derryl

Why We Have to Keep China Happy

Good article on the macro scene. In the early 1990s China began holding large quantities of US$ assets to back up the yuan so that China's trading partners would have faith in the value of Chinese currency. At this time China was opening up its economy to the world. Without US$ backing people thought of the yuan like the 1980s ruble, a 'worthless' currency. Nobody would sell you anything if you wanted to pay in rubles or yuan, but they would sell it for US$ or for yuan that were backed up by US$. By amassing US$ assets the Chjnese were successful in making their yuan a 'convertible' currency.

In 1944 Bretton Woods gave us the gold-dollar standard so that everyone's national currency could be converted into US$ that were backed by gold at a fixed price ($35 per ounce, if memory serves). In 1971 when Nixon found the gold standard was restraining his ability to print enough US$ to finance government expenditures (Vietnam) he ended the dollar's tie to gold and the world no longer had a formal currency exchange regime, though the US$ continued to be used as the world's 'hard money'.

With the recent attempts by the Fed and Washington to inflate the US$ money supply China is worried that the dollar, which is the 'gold' they are using to back up their yuan, is losing value. If the value of the yuan is linked to the value of the dollar vis-a-vis all other currencies, and if the dollar declines, then Chinese purchasing power declines. It will cost more yuan to buy the same basket of imported goods and China will experience price inflation. China will 'import inflation' via the yuan's link to the US$.

This is why China is advocating a new international exchange currency based on a basket of currencies rather than just the US$. They are worried that they are losing too much money (purchasing power) under the current US$ regime.

The Chinese clearly do not believe that their yuan has 'decoupled' from the US$. That is, they seem to not believe that the yuan can stand on its own, that their money will not be accepted as a currency of international exchange if it is not backed up by holdings of 'hard' assets like US$ or gold. China has recently made some bilateral currency exchange deals (Brazil, and Argentina I think) where the 2 countries agree to buy and sell in each other's currency rather than converting all transactions to US$. But apparently China shares the belief of goldbugs and other 'hard currency' advocates that the world needs a common, stable basis for everyone's money. If the US has proved too profligate to provide the world with a stable currency, then they want some other regime in place that will be stable.