China Tries to Solve Its Dollar Problem 14 comments
Boris Sobolev
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A huge portion of Chinese national wealth is currently held in the US dollars (US government, agency and corporate debt). There are $6.5 trillion of currency reserves in the world today. $4.3 trillion is held in the US dollars and 34% of US dollar holdings, $1.43 trillion, belong to China.
A decline in the US dollar exchange rate is extremely undesirable for the Chinese – the biggest holder of US debt in the world. Nevertheless, over the past few months, China repeatedly attacked the status of the USD as the world reserve currency.
China’s proposal to use IMF’s Special Drawing Rights (SDRs) to replace the USD as the world reserve currency is supported by India, Brazil, Russia and even France, but for many reasons cannot be put in place any time soon. The Chinese are likely to recognize this as well.
First, it is important to understand what the Chinese are trying to accomplish by backing SDRs. The main goal of the international/financial policy of China is to decrease the US dollar’s importance in world trade while maintaining the USD’s value and stability. This is a logical goal given the decrease in the United States’ share of global output over the past decade.
click to enlarge
If accomplished without any major shocks to the global economy (an ideal scenario), China will become less dependent on the greenback.
The Chinese are trying to accomplish its goal in three ways:
- China is trying to raise renminbi’s weight in international trade by signing bilateral currency swap agreements. As of today, this has been accomplished or is being negotiated with all countries of the ASEAN, Russia, Brazil, Argentina and others. China’s goal is to settle 30% to 40% of all trade in renminbi in the next three years. This will help replace $1-2 trillion dollars in world trade.
- The next priority for China’s economic policy is the reduction of its dependence on the US dollar exchange rate when purchasing natural resources. China is already investing a large portion of its surplus dollars into strategic reserves of natural resources, into the development of resource-rich areas in the under-developed world as well as into resource and energy companies.
- The Chinese government understands that the key to strengthening their national economy is to increase the share of consumption in China’s GDP. Today, China is a third world economy by size but its consumption per capita ranks only 132nd. Targeted stimulation of a huge internal market for China’s goods is the most important but also the most difficult goal for China today. At first look, consumption per capita growth of 8.9% year-over-year is quite impressive. But in the context of a tremendous explosion of new credit happening in the country today, such a level of growth may not be sustainable.
Only by successful navigation through all three challenges listed above will China be able to eliminate its dependence on the dollar and begin to make renminbi a freely convertible major world currency in the next ten years.
The dollar trap is a huge problem for China and no quick resolution is possible. As a result, China has a vested interest in the stability of the US dollar exchange rate for many years to come.
As far as the hypotheses about the multi-fold increase of gold’s share in China’s monetary reserves – while they may be correct – the process is likely to take a very long time. China, like any other major economy, is not interested in seeing gold prices increase and will make significant purchases only when large quantities are available for sale from other central banks. China is unlikely to buy gold in the open market unless gold falls significantly from current levels – providing a safety net for gold investors.
For years ahead, fuel for the precious metals bull market will continue to come from private investment demand which promises to rise sharply. A new wave of inflation in the coming years is inevitable.
This is an excerpt from the RSG Newsletter dated August 1, 2009.
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This article has 14 comments:
Consequently, the first step in shedding dollar dependece for the Chinese may be to focus on non -dollar clearing of grain, rice, soy beans etc trade : this in effect means much closer bilateral ties with Brazil,maybe Argentina, and a few selected nations in Africa and South Asia.
The second step could be non-dollar clearing of some porton of oil, LNG ,coal and uranium trade via extra-market, bilateral deals and large investments in parts of Central Asia, Latin America, Russia and a couple of African nations.
The 3rd step, if steps 1 and 2 are fruitful would be to extend the model to a few key mineral resources, notably copper(Chile is a candidate), again Brazil and selectively with Indian and Australian entities
There is no need for an abrupt or massive shift from the dollar, which cannot be executed successfully. However, a layered, incremental, national priority driven, strategy implemented with carefully selected commodities and trading partners/investment opportunities can work. This kind of patient, disciplined, focussed, strategy the Chinese, indeed many Asian nations, are good at.
2. Force feeding liquidity into the domestic market may create a brief (and inevitably painful) consumption/stock market bubble in China:it will not lead to a structural transformation from a producer-centric, high savings, export driven economy. That trasformation requires substantially greater per capita purchasing power for the Chinese people, a culture of consumer choice and above all much gretaer consumer confidence about health care, retirement, education and property rights. The very high savings rate reflects an almost complete lack of consumer confidence in Govt promises in these vital areas.
A consumer society needs not only much more discretionary consumer income but greater freedom of choice in many decisions and reliable, replicable, property rights The biggest impediment to an internal demand driven, sustainable consumer centric socity in China, is the Chinese Communist Govt itself.
Though I have not studied the structure of China's trade with each of the six, I suspect the typical model is China imports essential commodities and exports value-added manufactured goods. The swaps are ideal where the trade is balanced.
To me it's not clear what China's long-term currency goal is; I'm inclined to view the current swap agreements as a means of simply reducing the risk of accumulating additional dollars.....as opposed to positioning the renminbi as a reserve currency.
Until China makes a number of transformational changes, it will want to manage the convertibility of the renminbi which, along with other factors, will limit it as a potential reserve currency.
It is unusual if a top-down dictatorship like China were to successfully increase freedom to citizens to increase consumerism. They save so much because they know that a government with total power is arbitrary and untrustworthy (user 535732).
We are heading to state socialism and failure by the elites seems to gain them even more power. Our rights in the Constitution have been our greatest asset but power vested in the people is inconvenient and messy and is being ignored by the people and attacked by our leaders.
When the Chinese buy with US dollars commodities and natural resource companies all over the world. Then these US dollars have to come back to USA one way or another. Which means that people in those resource countries will convert their US dollars into their own currencies and make their currencies go up relative to the US dollar.
Instead of making its own currency go up relative to the US dollar, China is making the currencies of natural resource countries go up relative to the US dollar. Which makes commodities more expensive to buy for every country whose currency is tied to the US dollar. And this includes a lot of countries, including USA and China itself.
Basically, this spending of US dollars leads to inflation of prices in US dollars.
The only realistic way China can solve its dollar problem is let its currency appreciate relative to the US dollar. Which would increase US exports to China and thus let USA repay its debts to China over time.
But such a solution would put China at a big disadvantage not just relative to USA but relative to much of the rest of the world. Because with lower US dollar, USA would compete with China for export markets everywhere.
Have you looked recently, China is hardly a "Communistic" society, Rice paddy farmers are watching their stocks on LCD displays at the town square. I visit third world countries on a regular basis...what I see, not only Chinese products on every market level...Chinese cars are being displayed and sold in Mexico's department stores....with in-house financing. Then, look around the small Chinese merchants, rice kitchens, market stalls, are everywhere...most are so new to the respective country they can not even speak the local language beyond the concept of money exchange and inventory. These Chinks are new arrivals and they are everywhere and more on the way. China is an Oligarchy and with some pretty smart people at the top. USA, your children need to become proficient in Mandarin, Spanish, and whatever it is the Nigerians and other African emmigrants speak....look around.
On Aug 03 11:13 AM djj420 wrote:
> Buy what the US is buying (banks, autos) for a trade, and keep watching
> the tape for a reversal. Buy what China is buying and put it away
> for years.
It is sensible for her to rebalance her foreign reserve holding, but ultimately the value of the Yuan is the true prize. If the Yuan goes up against the dollar then China is richer.
So, what is the problem. Well the problem is that China is still to a degree dependent on exports to the US. They have no desire to create a hiatus in trade. But be realistic, going forward how much of the market is the US going to represent anyway? China might want to sell but she hardly wants to give stuff away. As with all situations, eventually the time comes when it makes more sense to simply walk away.
Think hard about such realities.
On Aug 03 08:43 AM Leftfield wrote:
> Bilateral agreements make complete sense and are the easiest step
> away from the dollar. But to make a successful consumer society has
> been the purview of the once-free-enterprise societies in the West.
>
> It is unusual if a top-down dictatorship like China were to successfully
> increase freedom to citizens to increase consumerism. They save so
> much because they know that a government with total power is arbitrary
> and untrustworthy (user 535732).
> We are heading to state socialism and failure by the elites seems
> to gain them even more power. Our rights in the Constitution have
> been our greatest asset but power vested in the people is inconvenient
> and messy and is being ignored by the people and attacked by our
> leaders.
Both now have FTA with China. Peru has old Chinese connections which the Peruvian goverment is now trying to leverage. They are also geographically well positioned as a hub for Chinese trade and investment activities in South America.
On Aug 03 05:53 AM User 353732 wrote:
> The 3rd step, if steps 1 and 2 are fruitful would be to extend the
> model to a few key mineral resources, notably copper(Chile is a candidate),
> again Brazil and selectively with Indian and Australian entities
> FYI. A Pew research poll in early 2008 showed that over 80% of Chinese
> trust their goverment vs. only some 20% of American toward the Bush
> goverment.
>
> Think hard about such realities.
Add to this:
Our freedom of expression and the press, (such as it is) vs. the Chinese equivalent
Our current +10% (?) unemployment vs. Chinese +40% unemployment
It makes me wonder if there’s a difference in the word “trust” as it’s used in Pew’s research. I would certainly trust the Chinese government to respond if a citizen were to express anything less than complimentary about “their” government.
Maybe I’m thinking too hard about such realities.
Sorry, that last comment is a joke courtesy of D. E. Everage.
> ".....The biggest impediment to an internal demand driven, sustainable
> consumer centric socity in China, is the Chinese Communist Govt itself."...
The net effect is the same as you stated, it drives down the USDollar/Aussie pair. As the US Dollar drops in relation to a global basket of currencies, it also drops slightly with respect to the Renimibi. China doesn't want the dollar to drop
On Aug 03 09:19 AM Nick36 wrote:
> The only realistic way China can solve its dollar problem is by unloading
> it onto someone else. And even then China doesn't escape this problem
> altogether.
>
> When the Chinese buy with US dollars commodities and natural resource
> companies all over the world. Then these US dollars have to come
> back to USA one way or another. Which means that people in those
> resource countries will convert their US dollars into their own currencies
> and make their currencies go up relative to the US dollar.
>
> Instead of making its own currency go up relative to the US dollar,
> China is making the currencies of natural resource countries go up
> relative to the US dollar. Which makes commodities more expensive
> to buy for every country whose currency is tied to the US dollar.
> And this includes a lot of countries, including USA and China itself.
>
>
> Basically, this spending of US dollars leads to inflation of prices
> in US dollars.
>
> The only realistic way China can solve its dollar problem is let
> its currency appreciate relative to the US dollar. Which would increase
> US exports to China and thus let USA repay its debts to China over
> time.
>
> But such a solution would put China at a big disadvantage not just
> relative to USA but relative to much of the rest of the world. Because
> with lower US dollar, USA would compete with China for export markets
> everywhere.
I agree that this approach is exactly what China is trying to accomplish in the long run, since the Chinese have time and spend it wisely. Remember they plan in generations, not like the West that plans until the next election. Good article and comments.