Returning from China last month, US Congressman Mark Kirk had a bearish take on a high-level visit by US officials. US treasury secretary Timothy Geithner claimed the US’ biggest creditor voiced great confidence in its debt. Kirk, an Illinois Republican, came back with the opposite impression. China is beginning to cancel Congress’ credit card, he told Fox News on 10 June. It doesn’t want to lend much more money to the US and is especially worried about the Federal Reserve’s policy of printing money to buy new debt.
A month later, there’s no doubt about whose assessment was more accurate. Chinese leaders are clearly concerned about the dollar. How they will react is a question hanging over markets, and it’s time to take up the discussion.
Everyone knows China wants to reduce its dollar holdings. Little is known about how that process may unfold and how much work and preparation needs to go into it. Lots, in fact.
Think of China and the US in history’s most expensive divorce. The two economies total $17 trillion (Rs827.9 trillion) of output, and polls in China show little support for adding to almost $800 billion of US treasurys.
This argument can be broadened to the rest of Asia. The idea that China or Japan—with $686 billion of treasurys—can just start selling massive blocks of dollars is ridiculous. It would devastate global markets and the fallout would boomerang on Asia. If you think markets are shaky now, just wait until word of a central bank fire sale gets around.
Sure, Singapore (with $40 billion of treasurys), India ($39 billion) or South Korea ($35 billion) could try to dump dollars on the stealth. Good luck in this highly connected, around-the-clock world. News that a key economy seeks a first-mover advantage over peers would inspire copycat selling. Expect investors and traders to respond with massive sell orders.
Warren Buffett can discreetly trim Berkshire Hathaway Inc.’s interest in a firm or a currency. How a central bank divests itself of tens or hundreds of billions of dollars on the sly is another matter.
Governments that may be concerned about getting stuck with their dollars for good have a point. And by curtailing investments in dollars today, Asia is ensuring that the US currency will be worth less a year from now. Bernard Madoff can tell you a thing or two about how this process works.
What may be necessary is a global framework or pact to end the dollar’s dominance. A Plaza Accord of sorts may be needed to dismantle the so-called Bretton Woods II system of tying currencies to the dollar that emerged after the global crises of 1997 and 1998. A Dollar Accord, anyone?
Politics will be a stumbling block. It’s hard to envision the US signing on to scrap the dollar as the reserve currency. Neither the euro nor the yen is ready to replace it. And China’s designs on currency domination are at least a decade away.
The amount of scrutiny the dollar’s successor would face makes you wonder who would want to print the reserve currency. That explains why the most credible argument making the rounds involves the International Monetary Fund’s (IMF) so-called special drawing rights, or SDRs.
They are really an account of exchange, rather than legal tender, and are calculated according to a basket of currencies consisting of the dollar, euro, yen and pound. Chinese central bank governor Zhou Xiaochuan wants IMF to move toward creating a super-sovereign reserve currency.
Or, here’s another suggestion: Brady bonds for less-troubled economies. The idea behind bonds created in the 1980s as part of Latin America’s debt restructuring was to let investors swap their claims on nations in turmoil for tradeable instruments. A similar process may work with the dollar.
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