China Continues to Expand its Economic Clout by Challenging the Dollar’s Dominance Ahead of the G20 Summit

By Jason Simpkins
Managing Editor
Money Morning

China has been more vocal than ever ahead of tomorrow's (Thursday's) Group 20 financial summit, a development that highlights the nation's dissatisfaction with the dollar, as well as its growing political and economic influence on the world stage.

After questioning the dollar's viability as the world's main reserve currency, Beijing recently took another step in its quest to expand the role of its own currency, the yuan, by agreeing to a $10 billion (70 billion yuan) currency swap with Argentina.  The deal will allow China to receive yuan instead of dollars for its exports to the Latin American country.

"Beijing has its eye on raising the status of the yuan," Ben Simpfendorfer, an economist at the Royal Bank of Scotland Group PLC (ADR: RBS), told The Associated Press. "They are the world's second-largest exporter and the third-largest economy, so it is in their interest to handle trade in the yuan."

The deal was signed Sunday by Zhou Xiaochuan, governor of the People's bank of China, and Martin Redrado, president of the Central Bank of Argentina. It eliminates the need for both nations to buy dollars to facilitate cross-border transactions.

"Dollars will not be needed for trade," said the People's Daily, the Communist Party newspaper. "This measure will play a positive role in improving regional currency stability, preventing financial risk and reducing the spread of the crisis at this extraordinary time when the financial crisis is growing daily."

Including the latest deal with Argentina Beijing has signed about $95 billion (695 billion yuan) of currency deals with Malaysia, South Korea, Hong Kong, Belarus, and Indonesia over the past few months.

These deals undermine the status of the dollar as the world's leading trade and reserve currency, but they also broaden the status of the yuan - something policymakers in Beijing see as being vital to the country's economic success, particularly in light of the current financial crisis.

"China is affected a lot when the dollar is up and down. Everyone is looking for balance and self-protection," Zuo Xiaolei, chief economist for Galaxy Securities in Beijing, told the AP. "How can China protect its own interests in the current economic situation? You can't change the U.S., so you can only change yourself."

China Disses the Dollar

China has been increasingly critical of the dominant role played by the U.S. dollar in the world economy as the G20 summit approaches.  Central bank governor Zhou last week called for a new global currency to replace the dollar as the world's main instrument for trade and stockpiling reserves.

 Zhou pointed to the dollar's unique status as the world's primary currency reserve as a contributing factor to many of the financial crises to occur since the collapse of the Bretton Woods system in 1971.

"The price is becoming increasingly higher, not only for the users, but also for the issuers of the reserve currencies," Zhou said. "Although crisis may not necessarily be an intended result of the issuing authorities, it is an inevitable outcome of the institutional flaws."

Zhou called for the "re-establishment of a new and widely accepted reserve currency with a stable valuation" to replace the U.S. dollar - a credit-based national currency - noting that the International Monetary Fund's Special Drawing Right (SDR) should be given special consideration. 

"The SDR has the features and potential to act as a super-sovereign reserve currency," said Zhou. "Moreover, an increase in SDR allocation would help the Fund address its resources problem and the difficulties in the voice and representation reform. Therefore,efforts should be made to push forward a SDR allocation."

Zhou's assault on the dollar came just one week after Chinese Premier Wen Jiabao expressed his concern that overzealous monetary policy might significantly devalue his nation's currency reserves.

"We have lent a huge amount of money to the United States," Wen said. "Of course, we are concerned about the safety of our assets. To be honest, I am definitely a little bit worried. I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China's assets."

Of China's $2 trillion in foreign currency holdings, about $1 trillion is invested in U.S. Treasuries and notes issued by other government affiliated agencies, such as Fannie Mae (FNM) and Freddie Mac (FRE).

China should seek to "fend off risks" by further diversifying its reserves, Wen said.

"We have already adopted a guiding management policy of diversifying our foreign exchange reserves, and at present our foreign exchange reserves are safe overall," Wen said. "Our first principle in managing foreign currency is averting risk. We have always adhered to the principles of foreign currency security, liquidity and maintaining value, and implemented a strategy of diversification."

China to Seek Greater Influence at G20 Summit

China's president, Hu Jintao, is expected to carry Beijing's concerns about the dollar into Thursday's G20 summit.

"Currently it's hard to shake up the U.S. position," Wang Yong, an international relations scholar at Beijing University, told the AFP. "But given what's going on, some reforms are necessary. That's going to be China's key message in the G20 summit."

China's goal at the G20 meeting will not be to effect the kind of dramatic change that immediately deposes the dollar. Instead the goal is to broach discussion about the dollar's status even if no long-term solutions are reached at the two-day meeting.

"When a problem comes up, it's always better to discuss it than not. But important reforms take more than one or two days," Sun Zhongtao, a professor of international strategy at the Central Party School in Beijing, told the AFP. "Under the new system, the dominance of the dollar is set to be challenged. But it's impossible to reach consensus on such issues overnight."

World Bank President Robert Zoellick came to the defense of the dollar in a recent interview with Reuters.

"I think the dollar will remain the principle reserve currency. The question will be whether you have complementary measures," Zoellick said. "It is appropriate to discuss the monetary system but one also has to be sensible and not throw out the baby with the bath water."

Zoellick echoed Sun's point that establishing a new reserve currency will take time.

"To create a reserve currency you need to have more than a summit or a meeting, you have to create financial markets where people feel comfortable moving in and out of the currency," he added.

Zoellick also said that China's contribution to the debate has been a positive development that shows its engagement and willingness to participate in the international financial system.

For many analysts just the amount of attention China has drummed up for itself heading into Thursday's meeting, is evidence of the country's growing political clout.

"In the Asian financial crisis, China kept a relatively low profile and it didn't assume any kind of leadership role at that stage," Brian Bridges, a political scientist at Hong Kong's Lingnan University told the AFP. "Now the contrast is very significantly different in terms of China being much more open and involved in the financial system."

For Bridges China's determination to flex its financial muscle and expand political influence is what sets it apart from other would-be success stories, like the Japan of 1980s.

"In the case of China, you have a power which is almost simultaneously both becoming a rising economic power and also involved in political and security issues around the world increasingly," said Bridges. "It's slightly different from the Japan model, because Japan was first an economic power and there was expectation it would become important in political and security issues. But it never actually fulfilled that role."

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