In the 1960s, a Belgian-American economist called Robert Triffin defined the Triffin Dilemma (or paradox) — the theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. It describes the problems of using any national currency as an international reserve currency.

The governor of the People's Bank of China cited the Triffin Dilemma as the cause of economic disorder, following the global economic crisis of 2008, and proposed a move away from the US dollar as a reserve currency and towards the use of IMF special drawing rights (SDRs) as a global reserve currency. The IMF also recommended that the world adopt a global currency with a global central bank to administer it. There has been much debate and discussion ever since about the US dollar's role and the Chinese yuan challenge to this long-held position.

This is where signalling theory comes in, which is used to observe patterns in the communication of government policy.

The issue is the EU debt crisis and the increasing role of China in the world economy. The likelihood of yuan internationalisation — part of a long game — has already started; more trading nations continue to settle with China in yuan. In January the UAE signed a three-year currency swap agreement with China signalling its intentions — and leading others in the region potentially to follow suit. In effect, this signals Dubai's recognition of the yuan as a common currency.

Basket of currencies

Dubai is strategically positioned in a time zone linking East and West and could serve as an offshore hub for yuan, much like Hong Kong. This is especially appealing when you consider that 60 per cent of China's re-exports pass through Dubai and that Saudi Arabia is also a major trading partner with China. Could we even see oil move to pricing in a basket of currencies, including the yuan, by the GCC for its oil and gas exports?

In examining the China situation, it is intra-Asean trade that is a key determinant of trade and economic activity — Asean nations export less than 25 per cent to non-Asean trading nations. Many of these nations could opt to settle trade in yuan.

Within a game dimension we identify the players; China as a player will play the long game in a process of internationalisation, mindful of the economic and financial impact of a more open capital account. The US as a player, for example, will have more immediate concerns about the future role of the US dollar and dollar-denominated resources.

Each player alternatively has different yet inter-dependent economic objectives communicated to market analysts by financial signals. Signals are becoming more frequent; they are ‘priced in' by analysts. In terms of trade settlement, it has been estimated by HSBC that 50 per cent of China's trade settlement could be settled in yuan within the next three to five years.

Advantage Dubai

As European banks continue to deleverage and Chinese companies wish to expand abroad there may be a strategic opportunity for more Chinese investment abroad. This coupled with the continued misalignment in currencies and the threat of a protectionist currency war, does provide the ideal conditions for the long game of yuan internationalisation and full convertibility to begin — Dubai's signal of an offshore hub is well timed.

The Triffin Dilemma is still with us today and whilst there is no doubt that it creates a challenge, the yuan may be lining up to supersede the US dollar as our de facto global reserve currency and Dubai is well placed to capitalise on the opportunity.

 

Patrick McNutt FRSA is Visiting Fellow at Manchester Business School, engages in academic research and provides consultancy and support to private clients.