U.S. Dollar: Still No Good Alternative

From an earlier post, point 4:

“We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.” [emphasis mine]

So said Mr. Luo, a director-general at the China Banking Regulatory Commission. I’ve been saying for a long time that China is stuck, and that we are their problem, and not vice-versa. There may come a point where they stop buying US Dollar-denominated debt, and let existing debt mature, but that will come after a shift in their own economy where they are no longer driven bythe promotion of their exports. There aren’t many large good alternatives to US debt for parking the proceeds from exporting aggressively.

So Wednesday, we get another volley from China as they realize that they are stuck holding US Dollar denominated assets that they are more certain than ever will depreciate. They see injustice in having bought too many dollars in exchange for the exports they paid to promote to the US. Excerpting from the article:

People’s Bank of China Governor Zhou Xiaochuan said he wants to replace the dollar, installed as the reserve currencyWorld War II, with a different standard run by the International Monetary Fund (IMF).

China, the top holder of US Treasury bonds with 739.6 billion dollars as of January, according to American figures, earlier expressed concern over its investment as the world’s largest economy battles a deep recession.

“The outbreak of the crisis and its spillover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system,” Zhou wrote in an essay posted on the bank’s website Monday.

Zhou’s comments come ahead of the G20 summit from April 2 in London, where world leaders and international organizations including the IMF are to discuss reforming the financial system.

He suggested the IMF’s Special Drawing Rights, or SDR, could serve as a super-sovereign reserve currency as it would not be easily influenced by the policies of individual countries.

Russia has also proposed the summit discuss creating a supranational reserve currency. The IMF created the SDR as an international reserve asset in 1969, but it is only used by governments and international institutions.

“The reform should be guided by a grand vision and start with specific deliverables,” Zhou wrote. “It should be a gradual process that yields win-win results for all.”

However, China’s proposal was unlikely to lead anywhere because the SDR is not a currency system backed up by a government, independent Shanghai-based economist Andy Xie said.

Xie said the proposal was probably a protest aimed at Washington’s plan to buy one trillion dollars of its own debt, diluting the value of China’s dollar reserves and raising fears of inflation.

“It’s a sad situation: China is America’s banker. America owes so much to China, but it’s not afraid of China,” he said. “China is America’s hostage. It’s not the other way around.” [emphasis mine]

As the world’s main reserve currency, US dollars account for most governments’ foreign exchange reserves and are used to set international market prices for oil, gold and other currencies.

As the issuer of the reserve currency, the US pays less for products and borrows more easily.

Strategic Drawing Rights are a cute idea, but it would be too small to support global trade. Like the Euro, it is a political construct, but one with less dedicated political and economic support.

As I commented in my piece, It is Good to be the World’s Reserve Currency, there’s no good alternative to the US Dollar yet. Like the mercantilists of old, who bought gold dear, and sold it cheaply, so will it be for China — they bought US Dollar claims dear, but will sell them more cheaply. This is the price of forced industrialization.

There will come a time when the US Dollar is no longer the world’s reserve currency, but there needs to be a worthy competitor, or a willingness to do without a single clearing unit. This is an age of computers, so there does not need to be a single dominant unit of exchange, but habits die hard. It will probably take some disaster to dislodge the US Dollar, and force the changeover. Whether that comes through inflation, default, partial default, or war remains to be seen.

Comments

[Prudent Man...:]

Wow! Talk about contradicting oneself. I don't believe many people, even those irresponsible government bureaucrats, will buy an asset they know is going to decline in value. The arrogance of thinking otherwise will have a terrible cost. What makes anyone believe that China or any other country will have the ability, let alone the will, to continue to buy our currency at anything but at a lower price or debt at a higher yield.

The continuing thinking that the U.S. has a monopoly on creativity is what has gotten us where we are economically. If one is hanging by a string they shouldn't aggravate the person with a knife.

Mar 25 01:12 PM

[ThinkRight:]

It works both ways.

1. Many currencies specially for emerging region lost their value against dollar in last decade or so, even after we factor in devaluation of dollar (within reasonable limit). No body can tell those countries are faired better by holding dollar reserves instead of their native currencies and reap additional benefit of diversification and risk mitigation.

2. In case of china, their US dollar reserves and their export business that help build those reserves are two sides of same coin. No body can tell where china would have been today without those exports and dollar rserves.

Mar 25 02:21 PM

[Dave Wrixon:]

Bubbles burst just when everyone thinks they cannot.

The dollar will fold very soon, unless somebody manages to legislate against the Force of Gravity.

Both the UK and the US are now struggling to sell government debt. When doubt turns to fear the dollar will get dumped like a hot rock.

Mar 25 04:44 PM

[Vuke:]

What the Chinese lose on a depreciating dollar they will gain back in spades by expanding their manufacturing base. Losing paper is a small price to pay in return for control of markets....especially true when the paper is diminishing in value.

That lesson appears to be coming clear to the Big Three automakers. The last laugh appears to be on us.

Mar 25 06:08 PM

[jstratt:]

Since China holds 740 billion of US Treasury Bonds I think we should help them out. I hereby propose that we create the CARP (China Asset Recovery Plan) and buy our debt back from them.

All kidding aside 740 billion isnt all that much in the world economy. It is about 5% of our GDP if I remember correctly?

PS My other proposal is to provide better nutrition for the Chinese people and sell them Catfish for CARP

Mar 25 07:57 PM

[zanardm:]

Another currency for America?

An alternative to another world reserve currency, or in addition, would be to introduce a competitive currency for our debased D.C. dollar.
Is the Fed just debasing the currency? Is it time for dual currencies here in America? Perhaps a Fed Reserve West in the heartland, with a N.A. dollar (North American dollar), with tight bank management controls, good IT team, and transparency and accountability, especially when temptation (creating money) is at the door or window. Start the 2 currencies at par. Then let all Americans decide what currency they prefer in transactions, both personal and for business accounting. A more limited supply increases the value of any commodity, including a currency; hence protecting the value of a currency. There is too much money out there idling already; more geenbacks by the Fed is not the solution; too much debt is the problem. Debt city or deleveraging city (D.C.) what's the call - America?

Mar 26 12:33 AM

[dybydx:]

i dont think there needs to be a competitor for the USD. as long as the US fiscal policy continue to be reckless as it had been, foreign investors will simply turn away to reduce exposure. if no other single currency can replace that role, they will simply hold a basket of it. and voila, you now hold the SDR.

Mar 26 11:54 AM