Monetary Machinations
By Peter A Buxbaum for ISN
One of the biggest international trade gripes the US has with China is its undervalued currency. A low-value renminbi, or RMB, artificially pegged to the US dollar by the People’s Bank of China, facilitates cheap Chinese exports to the US while inflating the price of US imports.
But China has its own bone to pick with the US over currency. With the US as China's chief export destination, China has accumulated $2 trillion in dollar reserves, much of it held in the form of US Treasury securities. The global financial crisis, which the Chinese blame on the US, has led to a falling dollar, leading to the prospect that the US will be repaying its debt to China with cheaper dollars.
The Chinese have been vocal in their desire to reform the international monetary system, making changes which would increase its currency's role in the global economy. The RMB could become more of an international trade transaction and settlement currency. Some Chinese banking officials have even proposed the RMB as an alternative international reserve currency to the US dollar.
China has already taken steps to internationalize the RMB. The central bank has allowed limited use of the RMB since 2003 in border trade with Vietnam, Laos, Mongolia and Russia. The Chinese have also entered into currency swaps deals with six countries, allowing bilateral trade to bypass the dollar in those cases.
The People’s Bank of China has also moved to diversify its reserve holdings. The Chinese have been investing their dollars in commodities, stockpiling oil, iron, copper and other metals as well as agricultural products, since the end of last year.
China's reserves diversification is motivated by multiple factors, according to Melissa Murphy, a China expert at the Center for Strategic and International Studies, a Washington think tank.
"The Chinese are seeking a more stable hedge against inflation," she told ISN Security Watch. "The move also plays well to the domestic audience, encouraging them to blame the US for the global economic crisis." That said, she added, "the recent purchases have spent only a fraction of China's dollar reserves." (external pageCSIS recently issued a report on RMB internationalization.)
The Chinese leadership has also expressed criticism of the reserve currency status of the dollar, recommending a greater role for the International Monetary Fund’s accounting unit, special drawing rights (SDRs), which are based on daily London exchange trades of the dollar, euro, yen and pounds sterling.
Some propose that China’s RMB become the fifth currency in the SDR basket, providing China with more influence within the IMF, as well as geopolitically, at the expense of the US.
Ironically, each time Chinese officials rail against the dollar, the US currency falls, noted Murphy, further depressing the value of China's dollar reserves.
Easier said than done
China's plans for the RMB, especially its promotion as an international reserve currency, are easier said than done. For the RMB to become a reserve currency, foreigners must be able to invest freely in onshore RMB financial assets such as stocks, bonds and bank deposits and freely repatriate their earnings and their capital.
"For foreign investors to hold RMB assets on a large scale, they must be convinced that China’s financial markets are trustworthy and not rigged," Arthur Kroeber, managing director of Dragonomics Research & Advisory, a Beijing-based independent research firm, told ISN Security Watch.
The emergence of a new reserve currency could take 20 to 30 years, noted Carolyn Bartholomew, chair of the US-China Economic and Security Review Commission, a US government entity.
"One thing about the Chinese government is that is has a long-term view," she told ISN Security Watch. "We have to expect some movement in this direction, but it will take place over the course of decades." (The commission recently released its external pageannual report to the US Congress, which included a discussion of currency issues.)
Such a move would be good for the US economy and the world monetary system, according to Pieter Bottelier, a senior adjunct professor of China studies at the Johns Hopkins School of Advanced International Studies.
"My concern is that China will promote the RMB as a settlement and transaction currency but will stop short of promoting its use as a reserve currency," he told ISN Security Watch.
Why? "Because the implications for China are very grave if its currency is to act as a reserve currency," Bottelier said. "The state will have to retreat from controlling the economy very significantly. It would have to give up currency control. Is the Communist Party ready to retreat to a back-room roll?"
Bottelier argued the internationalization of the RMB is already proceeding apace and that the US should support a move which would create an alternative reserve currency to take pressure off the dollar.
No big threat to dollar
In the meantime, Bottelier does not see any of China's monetary machinations as a big threat to the dollar.
"If there is that much distrust of the dollar one would expect the world to turn its back on it," he said, "but China and others continue to invest in dollars." If the dollar were in distress, the market for inflation-adjusted US treasury instruments "would boom," he added, "but that has not been the case."
Murphy agreed that the interdependence of the US and Chinese economies means that the Chinese "will continue to accumulate dollars as fast they can spend them."
In addition, the Chinese "must invest in US debt instruments. The Japanese and European bond markets are not big enough" to accommodate China's requirements.
"At the same time, China is pursuing a longer term strategy to reduce exposure to the dollar," she added. "It's not having a big impact on the dollar, but it is clear that the geopolitical sands are shifting."