China and the dollar – Yuan small step

Published on the Economist.com, (from HongKong), July 9, 2009.

The dollar’s role as the world’s main reserve currency is being challenged.

THE Chinese used to call dollars mei jin, which means “American gold”. Buying black-market dollars was considered the safest way to protect one’s savings. Yet in June when Tim Geithner, America’s treasury secretary, told students at Peking University that China’s official holdings of Treasury bonds were safe, the audience laughed. Faith in the greenback is waning.

In the build-up to the annual summit of G8 countries, which began on July 8th in the Italian city of L’Aquila, officials in China, Russia and India all called for an end to the dollar’s dominance in the international monetary system. Dmitry Medvedev, Russia’s president, declared on July 5th that the dollar system is “flawed”; his central bank has been reducing its dollar holdings. The People’s Bank of China (PBOC), China’s central bank, repeated its call for a new global reserve currency in June and is now taking the first steps towards turning the yuan into a global currency …

… The yuan will be used more widely for trade over the next decade but the idea that the yuan can become a reserve currency in the near future is ridiculous, says Arthur Kroeber at Dragonomics, a research firm based in Beijing. Not only does China lack the economic and political track record required to underpin a reserve currency, but its currency is not fully convertible. China would need to scrap capital controls so foreigners could invest in yuan assets and then freely repatriate their capital and income, but the government is wary of moving too quickly. A reserve currency also requires a deep and liquid bond market, free from government interference. This, says Mr Kroeber, implies a big retreat from China’s state-led model of credit allocation.

Even if China immediately scrapped capital controls the yuan would be unlikely to challenge the dollar as a reserve currency for years. The dollar did not replace sterling until half a century after America’s economy had overtaken Britain’s. America’s GDP is around three times as big as China’s, and its total trade is still larger.

Both the SDR plan and measures to internationalise the yuan also seem to assume that China’s problem is simply that too many of its reserves are in dollars. But China’s real problem is that it is running a persistent current-account surplus; in order to keep the yuan closely tied to the dollar it has to keep buying more dollar assets. If China really wants to reduce its exposure to the greenback it must allow the yuan to rise. It would incur a loss on its existing reserves but stem future losses. But so long as China maintains its current exchange-rate policy, it is, ironically, helping keep the dollar dominant. (full long text).

Links:

Geithner committed to strong dollar as reserve currency, AFP, July 13, 2009;

RPT-India cbank: not time to replace dollar as reserve, July 13, 2009;

G8-Gipfel wird zum Desaster für den Dollar, by Brigitte Hamann, 12.07.2009;

Insight: New order still needs the dollar
, by Ousmene Mandeng, June 17 200;

Medvedev Resurrects Idea of Replacing Dollar as Reserve Currency, by HELENE COOPER, on NYT, April 2, 2009;

Explained on wikipedia; Reserve Currency, and there specially: Other notable reserve currencies;

Categories on wikipedia: Currency, Money, Foreign exchange market.

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