seems to be around 2020<sup>68</sup> , which is also the projected date for China’s economic size to surpass that of the US.<sup>69</sup> Moreover, as of 2010, China not only overtook Japan as the second largest economy in the world, but it also overtook Germany as the largest exporter in the world. China has the largest foreign exchange reserves and has become a leading investor in both developed and developing countries. The Chinese government is encouraging a gradual process of internationalization of renminbi. As a result, Chinese firms and financial institutions are beginning to settle their cross-border business transactions in renminbi to an increasing degree, and there is an expectation of use of the renminibi in a growing range of crossborder transactions in the next two to three years, including possibly a limited form of capital account convertibility of the renminbi in the next five years.70 An important next step will be when central banks of key countries begin to hold at least part of their reserves in the Chinese currency. China has also taken steps to increase its role as a provider of last-resort liquidity by participating in the Chiang Mai multi-lateralization process, and it has signed bilateral swap arrangements in renminbi with a number of countries, including a few advanced economies.

Nevertheless, the challenges facing China’s financial sector, which remains underdeveloped, are considerable, and reforming it will take time. In particular, the size of the Chinese bond market remains quite small – not more than two or three percent of Japan’s and probably less than one percent of those of the US or the euro zone. So, although it is highly likely for the renminbi to become an international currency, its ascendance to a full-fledged reserve-currency must await considerable reform of its financial markets, though it will be playing an increasingly important role within the East Asian region, as well as in the rest of the world through China’s trade and financial transactions.71 So, by 2020 or 2025 China may be the largest economy in the world, but it will still be a developing country and-- via the “optimal financial structure”<sup>72</sup> argument--its financial market may not be deep enough for renminbi become a fullfledged global reserve currency. It is likely that these financial sector requirements imply that it will be a gradual process towards “internationalization” and eventual reserve currency status.

**Stability properties of the emerging system.** Financial stability requires that the international monetary system is capable of reducing the frequency, scope and severity of crises.  A multi-polar system would require the participating governments to be _disciplined_ in formulating and implementing their macroeconomic policies.  They should have a strong _incentive to cooperate_ with each other – e.g. by having to share part or all of the resulting seigniorage with international bodies to support global public goods -- and to set their policies in a way that would take into account the cross-border effects. In addition, each of the participating governments would need to have sufficient _internal policy autonomy_ as well as some sort of an arrangement for _reserve pooling_ among themselves and with those countries linked to their currencies.  Finally, a key property for the stability of the system is _adequate provision of liquidity_ -- to avoid asset bubbles due to excessive liquidity or deflation due to inadequate liquidity arising from normal international transactions in trade and finance.

> 68 See Eichengreen (2010).

> 69 IMF, “World Economic Outlook,” April 2011, based on PPP calculations of GDPs for China and US, projects that China’s economy may overtake the US economy by 2016.  Most other calculations based on market exchange rate rather than PPP put the date somewhere between 2020 and 2030.

> 70 See Huang et al (2011).

> 71 The Chinese and Japanese governments recently made a joint announcement of a agreement for greater use of the renminbi for settling trade transactions, as well as for Japanese corporate bond issues denominated in renminbi but issued in Japan and other foreign markets.  (Reported in the _Washington Post_ , December 25, 2011.)

> 72 As argued in Lin et al (2009), the optimal financial structure in an economy depends on its stage of development. They argue that the structure of factor endowments in a country is the most fundamental force determining its optimal financial structure.

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