is now included in the IMF's basket of currencies defining the Special Drawing Right (SDR), it still suffers from weak institutions that restrict the RMB's use as a global currency. So, while China has come a long way since 1978, it still has a way to go in becoming a global financial center with a trusted reserve currency.

Prasad begins with an overview of China's long monetary histoiy, noting that paper currency, in the form of certificates of deposit issued by "private deposit shops" and secured by coins or goods as collateral, first appeared in the 7th century during the Tang dynasty, well before the use of paper money in 17th century Europe. However, it was not until the 10th century, during the Song dynasty (960-1279), that paper money became widely used in the form of banknotes, again issued privately and backed by coins or goods. In 1160, the Song ruler established a monopoly over the supply of currency, which was backed by metallic base money. Private currency was outlawed "on the grounds that only the government could ensure a reliable supply of a currency stable enough to support economic activity" (p. 3).

The banning of private currency was controversial and provoked debate over the role of government in supplying a stable currency. That debate was not new; it went back a thousand years to the Han dynasty (206 BC-220 AD), when only metallic money existed and private mints competed with the government. Confucian scholars argued that giving the state monopoly power in minting coins would lead to debasement without competing private mints, while pubic officials contended that only they could provide sound money.

Although the debate over private money issuance was lost as the Song government exercised its power to ban private production, the results of that monopoly were as expected: an eventual overissuance of paper money, inflation, and economic instability during the later Song era.

In the 13th century, during the Yuan dynasty (1260-1367), China became the first country to issue an inconvertible paper currency (i.e., fiat money backed by nothing other than the government's promise to accept it as legal tender). It is noteworthy that Song intellectuals, such as Ye Shi, had a rudimentary understanding of the quantity theory of money, as well as the theory of monetary disequilibrium. They recognized that overissuance of paper currency would cause inflation and disrupt economic activity.

When inflation did occur during the Ming dynasty (1368-1644) because of an excess supply of paper money, China turned to the use of metallic money in the form of silver and coins. Paper currency did not appear again until 1853, during the Qing dynasty (1644-1911), and was backed by silver and bronze.

After the 1911 revolution, China experienced a period of competing currencies, as both government and private currencies circulated side by side. Those currencies were convertible into silver. However, the rise in world silver prices during the latter half of 1934 led to a drain of reserves, and in November 1935 China went off the silver standard.

From 1938 to...