Almost 65 years ago, the US treasury secretary had some big news for President Roosevelt. “England is broke,” Henry Morgenthau told a shocked FDR. “I had no idea” replied the president. “I will go over there, make a couple of talks and take over the British Empire.”
Instead, a conference was held in Bretton Woods that ended the British pound’s ascendancy as the world’s reserve currency. In its place: the US dollar.
Nowadays its California that looks pretty broke; and the federal government doesn’t look much better. Indeed, it’s America that is the debtor nation. And its major creditor is a rising China, which holds $768 billion of US Treasury bonds.
And it is China’s leaders that are discussing America’s parlous finances. Indeed, in a not dissimilar vein to FDR and Morgenthau, they are shocked. Premier Wen Jiabao aired his concerns in March. “We lent such huge amounts to the United States, and of course, we’re concerned about the security of our assets,” said the prime minister. “And to speak truthfully, I am worried.”
China’s anxiety has also sparked debate about the dollar’s future.
So is the world about to get a new reserve currency?
Up until the 1930s sterling’s role as the world’s reserve currency had been as enduring as a Burberry raincoat. But despite a century at the top, its demise was a swift one.
The dollar too has had a good run.
But recently its status has been questioned, including by China’s central bank governor. In an article published on the Peoples Bank of China’s website, Zhou Xiaochuan argued that the dollar should be replaced by “an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run.” He suggested that the IMF’s own SDRs (special drawing rights) have “the potential to act as a super-sovereign currency.”
At the end of March, Zhou’s proposal was endorsed by Joseph Stiglitz, a Nobel Laureate and economics professor at Columbia University.
Are other countries disillusioned with the dollar?
Yes, Brazil – and it now views China as a bigger trading partner than the US. On his visit to Beijing last week President Luiz Inacio Lula da Silva urged that China and Brazil trade with each other in their own currencies. He told Caijing magazine “We do not need US dollars.”
This has got a number of analysts excited. In fact, the speculation is that the world’s new reserve currency should be China’s not SDRs. Nouriel Roubini has waded into the fray in a New York Times op-ed. “We may now be entering the Asian century,” writes the professor of economics at New York University’s Stern School of Business. “It will be dominated by a rising China and its currency. While the dollar’s status as the major reserve currency won’t vanish overnight, we can no longer take it for granted.”
Similarly telling, Britain’s Daily Telegraph ran an article headlined: “China is preparing for a world where the yuan trumps the dollar.” The talk is that if there is a currency waiting in the wings to replace the dollar, it is China’s.
Is China trying to promote a wider use of its currency?
A series of recent measures have definitely sought to increase yuan usage internationally. Exhibit one: China has signed currency swaps deals worth Rmb650 billion ($95 billion) since December with six central banks (Argentina, Indonesia, South Korea, Malaysia, Belarus and Hong Kong). The agreements allow these reserves to be used directly in trade with China.
Exhibit two: five Chinese cities have been given the right to settle their import and export transactions in China’s currency. Hong Kong is also being promoted as an offshore renminbi centre, and HSBC and Bank of East Asia have been given approval to issue bonds in China’s currency – a move the South China Morning Post reckons “could help globalise the yuan”.
And at this year’s Canton Fair the nation’s exporters were encouraged to bill in China’s currency, not dollars.
Any problem with this thesis?
Yes, and the most elementary is that the currency lacks full convertibility. “The yuan is not convertible for purely financial purposes, ruling it out as a reserve currency for now,” admits the China Daily.
In fact, full convertibility is not expected until 2020, by which time Shanghai is supposed to become an international financial centre to rival London and New York.
Before full convertibility can occur, China will need to have ironclad confidence that its citizens won’t send most of their savings abroad.
As to the currency’s internationalization, that is in its very early stages. As of the end of February renminbi deposits in Hong Kong amounted to just Rmb54 billion.
And back at the Canton Fair, enthusiasm for the new measure was lukewarm. “We are worried European and American buyers would decline if we insisted on yuan settlement,” a Beijing-based porcelain producer told state media.
Even Brazil’s move is viewed as more political than practical. Tom Holland of the South China Morning Post points out: “Brazil runs a sizeable trade surplus with China, more than $1.6 billion in April alone. Think what that would mean if Brazil’s exporters were paid in yuan. They would soon accumulate a vast stockpile of the currency. About the only thing Brazil could do is place its yuan on deposit in Hong Kong for a miserly 0.5% interest rate.”
Indeed, nothing has been settled: Brazil and China remain in “technical discussions” as to the feasibility of Lula’s suggestion that the two nations ditch the dollar.
Any other problems?
The currency is called the ‘yuan’ in China, and uses the same character – meaning ‘round coin’ – as Japan’s yen. The symbol for the currency is the same as for the yen – ¥.
This could pose a problem. If China wants to establish its currency on an international footing, it will need to come up with a distinct symbol of its own.
Currently ‘Rmb’ is used in most foreign media. This is not a symbol (like $ or E) but merely a shortening of the other term used for the currency: renminbi. That was the term invented by the Communist Party when it took power in 1949, and literally means ‘People’s currency’.
Incidentally, with all this talk of currency names, you may be curious about the etymology of the dollar itself.
According to David Sinclair, a currency historian, the dollar got its name from a coin made in Joachimstaler (in Bohemia – now the Czech Republic) that served as the model for the Spanish peso (a coin widely in the 17th century).
It was later abbreviated to ‘taler’ in the UK, and Scots began to mispronounce it as ‘dollar’.
When large numbers of Scots made their way to the US, they influenced other colonists with their pronunciation too. Ergo the world’s most powerful currency is the result of a Scottish mispronunciation of a Bohemian-designed coin.
So what’s next?
China’s currency is likely to reach reserve status at some stage in the future. But there is still some way to go. Zhang Guanping, vice-head of the Shanghai branch of the China Banking Regulatory Commission has said there is no reason why renminbi (yuan) could not make up 3% of global foreign exchange reserves by 2020. Compare this to the US dollar today, at 64% of the world’s central bank reserves.
Senior economists predict it is more likely that China will soon want to see its currency included in the SDR basket alongside the dollar, pound, euro and yen. The SDR gets reweighted every five years, and is due to be recalibrated next year. That may be too soon for China, but by 2015 look for its inclusion.
In the meantime it seems that there is not too much that China can do to escape the “dollar trap”, says the Financial Times.
A further $23.7 billion of US Treasury bonds was added to reserves in March. As an anonymous official told the paper: “Because of the sheer size of its reserves, China will immediately disrupt any other market it tries to shift into in a big way and could also collapse the value of its existing reserves if it sold too many dollars.”
That being the case, we can expect Premier Wen to remain distracted by the dollar for some time to come.
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