Almost two years after a modest currency revaluation, China is still thumbing its nose at the United States’ demands for big gains in the yuan.
Last week, officials in Beijing seemed to yawn as Charles Schumer, a US senator pushing for tariffs on Chinese imports, predicted that a new measure aimed at forcing China to boost the yuan will pass Congress by next year.
The US also imposed tariffs on imports of Chinese coated paper.
China’s response was summed up by central bank researcher Tang Xu, who said a stronger currency alone won’t solve US trade disputes. Traders were equally unmoved by the US action.
In Japan, meanwhile, neither the government nor investors seemed concerned about a US senator’s proposal to require Asia’s biggest economy to stop holding down the yen. “It’s time for our government to hold Japan accountable for what amounts to illegal trade subsidies,” Michigan Democratic senator Debbie Stabenow said last week.
What gives? You would expect the US to have more sway in markets. It does, after all, print the reserve currency. And while China is growing at 10%, India isn’t far behind and Japan is recovering, the $13 trillion US economy is still proving hard to replace.
Short on reserves
One explanation for the US’ waning clout in foreign-exchange markets is something that gets little attention: the country’s lack of currency reserves.
Certain benefits come from printing the most-used currency, having great sway over the International Monetary Fund and being the pre-eminent economic power. It means you can get away with more.
In the US’ case, it’s massive current account and budget deficits, negligible household savings and a pricy military quagmire in West Asia.
Even so, the US’ $41 billion of currency reserves seem puny compared with China’s $1.07 trillion, Japan’s $884 billion and even Malaysia’s $82 billion. At the moment, the US has fewer reserves than Nigeria’s $42 billion, Indonesia’s $46 billion and Poland’s $49 billion.
All this makes the US look (a) highly confident about its financial condition, (b) complacent amid a growing number of global imbalances or (c) arrogant. There’s little doubt that, if asked, US President George W. Bush and his Treasury secretary, Henry Paulson, would say (a) is the right answer.
Bretton Woods II
There’s some merit to the view, considering the so-called Bretton Woods II world in which we live. The breakdown of the post-World War II system centred on the gold standard led to a kind of dollar standard.
Many nations adopted the dollar as a new anchor, either formally or informally pegging currencies to it. When you’re the US, who needs reserves?
Yet in a world littered with risks—from slowing US growth to global imbalances to terrorism to bird flu to the yen carry trade to overheating in the Chinese economy—one wonders how wise it is for the US to have so few reserves. (Carry trade is a strategy where an investor sells a currency with a relatively lower interest rate and uses the funds to buy another currency yielding a higher interest rate.)
That’s especially true when you consider that the US has arguably lost control of the dollar. With its economy facing big challenges, the US probably wants a weaker currency for the same reasons everyone else does. How much control does the US have, though, when overseas investors—Asian governments among them—own its bond market?
Perhaps that’s why the US tries to influence other currencies; it realizes it has lost control of its currency and interest rates to foreigners. Given that arrangement, the US may want to be careful slapping around China and Japan, its two biggest debt customers.
One could argue that Asia has created a reserve bubble. There would seem to be better uses for the trillions of dollars on which Asian central banks are sitting. Also, monetary authorities may have reached the point of no return in their ability to reverse course or manage their massive holdings.
Yet the US decision to boost its foreign reserves by just $10 billion in 10 years (they were $31 billion in 1997) was either a shrewd move or a mistake. Only time will tell.
In the meantime, the US should expect more shrugging from officials in Beijing and Tokyo on currency matters. China’s need to create millions of jobs to keep the peace trumps the desire to make nice with the US. Japan also remains unwilling to try living without a weak exchange rate.
Besides, what is the US going to do about it? Intervene in currency markets to strengthen the yuan or yen with less money than either Bill Gates or Warren Buffett has? It’s doubtful.
If there’s any positive spin here for the US, it’s that it now has two potential saviours in the event of a crisis. The credit crunch known as the Panic of 1907 forced the US to turn to one man for financial aid: J.P. Morgan. The White House now has at least two wildly rich men to call if the dollar plunges and reserves run low.
The truth is that when it comes to swaying currency markets, the United States has little money to put where its mouth is.