By Jason Simpkins
Finance officials from Beijing in Moscow on Thursday held a videoconference to discuss the creation of a "supra-national reserve currency," the latest evidence of the support China is getting from developing countries as it seeks to replace the U.S. dollar as the world's main reserve currency.
This controversial proposal – and the support that it's getting – also underscores China's continued emergence as a growing global force in both the financial and political arenas. That's a trend that successful global investors won't be able to ignore.
The recent torrent of criticism to swirl around the dollar began with remarks by Chinese Premier Wen Jiabao. Speaking last month at a press conference leading up to the recent Group 20 meeting in London, Premier Wen voiced his concern about the value of China's large holdings of U.S. Treasuries.
"We have lent a huge amount of money to the United States," he 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).
"JPM) analyst Frank Gong told The Associated Press. "Inside China, there has been a lot of debate about whether they should continue to buy Treasuries."," JP Morgan & Co. (
Earlier this year, the Congressional Budget Office (CBO) projected that the U.S. budget deficit would nearly triple from last year's $455 billion – and would reach a staggering $1.2 trillion. And that was even before U.S. President Barack Obama unveiled his $787 billion in stimulus, bank-rescue and anti-foreclosure plans. And that massive projected shortfall also doesn't include other fix-up initiatives that are sure to surface in the months ahead.
But rather than sit idly by and watch the value of its reserves be eroded by the U.S. government's economic policies, China is trying to lay the foundation for future change.
China and the SDR
On the eve of the G-20 summit, Zhou Xiaochuan, governor of the People's Bank of China, released an essay entitled "" on the BOC's Web site.
Without explicitly mentioning the U.S. dollar, People's Bank Gov. Zhou asked what kind of international reserve currency the world needs in order to secure global financial stability and facilitate economic growth.
According to Zhou, the dollar's unique status as the world's primary currency reserve has resulted in increasingly frequent financial crises ever since the collapse of the Bretton Woods system in 1971.
"The price [of relying solely on the dollar] 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. The central bank governor noted that the International Monetary Fund's Special Drawing Right (SDR) should be given special consideration.
Created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system, the SDR was redefined in 1973 as a basket of currencies. Today, the SDR consists of the euro, Japanese yen, pound sterling, and U.S. dollar.
"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 proposed the following actions to move the SDR in a direction that could better accommodate demand for a more stable reserve currency:
- Set up a settlement system between the SDR and other currencies. Therefore, the SDR, which is now only used between governments and international institutions, could become a widely accepted means of payment in international trade and financial transactions.
- Actively promote the use of the SDR in international trade, commodities pricing, investment and corporate bookkeeping. This will help enhance the role of the SDR, and will effectively reduce the fluctuation of prices of assets denominated in national currencies and related risks.
- Create financial assets denominated in the SDR to increase its appeal. The introduction of SDR-denominated securities, which is being studied by the IMF, will be a good start.
- Further improve the valuation and allocation of the SDR. The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies, and the GDP may also be included as a weight. The allocation of the SDR can be shifted from a purely calculation-based system to one backed by real assets, such as a reserve pool, to further boost market confidence in its value.
China Rallies BRIC Allies
While China has been the most vocal proponent of a new – less-dollar-oriented – global currency system, other countries around the world have taken up the cause.
Russia, as Thursday's videoconference illustrated, is working with China to push for an overhaul of the current currency system. In fact, the creation of a new reserve currency to be issued by international financial institutions was one of the measures Russia proposed to the G-20 on March 16.
Russia and China have also been joined by India and Brazil. Representatives from each of the four BRIC countries met in the weeks before the G-20 summit, and an unnamed source told Reuters that a shift away from the dollar was discussed.
"They (China) did not formally put forward their position for the G-20 summit but unofficially they had distributed their paper regarding the same ideas (the need for the new currency)," the source told Reuters, speaking on condition of anonymity.
Shortly after the G-20 meeting, Russia proposed that the IMF or G-20 study the creation of a new international reserve currency.
"The new global reserve currency has not been discussed at the summit. We only discussed it at several bilateral meetings," Russian President Dmitry Medvedev's chief economic aide, Arkady Dvorkovich, told a news briefing.
Weeks later, China agreed to a $10 billion (70 billion yuan) currency swap with Argentina. That deal will allow China to receive yuan, instead of dollars, for its exports to the Latin American country.
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 China's economic success, particularly in light of the current financial crisis.
"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."
While it continues to push for reform, China is also realistic about a timetable for achievement.
""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."
But for many analysts, the support that China has been able to drum up in just a short matter of time is evidence of the nation's growing economic and 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 [becoming increasingly] involved in political and security issues around the world," 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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News and Related Story Links:
- Money Morning:
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- Associated Press:
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- Money Morning News:
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