Confusion over this this difference between what is required for trade and establishing the RMB as an international capital unit has created destabilizing calls for too rapid liberalization of China's capital account. Economic theory, confirmed by other countries experience, shows liberalisation of China's capital account will not lead to a balanced flow of funds in and out of China, but only to large scale exit of capital from China.

This would reduce China's economic development by decreasing funds available for investment and raising interest rates, potentially leading to further falls in China's foreign exchange reserves if currency interventions are made to try to prevent the RMB's exchange rate falling when faced with capital outflows.

The reason why without capital controls there is only a net one way flow of funds into the dollar is that any market, including the global economy, can only operate with a single price standard requiring a single price unit. This in turn determines the demand for foreign currencies including foreign exchange reserves. A relatively few individual companies seek to profit from relative movements in currencies, but globally this is a peripheral activity. The aim of most foreign exchange holdings is to possess the unit used to price international transactions - which is the dollar. This is not only the goal of central bank's foreign exchange reserves but also the safest form of currency hedging by companies.

Consequently if countries capital accounts are liberalized, the net flow is always into dollars - as global experience since international capital account liberalization seriously began in the late 1970s confirms.

China can be no exception to this fundamental economic rule. Therefore as China moved to liberalize its capital account, the data shows destabilizing movements out of the RMB into dollars began. China's foreign exchange reserves would have been increased by its trade surplus rising from $306 billion in the year to August 2014 to $540 billion in the year to August 2015. But instead of rising China's foreign exchange reserves fell at a rate much faster than was caused by productive Foreign Direct Investment outflows. In 2015 China's foreign exchange reserves have fallen by an average $36.5 billion a month and the decline has risen sharply - August's fall was $94 billion. This demonstrates large scale capital outflows are taking place with negative economic consequences.

The positive effects of the RMB's use in relation to international trade, therefore, led to it organically becoming the fourth largest currency for international transactions - a healthy process which should be allowed to continue. Failure to accurately recognize the nature of the international capital system that can only create a flow into dollars, can lead to overhasty relaxation of capital controls with negative effects for China's economy.

The writer is a columnist with China.org.cn. For more information please visit:

http://www.h5a3.com/opinion/johnross.htm

Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.