An Exclusive Interview with Professor Carmen Reinhart on ...

Title: An Exclusive Interview with Professor Carmen Reinhart on Currency Internationalization

Authro: GAO Zhanjun Carmen Reinhart

In an exclusive interview to China Forex，Carmen M. Reinhart，the Minos A. Zombanakis Professor of the International Financial System at Harvard Kennedy School and former World Bank's vice president and chief economist，shared her views with GAO Zhanjun，the Executive Editor-in-Chief of China Forex and once a visiting scholar at Harvard University，on currency internationalization.

Professor Reinhart was Senior Policy Advisor and Deputy Director at the International Monetary Fund and held positions as Chief Economist and Vice President at the investment bank Bear Stearns in the 1980s. She served in the Advisory Panel of the Federal Reserve Bank of New York and was a member of the Congressional Budget Office Panel of Economic Advisors. She has written on a variety of topics in macroeconomics and international finance. Her best-selling book (with Kenneth S. Rogoff) entitled This Time is Different: Eight Centuries of Financial Folly documents the striking similarities of the recurring booms and busts that have characterized financial history. It has been translated to over 20 languages and won the Paul A. Samuelson Award. Based on publications and scholarly citations，professor Reinhart is ranked among the top economists worldwide. In May 2020，she was appointed as the World Bank’s vice president and chief economist，and returned to Harvard University in July 2022 as her two-year public service leave from the institution ends.

The conversation，which follows in edited form，has documented a variety of crucial issues related to currency internationalization.

Dr. Gao: It’s very nice to see you again，Professor Reinhart. When I was thinking about doing this dialogue on currency internationalization a few months ago，there were a handful of experts that I wanted to talk to，but Carmen，you were really at the top of that list. I appreciate that you accepted my invitation and we are so lucky to have you.

Professor Reinhart: It’s nice to see you again as well，and I’m happy to be here. It’s a wonderful topic. I’ve been working in this area going back to early 2000s with Ken Rogoff on the modern history of exchange rate，focusing on the reserve currency issue over time，and with Guillermo Calvo，on the widespread phenomenon of reluctance to adjust exchange rates in emerging markets. Now with Ethan Ilzetzki，we continue this big line of work that I’m pursuing.

Discussion 1

Why is the Euro Punching below its Weight?

Dr. Gao: Let's first start with your paper. In your influential article Why is the Euro Punching below its Weight? (coauthored with professor Ethan Ilzetzki and Kenneth Rogoff)，you argue that an important purpose behind the launch of the euro was to create a currency with the same status as the US dollar，but from many dimensions，the share of the euro has basically remained the same since its birth in 1999，and its role has not even surpassed the mark or French franc which it replaced，thus the euro is still only a regional rather than an international currency. Could you please elaborate a little bit more why this has been the case?

Professor Reinhart: Absolutely! When the euro was launched，it was bringing together the former French franc zone and Deutsche mark anchored countries，and I thought the merging into the euro would be more dynamic. But over time，this is an issue that we stress in our work and include in the paper that you mentioned on Why is the Euro Punching below its Weight? The central banks and investors do not hold euro and they do not hold dollars，they hold the underlying assets. In the period before the 2008 global financial crisis，in eurozone countries we have seen as closer substitutes in terms of their assets，whether you are holding a German bund or an Irish bond，they were seen as closer substitutes，and so that I think tended to be liquidity enhancing in that it was behaving like a pool market. And after the global financial crisis，it became very clear that Greek bonds were not very good substitutes for German bunds，and they were very different from Portuguese bonds. Therefore you had the euro single currency，but you had many underlying smaller debt markets. So why is the euro is punching below its weight? It's not because it's not important in trade invoicing. For example，the euro is very important in trade invoicing when a lot of volume of trade is invoiced in the euro，but it lacks the liquidity of the US Treasury market，the idea that whether it's a German bund or whether it’s an Italian bond that you can buy and sell without affecting prices. But they're just much shallower markets that I think has been a big factor holding it back from expanding its role globally.

Dr. Gao: The fragmentation of the financial markets in the euro area is the main reason that has caused the euro punch below its weight，is this the point you are making?

Professor Reinhart: Indeed! Indeed! It's a fragmented debt market，so it doesn’t offer the liquidity of a broader based reserve currency.

Dr. Gao: The European Commission has an explicit goal to work to internationalize the euro，and a wakeup call，in the European Commission’s own terms，was created by the U.S.’s use of extraterritorial sanctions on Iran. And with COVID-19 and other recent events，the European Commission has taken some further steps towards internationalization of the euro，including setting up the Recovery Fund by which the European Commission could issue unified bonds on behalf of individual countries，and the result would be more EU level shared resources and a bigger EU level bond market. So it seems to be a further step. I wonder what your take might be about this.

Professor Reinhart: I think from different parts of the world，including China，including Russia，including much of Europe and broad based，there is a concern of the weaponization of the dollar. That is a rising concern in terms of the sanctions and the reliance on the dollar and at the same time being vulnerable to being shut out. For example，Russia began to diversify away from the dollar. There are limits to that，as they say in economics that it takes a model to beat a model. And there's so much you can do with gold，so much you can do with euro，with Renminbi，with Yen，because of different issues that we've been discussing. But I think the steps taken in eurozone are certainly going in the direction that we've been talking about，the realization that you need a unified market to really offer depth. Now you don't build depth overnight，and this is when you cited all the optimism by Arvind Subramanian，by Barry，and so on，for we say this in our book “This Time is Different”，which is currency transitions are slow and it's not like you can come out two years later. I mean the United States dollar really took several decades to replace the British pound，just as the British pound had replaced the Spanish silver. It started in the late 1800s but it really doesn't take over until the end of World War I，until 1920s that the New York emerges as a global financial center.

And here what you're asking me，as I said it's going in the right direction，but do I think a eurozone unified debt market is going to emerge quickly? No! Because there's also a lot of political issues and sovereign issues behind this. I'm sure many countries like Greece，Italy，and Spain，and so on that would be quite willing to push for more issuance. But then you have countries like the Netherlands，Germany，Finland on the other side that are going to be holding back the amount of new debt issued.This is a dynamic that's going to shape how quickly you build a deep market，and the emphasis being on a deep market. So that's going to take a while. Step in the right direction，but it'll take a while. That's my sense.

Discussion 2

Role of Renminbi Swap Line Arrangements

Dr. Gao: Bilateral currency swaps between central banks have attracted increasing attention for quite some time. The People’s Bank of China (PBC) has currently rolled out swap lines to about 40 central banks. In June 2022，the PBC and the Bank for International Settlements (BIS) signed the Renminbi Liquidity Arrangement (RMBLA)，and the other initial participants include Bank Indonesia，Bank Negara Malaysia，the Hong Kong Monetary Authority，the Monetary Authority of Singapore and the Central Bank of Chile. How could a global network of renminbi currency swaps and reserve pooling schemes influence the process of the renminbi internationalization?

Professor Reinhart: This is an important step in that direction. I have actually been following the PBC swap line arrangements. Some of the PBC swap lines with emerging markets were established a long time ago，but most of them were actually never tapped，and of course Argentina tapped the PBC swap line a long time ago. But in the more recent period we've had a very big increase in countries that are actually tapping the swap lines，Egypt and Pakistan and Turkey. These are not small countries. And so to answer your question，I think not only the establishment，which is the point I was making，but the swap lines have been there for a long time and they're becoming more active. They are being used more in the current context，and often，what we have concluded they are being activated also because of the rising distress in many of these countries，like Egypt losing a lot of reserves.  British bills of exchange took over Spanish silver coins in part because they were promoting credit lines also denominated in bills of exchange. And they increasingly became very liquid，and so on. So the bottom line is the swap lines are certainly a step that catapults and enhances the internationalization of the RMB. This is an area that I still have a lot of evolving research and policy interests.

Discussion 3

The Case of the Japanese Yen

Dr. Gao: What about the Japanese yen? As we all know，there were some similar debates around the time of the introduction of the euro，some debates in the US about “Is the euro going to rival the dollar?” But if you look back 10 years ago，it was the Japanese yen. At that time，Japan was the second largest economy in the world，and it also met some other conditions for internationalization of the currency，but the yen has never been，it is a significant reserve currency now for sure，but it has never been a rival to the US dollar. What could be the reason behind this?

Professor Reinhart: It's a wonderful question! And let me just start with a little personal story because it's directly relevant to the question. When Vincent and I got married，we were in graduate school and classmates，and my first job was at Bear Stearns starting in March 1982. I bring this up because in March 1982，Japan was the big competitor of the US，and you had the loss of competitiveness in the US car manufacturers，and Japanese cars had made huge inrodes，and there was the Japanese model. You had the booming real estate market and the booming equity market. So in the era of the 80s，the question was: what is the yen going to make a big international appearance，right? Because it was the second largest economy with a big expansion in trade and a big expansion in political influence，but the yen was nowhere to be seen.

I don't think Japan ever really systematically pursued the goal of the internationalization of the yen. So the answer to your question，I think，has two parts. Number one is，I don't think，as a policy，they pursued the internationalization of the yen. They certainly didn't have outreach with swap lines，with inroads pushing the idea of the yen for invoicing. In effect，on the contrary，most Japanese trade is invoiced in dollars.

Number two，which could be no doubt related to number one，is up until the crash of 1989，Japan had a very low level of public debt，pretty much of which was held domestically by banks，pension funds，and individuals. You didn't have the market，a deep，internationally traded market. So holding yen for a central bank，for example，for the Bank of France to hold Japanese sovereign debt denominated in yen，wasn't easy. And so those two things commingled. And even at the peak of its global footprint，the big pursuit of yen assets was really limited to equities，not sovereign debt，not even real estate.

Dr. Gao: Yes，and there seems to be a sense of fear of opening up in Japan historically，and Japanese financial markets have never been as open as some other developed countries.

Professor Reinhart: Absolutely! Japan wasn't as explicit as China，or many emerging markets. But Japan，like France，like Italy，had a pretty financially repressed system，with a lot of heavy duty regulation of financial institutions. In the case of France，it liberalized quicker. But Italy and Japan，which are often paired together in this context，had a much more financially repressed domestic bias system. They also never really push them to work to