In one sense, China achieved what it wanted when its central bank governor posted an article on the website of People’s Bank of China (PBoC) on the need for a super-sovereign reserve currency. It has elicited a lot of attention. But attention has been mostly concentrated on whether this was a power grab by China. There has been very little informed discussion on the central theme of the paper that sovereign fiat money reserve currency creates imbalances and that its costs might exceed the benefits to the global monetary system and financial stability.
Those who think that this is a power play or power grab by China appear to show little understanding of how these things work. If China indeed wanted to challenge the dollar’s dominance with its own currency, the attempt would be far subtle. Such insinuation helps only to deflect attention from the central question. The US gets to keep the status quo due to little informed discussion on the role of its monetary, fiscal and regulatory policies that affect the world by virtue of having its currency as the global reserve currency.
According to Bare Talk, the motive behind China posting that thought on the central bank website was self-preservation. The post came a week after the US Federal Reserve took the decision to increase the size of its balance sheet by around a trillion dollars. Then, there was the Group of Twenty summit in April where China faced likely pressure on its exchange rate policies, on its export-driven growth, on the need to do more to stimulate domestic demand, so on. It wanted to pre-empt that.
The Fed policy carries a high risk of the erosion of the purchasing power of the dollar over time. PBoC holds far too much of dollars in its foreign exchange reserves. At the same time, with hot money inflows, foreign direct investment inflows and export revenues slowing, China’s power to hold up the dollar’s value through its own intervention and reserve accumulation had greatly diminished. Hence, the note was meant to persuade the US not to unilaterally debase the dollar too much too soon.
That it was not an attempt to project the yuan immediately as a dollar replacement became evident in the sometimes clumsy and sometimes conflicting defence of its high savings rate in the next paper the central bank governor wrote on China’s high savings rate. Paul Krugman did a good dissection of that note in his The New York Times column on 2 April. On Page 2 of that note, the governor said the view that inadequate social security systems led to high savings ratio lacked empirical support. On Page 4, he noted that precautionary savings rose after the reform of the 1990s because effective social security systems had not been in place!
The Los Angeles Times piece on the topic comes close to getting it right, although the article header panders to popular hysteria (“China positioning its currency for a run at world supremacy”, 3 April). China’s readiness to engage in currency swaps with other Asian nations is a smarter way of internationalizing its currency, the yuan, than any of these think-pieces. Further, any timetable for the yuan to make a realistic leap of being a global currency has to be a rather long one, since the currency is not internationally convertible and that many a hurdle stands in the way. Not the least of which is a banking system that is currently engaging in hyper-energetic lending.
Hence, all sane thinkers must now focus on the issue that the PBoC governor has raised rather than the fact that China’s central bank governor had raised it. That issue is the continued eligibility of the dollar to remain as the global reserve and transaction currency. All sovereign fiat money standards have the risk that their national priorities trump their international obligation. It happened to the European Monetary System when the German government took a political decision to reunify East Germany with a generous currency swap. Inflation shot up in Germany and the German central bank raised interest rates. The rest of Europe was suffering from the shock of the collapse of the Soviet Union, mortgage and credit boom and bust. It needed lower interest rates. The resulting policy mismatch made George Soros rich and famous.
In the case of the US, however, national interest has trumped international obligations too often. Unilateral monetary, fiscal and regulatory policy changes have unsettled other economies— small and big—far and wide. That the frequency has increased recently is no coincidence. It is an outcome of the last quarter century of accumulated economic imbalances. Indeed, the real issue is not even whether the dollar should remain the global reserve or transaction currency, but whether America is in a position to pursue macroeconomic policies that would enable it to perform that role without putting other economies through the wringer. Let the real debate begin.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org