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China Ups the Ante

Posted by Larry Doyle on March 23, 2009 11:12 PM |

In ten days, the leaders of the G-20 will meet for the most highly anticipated financial conference since Bretton Woods in 1944. In a bold and aggressive move prior to this conference, China’s central bank called today for the replacement of the U.S. dollar as the international reserve currency. 

I have written about the tension in U.S.-Chinese relations over the last few months. The essence of this tension is captured in the Prisoner’s Dilemma and A Question of Honor.

Make no mistake: the timing, tone, and substance of this message so close to the start of the G-20 is another major shot across our bow. The ramifications for a change in this international reserve currency are enormous, both politically and economically. Check out current, worthwhile discussions on this topic collected from a variety of sources at Memeorandum.com. In addition, I recommend reading the following article from the Financial Times:

China calls for new reserve currency
By Jamil Anderlini in Beijing
Published: March 23 2009 12:16 | Last updated: March 24 2009 00:06 

China’s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund.

In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.

Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China.

“This is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money,” said Qu Hongbin, chief China economist for HSBC.

Although Mr Zhou did not mention the US dollar, the essay gave a pointed critique of the current dollar-dominated monetary system.

“The outbreak of the [current] crisis and its spillover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system,” Mr Zhou wrote.

China has little choice but to hold the bulk of its $2,000bn of foreign exchange reserves in US dollars, and this is unlikely to change in the near future.

To replace the current system, Mr Zhou suggested expanding the role of special drawing rights, which were introduced by the IMF in 1969 to support the Bretton Woods fixed exchange rate regime but became less relevant once that collapsed in the 1970s.

Today, the value of SDRs is based on a basket of four currencies – the US dollar, yen, euro and sterling – and they are used largely as a unit of account by the IMF and some other international organisations.

China’s proposal would expand the basket of currencies forming the basis of SDR valuation to all major economies and set up a settlement system between SDRs and other currencies so they could be used in international trade and financial transactions.

Countries would entrust a portion of their SDR reserves to the IMF to manage collectively on their behalf and SDRs would gradually replace existing reserve currencies.

Mr Zhou said the proposal would require “extraordinary political vision and courage” and acknowledged a debt to John Maynard Keynes, who made a similar suggestion in the 1940s.

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  • TeakWoodKite

    The concepts are not with historical precedent,
    yet the IMF is already a dodo bird who has
    an albatross for a friend.

    Yet i can imagine what the Romans might have felt.
    Currencies of the realm come and go as do nations.

    Will this nation be any different? I wonder who gets to be chairman of the board in this senerio.
    That fool Wolfawitz we sent to the IMF,
    started this mess. As I recall, during this time many nations were pining to remove us as CEO and change denominations, because they understood one basic truth.
    Nations such as China who carried the greatest burden of our debt had no direct control.
    There is a price to pay coming very soon. When all those dollars flowed into Japanese yen, a ways back, the US was on a runaway treadmill.

    Even if the market was on cloud nine by next year, the fundamentals are yesterdays recycled shattered dreams.

  • fiscalliberal

    A lot of people have been alerting us that China has been viewing us with concern. How can they be any different than a lot of us who view us with concern.

    I recall that China had converted 2 Billion of Fannie and Freddie paper to short term Treasuries. Two weeks later Fannie and Freddie were under Conservatorship. They still have 4 Billion in Fannie and Freddie.

    Lehman and AIG are the poster children of the inept and corrupt finacial system we have. I support that statement with: bad underwriting of real estate loans, corrupt rating agencies, investment banks selling toxic securities to the world, investment banks hiding their positions off the books, overleveraging and convincing our corrupt government officials to bail them out. Our financial system is composed of momma’ people who have never been told no.

    China and a lot of us see a government not willing to step in to take over the banks and clear the mess out. In short the money changers are still in the temple. While the latest Geitner plan might be the best option in view of a reticent government, it still is a bail out in terms of the bank not being able to clean up their mess with out government backing. How can anyone call this capitalism. The concept of risk managemtn is a joke.

    Our only hope is that we have people like Sheila Bair, Elizabeth Warren and Meideth Whitney to call things like they are.

    Furthermore lets stop calling these Harvard MBA’s the best and the brightest. I think the term inept greedy managers or manipulative crooks might be more appropriate.

    May I suggest we need to follow Merideth Whitneys advice and put our CD’s in small banks. Pull our Credit cards from Citi, get out of Bank of America, transfer 401k’s from funds that use Blackrock (Merrill) to manage them. If the government will not disable them, we as individuals can. Simply take away our money and use people who are prudent.






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