In case you (like me) missed this story because it was buried between pages of bullish commentary from Geithner-lovers, it turns out China is still worried about the dollar. Didn’t anyone tell China that was yesterday’s news?
The People’s Bank of China posted an essay on its website suggesting the world adopt a new 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”.
Is there any doubt that China is concerned about the US de-basing its currency? Rightly so.
Currently, there is little China can do since dumping US assets would harm Chinese exports as much as it would hurt US interest rates and the dollar. Instead, China has stepped up to the global stage and is initiating critical steps to lead to a more stable monetary system. This was unimaginable just a few years ago. The global trade winds are shifting.
In an arrangement that would rival the scale of Bretton Woods fixed exchange rate regime, China is suggesting that SDRs (Special Drawing Rights), which are now based on a basket of four currencies (the USD, Yen, Euro and Sterling), be broadened to reflect the value of all major currencies.
Essentially, instead of buying USDs or US Treasuries, central banks would hold the broadly-diversified SDRs or SDR-denominated debt on their balance sheets as reserves. The new broader SDR valuation basis would help shelter central bank reserves from exposure to depreciating currencies (often due to monetary mismanagement).
This would change the rules of cross-border financing for governments around the world. Governments that lacked monetary credibility (basically the US, UK, Japan…and any developing nation) would likely be forced to issue SDR denominated debt, internalizing the costs from domestic currency depreciation (since they must convert domestic currency to SDRs to service debt). As with the Asian countries of the 1990s, this effectively transfers currency risk from the debt purchaser to the debt issuer.
Bottom line: China wants to transfer currency risk back to the US government. This is a bold assertion of China’s growing stature in the global financial community.
