Research Spotlight: Buying Monetary Status: Chinese Foreign Aid and the Rise of the Renminbi

Why do countries invest in an emerging powers currency? Scholars have long studied the influence geopolitical considerations have on the rise and persistence of reserve currencies. I argue that when the economic factors of a state’s currency alone are insufficient in attracting other nations to invest in its currency, a state will need to link investing in its reserve currency with a policy that benefits the investing state. Past literature has shown that security guarantees have often been linked to monetary status. However, security is not the only commodity reserve currency issuers can leverage to increase their monetary status.

I propose that an alternative tool that a reserve currency issuer can use to encourage states to invest in its currency is foreign aid. Using an instrumental variable, an interaction of Chinese steel production with a state’s probability of receiving Chinese aid in a given year, I demonstrate how China used foreign aid to induce other nations to invest in the renminbi (RMB) and thereby enhance its monetary status.

I find that, for every project that China finances in a country, the probability that country will adopt RMB as a reserve currency increases by 3.5%. Therefore, if China committed in a year to finance 10 projects in a country, the probability that country will invest in RMB, holding all else equal, increases by 35%. From 2009 – 2013, the most projects China financed in a country during a particular year was 32 and they financed 10 or more projects in a country 20 times.

This article shows that nations can use foreign aid to incentivize other nations to invest in its currency. I argue when the economic factors of a state’s currency alone are insufficient in attracting other nations to diversify into its currency, the state will need to link investing in its reserve currency with a policy that benefits the investing state. Past literature has shown that states have linked security guarantees to monetary policy. However, security is not the only commodity reserve currency issuers can leverage to increase its monetary status. I show that an alternative tool that states can use to encourage states to invest in their currencies is foreign aid.

Zachary Houser | Florida State University

Zachary Houser is a PhD Candidate at the FSU Department of Political Science. His research focuses on the motivations of foreign aid and how donor nations use foreign aid to achieve domestic and foreign policy objectives, increase their international status, and enhance their economic and monetary position in the world. You can learn more about Zachary here.

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