Introduction

On January 25, 2025, the Bank of Japan made a significant announcement: a 25 basis point increase in interest rates, the first such adjustment in 18 years, signifying a departure from its longstanding zero-interest rate policyThis decision, while modest in percentage terms, sent ripples through the financial markets, especially in the context of the yen's role as a safe-haven currency.

Analysts opined that this historic interest rate hike might have profound implications not only for Japan but for the global economy at largeSince the yen has been a preferred choice for international investors seeking refuge during turbulent times, a narrowing interest rate differential between the yen and the U.S. dollar could diminish the appeal of yen-denominated assetsSuch shifts might lead to a significant reconfiguration of the global currency landscape, raising concerns about the stability of some highly leveraged financial instruments.

While a financial storm may well be brewing following this move, it presents an unforeseen opportunity for China in its quest for the internationalization of its currencyThis transition could usher in a phase of heightened asset values boosted by external inflows of capital aiming to capitalize on the emerging economic conditions.

Yet, one might wonder why the Bank of Japan's decision to raise interest rates could be perceived as a springboard for China's economic rise, especially regarding the internationalization of its sovereign currencyThe journey of Japan’s economy has been marred by prolonged stagnation and deflationary pressures post the 1991 real estate bubble collapseThe Bank of Japan, over the past three decades, took various measures to stabilize its economy, and it wasn't until 2012, with the introduction of "Abenomics," that any substantive recovery appeared on the horizon.

Critics argue that Japan squandered the chance to leverage the 2008 financial crisis to propel a robust recovery akin to measures taken in other regions

Advertisements

But there lies a fundamental differenceThe crux of Japan’s economic dilemma was its over-leveraged housing sectorInitially, aggressive attempts to de-leverage sent shockwaves through the economy, prompting policymakers to adopt a myriad of monetary strategies to delay market correctionsUnfortunately, years of sluggish growth and low liquidity contributed to Japan's so-called "Lost Decade.”

In stark contrast, the 2008 financial crisis in the United States exemplified a chain reaction within the financial derivatives market rather than merely a housing crisis, demonstrating a deep-seated failure in financial product design and risk managementConsequently, while Japan experienced stagnation without severe contractions in economic size, maintaining a steady GDP of around $5 trillion, the U.S. endured a much more tumultuous period marked by widespread financial collapse.

Despite Japan's stagnant growth over the years, it has remarkably sustained its economic metrics, with individual GDP and disposable income consistently hovering around $40,000. This achievement speaks volumes about Japan’s ability to maintain resilience in the face of adversityIndeed, such a performance in a nation with over 100 million individuals and a landmass of around 370,000 square kilometers is, by many measures, an economic miracle.

A significant contributing factor to Japan's economic endurance has been its “outbound economy.” This term refers not to the country’s traditional export-focused manufacturing, but rather to domestic businesses expanding into international markets in response to excess production capacity or engaging in technology-driven sectorsHowever, with increasing competition from emerging markets, particularly the "Four Asian Tigers" and China, Japan's outbound economic growth has faced substantial headwinds since the early 2010s.

Amid growing challenges, "Abenomics" emerged as a beacon of hope, implementing unconventional monetary policies, including the controversial control of yield curves

Advertisements

Keeping interest rates historically low made yen-denominated assets increasingly attractive to international investors seeking safe harbor during market volatility.

This phenomenon of “financial outbound” has become essential for Japan's economic sustainability, making it particularly relevant for China's future economic trajectorySince its accession to the World Trade Organization (WTO) in 2001, China had initially benefited from external manufacturing relocations and subsequently evolved to prioritize low-to-mid-end manufacturing and exportationThis dual approach has generated substantial foreign reserves and industrial capital.

However, as the global landscape shifted, presenting challenges such as the gradual decline of manufacturing's share in the global market amidst fierce competition from developed nations, the need arose for Chinese enterprises to pivot aggressively into international marketsYet, this also exposes China to competitive traps not previously experienced by Japan.

The historical insights from Japan’s economic ordeal provide a roadmap: facing challenges in transitioning its manufacturing economy abroad, China might need to explore "financial outbound" avenues, albeit by addressing fundamental issues like enhancing domestic capital fluidity and transactional efficiency.

Ironically, Japan's recent interest rate hike indicates a potential loss of its status as a safe-haven currency, opening the door for China’s sovereign currency to step in as the new preferred investment choiceIf the renminbi were to replace the yen, it could not only accelerate China's quest for currency internationalization but also aid in stabilizing its economic fundamentals amidst global market upheaval.

Beyond the prospect of replacing the yen, could other pathways facilitate the internationalization of the Chinese sovereign currency? Japan, regarded as a smaller-sized economy in the global context, benefited from its manageable demographic and territorial size

Advertisements

In contrast, China's vast populace and expansive geography command significant influence in international markets.

Many proponents advocate for strategies such as enhancing regional collaboration through multilateral trade agreements that favor the use of local currenciesYet, the practicality of replacing the U.S. dollar as the world’s primary reserve currency remains a daunting propositionThe entrenched structural advantages of the dollar stem from its deep-rooted network of trust globally encapsulated in the phrase: it is "the least bad" currency and thus preferred among nations.

Efforts to shift away from the dollar may face inevitable challengesNotably, adopting local currencies in trade could inflate transactional costs and economic inefficiencies, resulting in a zero-sum game for participantsWithout substantial incentives or a compelling reason to do so, many nations will continue relying on the dollar to optimize their trading outcomes.

In light of these realities, the feasibility of a regional currency supplanting the dollar appears tenuous, as demonstrated by the challenges the euro faces, also reflecting on what triumphs and tribulations lie ahead.

With regards to the technological advances in AI and big data lauded by some as pathways to simplifying transactional costs, it must be noted that the inherent complexity and fluidity of human demand and market dynamics often escape the grasp of any rigid, calculated frameworkThis alludes to Friedman’s monetary paradox—understanding that the true supply of money cannot be precisely delineated, rendering efforts to quantify it an incessant challenge.

Ultimately, the global preference for the dollar is not merely a consequence of coercive forces but rather the realization that it presents the most effective means of conducting business in a highly interlinked global economyThe tasks surrounding currency issuance, policy-making, and related concessions intertwined with national sovereignty further complicate the prospects of currency internationalization for China.

Nevertheless, for China to seize productive momentum, the country must engage in substantive measures that can bolster its role in the global economic dynamics

Advertisements

Advertisements