Can China Do Without the U.S. Dollar?

China’s announcement overnight that it will allow companies to settle international trade claims in yuan shows how serious the Chinese authorities are about building a local currency market. Bloomberg reports,

July 2 (Bloomberg) — China will allow companies to use the yuan to settle cross-border trade and let them keep their entitlement to export tax rebates, seeking to reduce the reliance of importers and exporters on the U.S. dollar.

The People’s Bank of China will encourage banks to offer yuan settlement services from today, the bank said in the regulations published on its Web site. Transactions inside China will take place in Shanghai and four cities in southern Guangdong province, including Guangzhou and Shenzhen, while those outside China will occur in Hong Kong, Macau and the Association of Southeast Asian Nations, it said.

“It’s China’s first step to make the yuan global,” said Shi Lei, an analyst in Beijing at Bank of China Ltd., the nation’s largest foreign-currency trader. “It will protect exporters from swings in exchange rates and boost the yuan’s role in the world currency system.”

China is promoting greater use of the yuan in international trade and finance after Premier Wen Jiabao in March expressed concern that a weakening dollar will cause losses on the country’s holdings of U.S. assets. A Chinese Foreign Ministry official said today he hoped the U.S. currency would remain stable, while reiterating a call for diversification of the international monetary system.

“Companies in China and neighboring countries are facing relatively huge risks of exchange-rate fluctuations because of big swings in the U.S. dollar, the euro and other major settlement currencies,” today’s central bank statement said.

This blog has followed Chinese warnings about dollar instability. As a matter of fact, the cost of hedging dollar instability has crashed during the past few months. A rough proxy is the implied volatility in options on the PowerShares US Dollar IDX Bearish Fund (UDN):

Implied Volatility of UDN Options (Proxy for Dollar Exchange Rate Risk)

Implied volatility has fallen from nearly 40% at the end of 2008 to around 12% at present. That doesn’t look like an immediate prospect of “relative hulge risks of exchange-rate fluctuations,” as the People’s Bank of China said today.

China clearly is talking about something else. In my June 30 “Spengler” column for Asia Times Online I warned that US foreign policy and economic policy both are subject to catastrophic failure:

The last thing China wants at the moment is to undercut the US dollar, for three reasons. First, as America’s largest creditor, China has the most to lose from a dollar collapse. Second, Americans would buy fewer Chinese imports. And third, the collapse of the dollar would further erode America’s will to fulfill its superpower function, and that is what China wants least of all.

America remains the indispensable outsider in Asia. No one likes the United States, but everyone dislikes the United States less than they dislike their neighbors. India need not worry about China’s role in Pakistan, for example, because America mediates Indian-Pakistani relations, and America has no interest in a radical change to the status quo. Neither does China, for that matter, but India is less sure of that. China does not trust Japan for historical reasons that will not quickly fade, but need not worry about it because America is the guarantor of Japan’s security. The Seventh Fleet is the most disliked - and nonetheless the most welcome - entity in Asia.

All of this may change drastically, quickly, and for the worse.

If the US economy fails to recover and China has no choice but to develop its internal market, than it will have to finance the internal market in local currency and do everything possible to give it regional and perhaps global status. If other countries in the region re-orient their exports away from the US and to the Chinese (and related) internal market, they will tend to link their currencies to the yuan. This might lead to a regional currency arrangement which well might be commodity based, as I commented a month ago.

When I speculated on a regional currency, the Asian central banks had passed a milestone in regional cooperation, in the form of a creation of a $90 billion swap line for mutual currency support.

Yuan settlement of international trade is another milestone.

A few more milestones, and we will be past the point of no return.

Comments

[Larry House:]

The Chinese move in small, measured steps to reach their goals. It may take 30-50 years to change the world's reserve currency, but the USD is in decline around the world. You cannot have bad economic policies, huge debt, and a strong currency at the same time. We have chosen our path; the Chinese have chosen theirs. China is in the process of climbing up while we are sliding down.

Jul 02 12:05 PM

[nova:]

"The last thing China wants at the moment is to undercut the US dollar, for three reasons.
First, as America’s largest creditor, China has the most to lose from a dollar collapse.
Second, Americans would buy fewer Chinese imports.
And third, the collapse of the dollar would further erode America’s will to fulfill its superpower function, and that is what China wants least of all."

These all 3 points are outright foolish and a wishful thinking of America's elite:
1. Yes, indeed, China has lots to lose from a US$ collapse. But Chinese clearly understand that US$ collapse is inevitable, and it is the time to minimize and "eat their loses." Consequently, they are moving forward creating a new world geopolitical order.

2. Lately, America was a big buyer of Chinese products without paying for them. Again, China will find "better " ways to do business like buying technologies and natural resources.

3. I do not think that China "needs" America as a world superpower. Chinese are feverishly building their own military and international political alliances.

Jul 02 12:18 PM

[Mad Hedge F...:]

Not in a million years. Make that ten years. Will people pleeease stop incessantly talking about the possibility of China dropping the dollar as a reserve currency? What else are they going to use? Monopoly money? Taiwanese dollars? Collectable postage stamps? At nearly $2 trillion, the Middle Kingdom’s reserves are so enormous that no other currency in the world could accommodate the switch, and no other security offers the necessary depth and liquidity but Treasury bills. Chinese attempts to buy anything in size causes its price to immediately skyrocket, such as we saw in the relatively Lilliputian commodity markets last year. And really, how like is it that China embarks on policies that quickly halve the earnings of the country’s exporters, as well as its 30 year hoard of accumulated savings? The demise of the dollar has been predicted more often than the ditching of Microsoft’s Windows as the global PC operating system, and is just as likely. Hate the greenback as much as you like, but there just isn’t any other alternative. I have been hearing these arguments ever since the US went off the gold standard in 1973. First there was a perennial Arab threat to price crude in a basket of currencies. Gee, they never seem to complain when the buck is going up. Then there was the speculated emergence of the “Yen Block”, in the eighties, back when Japan was dominating international trade and the yen was bumping up against ¥80 to the dollar. Remember the book “Japan as Number One? Ha! Double Ha! Then we got all that European whining after the launch of the euro when the weak dollar was everyone’s one way trade. Let’s face it, Europeans hate using someone else’s currency as the primary reserve instrument. Before the dollar, sterling was in widespread use and was equally despised. So rather than waste time discussing this issue anymore, let’s talk about something more important, like which of those two flies over there will jump off the wall first.

Jul 02 12:24 PM

[nova:]

Larry House wrote:
"The Chinese move in small, measured steps to reach their goals.
It may take 30-50 years to change the world's reserve currency".

It is a very wishful thinking. I would say: 3-5 years are more realistic.

Jul 02 12:26 PM

[dybydx:]

hmm...... this is actually a pretty big move. i like to see where this goes 1yr from today.

Jul 02 01:35 PM

[Spook:]

Few months ago, this thoughts and statement is correct, but as the economic crisis evolves, the global trade and policies develop forward, the rule and thinking will have change by now.

Putting oneself in the shoe of Chinese policy maker, you would have realize the 3 points indicated below, by now you will have already develop an alternate policy to minimize the loss and impact.

If the article I read weeks ago that the Chinese sold some of the US debt, the trend will indicate that the Chinese is reducing their exposure, but moving at snail pace to avoid market panic, it will probably take years for the Chinese to reduce their US debt holding, .


> "The last thing China wants at the moment is to undercut the US dollar,
> for three reasons.
> First, as America’s largest creditor, China has the most to lose
> from a dollar collapse.
> Second, Americans would buy fewer Chinese imports.
> And third, the collapse of the dollar would further erode America’s
> will to fulfill its superpower function, and that is what China wants
> least of all."
>
> These all 3 points are outright foolish and a wishful thinking of
> America's elite:
> 1. Yes, indeed, China has lots to lose from a US$ collapse. But Chinese
> clearly understand that US$ collapse is inevitable, and it is the
> time to minimize and "eat their loses." Consequently, they are moving
> forward creating a new world geopolitical order.
>
> 2. Lately, America was a big buyer of Chinese products without paying
> for them. Again, China will find "better " ways to do business like
> buying technologies and natural resources.
>
> 3. I do not think that China "needs" America as a world superpower.
> Chinese are feverishly building their own military and international
> political alliances.

Jul 02 06:39 PM

[Simon Smelt:]

If you were right and there is no possible alternative to the U.S. $, then America should stop worrrying and just keep borrowing until the economy comes right. 'Cos nobody has any choice but to accept the US.
But back in the real world, the main actors balance and re-assess their risks all the time. The US has extracted probably near the max from reserve currency status and is now clearly having to adapt its policies to keep its creditors content. Meantime, China is demonstrating that it is exploring many alternatives to the US $ both as store of value and means of exchange. The main protection for the U.S. is that China's elite does very well out of current export arrangements and would be threatened by any big shifts. So, U.S. survival depends on the present regime in Beijing. A more radical regime might decide to enrich its own people (China's phenomenal growth has offered only crumbs to most households) and boost domestic demand rather than export capacity or take the loss on its U.S. savings in order to achieve world domination through collapsing the U.S. economy. Meantime, what were the options of the U.S. government again? Punish China by withholding all those shiny new $$ that China so needs??

On Jul 02 12:24 PM Mad Hedge Fund Trader wrote:

> Not in a million years. Make that ten years. Will people pleeease
> stop incessantly talking about the possibility of China dropping
> the dollar as a reserve currency? What else are they going to use?
> Monopoly money? Taiwanese dollars? Collectable postage stamps? At
> nearly $2 trillion, the Middle Kingdom’s reserves are so enormous
> that no other currency in the world could accommodate the switch,
> and no other security offers the necessary depth and liquidity but
> Treasury bills. Chinese attempts to buy anything in size causes its
> price to immediately skyrocket, such as we saw in the relatively
> Lilliputian commodity markets last year. And really, how like is
> it that China embarks on policies that quickly halve the earnings
> of the country’s exporters, as well as its 30 year hoard of accumulated
> savings? The demise of the dollar has been predicted more often than
> the ditching of Microsoft’s Windows as the global PC operating system,
> and is just as likely. Hate the greenback as much as you like, but
> there just isn’t any other alternative. I have been hearing these
> arguments ever since the US went off the gold standard in 1973. First
> there was a perennial Arab threat to price crude in a basket of currencies.
> Gee, they never seem to complain when the buck is going up. Then
> there was the speculated emergence of the “Yen Block”, in the eighties,
> back when Japan was dominating international trade and the yen was
> bumping up against ¥80 to the dollar. Remember the book “Japan as
> Number One? Ha! Double Ha! Then we got all that European whining
> after the launch of the euro when the weak dollar was everyone’s
> one way trade. Let’s face it, Europeans hate using someone else’s
> currency as the primary reserve instrument. Before the dollar, sterling
> was in widespread use and was equally despised. So rather than waste
> time discussing this issue anymore, let’s talk about something more
> important, like which of those two flies over there will jump off
> the wall first.

Jul 03 12:20 AM

[TeresaE:]

That is only because they have ALREADY been working for the past 30 years.

Nixon started it and Clinton threw open the barn doors.

China is only waiting for our inevitable crash.

Then, Warren Buffett's predictions will be true: our children will be sharecroppers forced to pay taxes to both the US fed and China.


On Jul 02 12:26 PM nova wrote:

> Larry House wrote:
> "The Chinese move in small, measured steps to reach their goals.
>
> It may take 30-50 years to change the world's reserve currency".
>
>
> It is a very wishful thinking. I would say: 3-5 years are more realistic.

Jul 03 09:29 AM

[TeresaE:]

China will smash us, sooner rather than later.

There middle class is TWICE the size of our ENTIRE population.

Under the "experts" noses, China has already been revalueing the yuan and quietly upping the cost of many of the things we import.

No one has noticed, but I sure as hell have.

Once China decides the day has come, look for our cheap socks to skyrocket and medicine and food to become unaffordable.

And, since our government has spent the past couple decades doing nothing but putting up obstacles to the American small business success, we are going to collapse completely.

Good luck to us all, especially those of us who still believe we are the "richest country on earth.".

We ain't, China is.

Jul 03 09:32 AM

[lazzybum:]

China's internal demand will eventually replaces the export based system. The trouble is that the huge internal demand will also push up the cost of commondity. It will also push up the China's labor cost. There will be less demand wroldwide for China's expensive goods. I welcome this development. US manufacturers will finally have a chance to compete. Americans' service based economy will be balanced with manufacturing industries. It means our grandchildren will have jobs. There is no need for US to play world cop, and world banker. All we have to do is to mind our own business. Our children and grandchildren will not risk their lifes to save the world. Let the rest of the world to fight it out.

Jul 03 01:21 PM

[Mono:]

already mentioned once...good to see your writing and sharp wit again


On Jul 03 03:28 PM Freya wrote:

> TeresaE: Ignorance is Not bliss. The Yuan varies within an approximate
> range of +/- 2% of the USD. Thats the range it has been in for the
> Past Year or so.
>
> The USD has dropped recently from 89-90 to 79-80, the Yuan has maintained
> its range. Since Chinese exports have dropped some 30% on a year
> to year basis, what you are probably experiencing are shortages of
> once plentiful products.
>
> The US wanted them to concentrate on developing Internal Consumer
> demand, they are doing exactly as requested.
>
> Exports will continue to suffer. Get used to it.

Jul 03 03:43 PM

[Peter Stenwick:]

Ha! Spoken like a true Chinaman. ;) Never paid for products? What PRC lies are those? FACT: Over 60% of EVERYTHING made in China is for other nations! You don't own any of it! So when U.S and European companies pull out of China and don't have anything made there anymore...let's see how great you think China will do then. The China MYTH is coming out in the open now....and your corrupt government knows this and is trying to do what they can before it's too late. Read a book: "Poorly Made in China."


On Jul 02 12:18 PM nova wrote:

> "The last thing China wants at the moment is to undercut the US dollar,
> for three reasons.
> First, as America’s largest creditor, China has the most to lose
> from a dollar collapse.
> Second, Americans would buy fewer Chinese imports.
> And third, the collapse of the dollar would further erode America’s
> will to fulfill its superpower function, and that is what China wants
> least of all."
>
> These all 3 points are outright foolish and a wishful thinking of
> America's elite:
> 1. Yes, indeed, China has lots to lose from a US$ collapse. But Chinese
> clearly understand that US$ collapse is inevitable, and it is the
> time to minimize and "eat their loses." Consequently, they are moving
> forward creating a new world geopolitical order.
>
> 2. Lately, America was a big buyer of Chinese products without paying
> for them. Again, China will find "better " ways to do business like
> buying technologies and natural resources.
>
> 3. I do not think that China "needs" America as a world superpower.
> Chinese are feverishly building their own military and international
> political alliances.

Jul 03 10:48 PM

[harammph:]

Mr. Stenwick: when the Americans and Europeans pull out of China, will they dismantle their Factories and bring them out also?

Jul 04 03:24 AM

[odin:]

China extending credit is not the most critical thing to the strength of the US$. The respective strengths of the global and the US economies are what matter (and the Chinese economy, while growing rapidly, is still not significant portion of the global economy). Furthermore in a trade collapse (the environment prevalent at the moment), the export dependent, surplus nations suffer much more than any other nation.

The US does not "need" China to fund its fiscal deficit. By definition, if by any mechanism trade collapses (US buying fewer Chinese goods and China not buying treasuries), the US currents accounts deficit will shrink (with some minor assumptions about investment flows). As for funding the fiscal deficit, the increase in saving rates in the US will fund it, granted perhaps at higher rates.

China buying or selling treasuries over the long run I think will have minimal impact on the US$ relative to other currencies.

Looking at the +ve and -ve marks, its amazing to me how entrenched the $-bears are (undoubtedly political biases come into play here) and how unpopular the $-defenders are. But I draw strength from Ibsen: the majority is always wrong! (Yes, I am aware of the rest of the quote).

Jul 04 09:39 AM

[whidbey:]

Great question, but the answer is not here yet. We know how we got here, but we can not see whether China wants a reserve currency to manage. It is not a one way choice. Frankly China can not yet manage a reserve currency, and such a unit will have less value to them than the US. The credibility to manage a reserve currency is earned from the costs and benefits it confers . That does not mean the US should have a reserve currency, it means we cannot dump the status easily or with no cost to our economy. I would guess the US wins by default for the next five - seven years, then the inflation bites hard and dropping the dollar will be absolutely required. Poverty is such an embarrassment.

Jul 04 05:14 PM

[lazzybum:]

Poverty is not an embrassment. It is how we become poor that is embrassing. USA will be poorer relative to the other countries. However, I doubt USA will stay poor. As other countries' cost of living continue to rise, our competitiveness will pull us out of this so called emprassment.

Jul 04 08:13 PM

[coreopsis:]

A perfect example of incoherent, badly spelt thinking (can't Americans be literate? why are they so lazzy?)...Whining about being 'only' reflects the poverty of the American mind.


On Jul 04 08:13 PM lazzybum wrote:

> Poverty is not an embrassment. It is how we become poor that is embrassing.
> USA will be poorer relative to the other countries. However, I doubt
> USA will stay poor. As other countries' cost of living continue to
> rise, our competitiveness will pull us out of this so called emprassment.

Jul 04 11:07 PM

[Spook:]

Even if commodity price increases and cost of living and living standard in China go up, US wages will still be more expensive than China.

Also with much of the high volume manufacturing base already in China, Vietnam, India, Mexico, the only manufacturing in US will be the low volume, niche or for US consumption only.


> China's internal demand will eventually replaces the export based
> system. The trouble is that the huge internal demand will also push
> up the cost of commondity. It will also push up the China's labor
> cost. There will be less demand wroldwide for China's expensive goods.
> I welcome this development. US manufacturers will finally have a
> chance to compete. Americans' service based economy will be balanced
> with manufacturing industries. It means our grandchildren will have
> jobs. There is no need for US to play world cop, and world banker.
> All we have to do is to mind our own business. Our children and grandchildren
> will not risk their lifes to save the world. Let the rest of the
> world to fight it out.

Jul 09 05:54 AM

[Spook:]

Economic landscape have change lately, Taiwan just open up trade with China after 60 years of ban, guess what? Chinese buyer are already all over the island on buying spree, not for re-export, but for local consumption in China.


> Ha! Spoken like a true Chinaman. ;) Never paid for products?
> What PRC lies are those? FACT: Over 60% of EVERYTHING made in China
> is for other nations! You don't own any of it! So when U.S and
> European companies pull out of China and don't have anything made
> there anymore...let's see how great you think China will do then.
> The China MYTH is coming out in the open now....and your corrupt
> government knows this and is trying to do what they can before it's
> too late. Read a book: "Poorly Made in China."

Jul 09 05:58 AM