Earlier this year, Zhou Xiaochuan, governor of the People's Bank of China, called for the establishment of a new global reserve currency to supplant the US Dollar. Zhou suggested that the new currency will be super-sovereign. That is, not belonging to any state. The actual exchange value, according to Zhou, will be determined through discussion between different countries. Zhou claims that his new plan would 'secure global financial stability and facilitate world economic growth'. Sounds like a good idea? In addition, if China wants to undermine the US Dollar's supremacy, why not use it's own currency, the Yuan, as a replacement? Let's put things in context.
Over the past 60 years, The US Dollar has been the reserve currency of choice for most of the world's major economies. This means that governments chose to hold significant amounts of their currency reserves in US Dollars, and the that Dollar was the main currency used in international trade. It still is.
After the end of World War II, this arrangement was formalized through international agreements under the Bretton Woods System. Back then, the US Dollar was backed (mostly) by gold, at a fixed rate, and other countries used the Dollar as their main reserve currency, instead of tying their currencies directly to gold. In essence, gold served as the global reserve commodity, with the US Dollar serving as its proxy. So, other countries purchased US Dollars, and the US promised to pay them back in gold at a fixed rate whenever they required it.
The arrangement worked for a while, but fell apart in the early 1970s since (i) several other countries wanted their currency to receive more prominence and (ii) the US wanted to spend more than it had and did not have enough gold to cover all its obligations. In 1971, president Nixon cancelled the direct convertibility of US Dollars to gold, mainly in order to sponsor the Vietnam war**. Back then, Nixon said this was a temporary solution. And so, the US Dollar became a paper currency, backed by... more paper. This means that the US enjoys the unique privilege of being able to borrow money from other countries, in USD, and then print more Dollars in order to pay them back.
Still, the US Dollar remained the global reserve currency of choice. This was because most countries already had large USD reserves, and knew that if they start selling them, their value would decrease dramatically. In addition, the US was still the world's largest and most productive economy, and there were no serious alternatives to the US Dollar.
Which brings us back to China. During the last decade, China has been running a growing trade surplus with the US. This means that lots of US Dollars were coming into China, purchasing DVD players, flat screen TVs, and what not. Since China spent less US Dollars than it earned, it ended up accumulating more US Dollars than any other country.
In a free market, this would have decreased the value of the US Dollar compared to China's currency, the Yuan. However, in order to make sure that Chinese goods remain cheap and that Chinese factory workers remain employed, China needed to keep the Dollar strong (so that Americans could buy lots of Chinese stuff, for cheap). To achieve this, China had two key strategies: (i) prevent the Yuan from becoming a freely-traded currency, in order to maintain government - and not free market - control over its exchange rate; and (ii) spend a large part of the proceeds from its export industries to purchase US Treasury Bills. In essence, China was hoarding US Dollars, and then lending these US Dollars back to America in order to ensure that US consumers have enough money to spend, and that the price of money (interests rates) in America remains low.
Because of this, China now holds most of its reserves in US Dollars. In addition, the US owes China hundreds of millions of US Dollars (in exchange for Treasury Bills). However, all these loans are denominated in US Dollar. This means that the US can pay them back by creating new Dollars out of thin air. In this way, America can pay China back the amount it borrowed, but the value of this amount will actually be much lower.
Let's look at an example: I have a currency called A and my friend has a currency called B. There are 100 notes of A in the world and 100 notes of B. So, one B is worth one A. Then, I give my friend a loan of 50 A. However, instead of denominating the loan in A, I denominated it in B. So now, my friend owes me 50 B. As it happens, my friend does not have enough money to pay me back. So, he prints 50 more notes of B and uses them to repay the loan. Only now, there are already 150 B in the world and only 100 A. So, even though I got all the money back, the 50 B I receive are actually worth much less than the 50 B I originally gave out.
And this is exactly what is currently happening. Since the beginning of the current crisis, the US Federal Reserves expanded the money supply in the US by more than 100% - the overall money supply in the US was about USD 800 billion one year ago, and it is almost USD 2 trillion today. This means that the value of China's assets is about to get a serious dent. Ironically, as the US continues to create new money, China continues to purchase more and more US Treasury Bills, in order to try to keep the US Dollar strong.
So, the imbalance behind the current crisis was caused by government manipulation on both sides of the pacific, in order to meet short-term political goals. The Chinese government wanted to maintain high growth and employment, and the US government wanted to keep the price of exports low and have enough money to sponsor the war in Iraq and other adventures. Now, America is stuck with a huge debt, and China is stuck with a lot of cash that might soon lose its value.
So why is China calling for the creation of a new reserve currency? Quite simply, because it cannot get rid of its US Dollars (if China starts selling them, or even just stops buying them, their value will decrease). China now wants the world to come together and share its burden; it wants other countries to share the costs of its mistakes.
Why not use the Yuan as a global currency? Because doing so would require China to let the Yuan's value be determined by market forces. It would cause a short-term shock to China's exports and massive unemployment. It would also generally take power away from China's rulers. And they love power.
More importantly, in line with China's ideology of central planning, China wants to have a global currency that will be centrally managed and controlled by bankers and politicians. This means that more power will be concentrated in fewer hands. As we've seen in the story above, giving politicians the power to control the supply and price of money on a national scale has severe consequences. You can only imagine what will happen if we let them do it on a global scale.
**The need of the US government and Federal Reserve to print money has a strong correlation with military activities: Starting from the war of independence, through the civil war, through the world wars, and onwards to Vietnam and Iraq. More on this soon. In the mean time, check out this video from Prof. Robert Higgs.
and what not. Since China spent less US Dollars than it earned, it ended up accumulating more US Dollars than any other country.
In a free market, this would have decreased the value of the US Dollar compared to China's currency, the Yuan.
I think you messed up here. China hoarding dollars isn't going to lower the value of the dollar.
China now wants the world to come together and share its burden; it wants other countries to share the costs of its mistakes.
Funny, because Japan, OPEC and the Tigers also have a huge amount of dollars but only the late comer is accused of any wrongdoing. The US had a POLICY of forcing other nations to deal in dollars to confer them a strategic advantage. That's the fact.
China had no choice especially considering how belligerent the United States is. China exported for dollars not to lend Americans more money to buy more dollars, but for leverage. That way it can be guaranteed that America doesn't try it's Israel/Middle East or Balkans strategy of "fragment and destroy" on China.
Thanks, Captcha:
- No mess up. Of course, if China only bought dollars, this would have driven the price of dollars up (which is what is currently happening, by the way). But during most of the last 10 years, China had a trade surplus with the US, meaning that there were always more dollars spent on Chinese goods than there were RMBs spent on USD/American goods. So, while China managed to hoard USDs, it did so not by purchasing them, but by taking all the dollars that were already making their way into local banks through trade.
- Japan, OPEC, and Tigers indeed have lots of dollars, but China is the main proponent of the new SDR. In addition, Japan's reserves are more diversified than China's. I don't know about OPEC. In any case - you agree that China is trying to get out of it's dollar trap by convincing the world that a new currency would be good for everyone (?).
- There is always a choice. Didn't we previously discuss this? Blaming others for your own mistakes is not a healthy way for a country to grow up. In addition, unilateral free trade is still better than bilateral protectionism. In any case, agree with you that if America is not playing by the rules, blaming only China is a bit rich (which is why most of the above post is about America...)
by the way, it looks like China has more USD than all of the OPEC countries combined.
but China is the main proponent of the new SDR
Russia and India are both proponents. I don't think you even have to bother asking the Arabs either. Not sure about Brazil.
There is always a choice.
Technically you can pick the bad choice and be destroyed by an enemy nation, or go the only way that allows for survival.
Blaming others for your own mistakes is not a healthy way for a country to grow up
America as well as a lot of European nations are the ones doing this. "Blaming others", in China's case not really. It's just an assessment of reality. America coerces other nations (like Iraq, by killing hundreds of thousands) into supporting the dollar regime.
by the way, it looks like China has more USD than all of the OPEC countries combined.
There are hundreds of billions of petrodollars in circulation iirc.
China was the main proponent of this initiative. Russia is quite agnostic on SDR's in general, by the way.
There is always choice. Always. If you are saying that doing otherwise would destroy China - that's fine, but you cannot claim at the same time that what they did do, and the consequences of it, are anyone else's fault. All governments, by definition, are obsessed with power. It is natural for each of them to try to expand its influence. That's a given.
My concern is not that China was not nice to other countries. My concern is that through it's short term scheming, China is causing incredible damage to itself, and wastes the capital of its hard working citizens.
As for OPEC - we are talking about forex reserves, not overall trade or any other indicator. China is the largest holder of USD reserves in the world, by a long margin (more than Japan, Europe, and Russia combined).
There is always choice. Always. If you are saying that doing otherwise would destroy China - that's fine, but you cannot claim at the same time that what they did do, and the consequences of it, are anyone else's fault.
So if someone puts a gun to your head, and tells you to pick one of two choices, you tell him to pull the trigger?
Not likely.
China is causing incredible damage to itself, and wastes the capital of its hard working citizens.
Yes you've stated this several times. Usually by saying "lost half their money". Which isn't really true- the net worth of China is at 4 trillion now, then there's the 2 trillion in foreign reserves. GDP is another 4 trillion (8 if you're taking living standards into account).
2 trillion is half of the nation's income in one year. "Half of China's money" would be 3 trillion. So what it comes down to is assessing just how badly the government spends its money.
But considering Americans spend 7% of GDP getting fat, 17% of GDP dying from their fatness, 30-50% on houses that are decreasing in price, and the rest on socialism and unintelligent spending (toys, games, brand names, everything made by Apple) I really doubt the Chinese government can outdo many developed countries in terms of "bad spending".
Captcha - even a man with a gun to his head has alternatives, and China was far from being in such a situation. Don't be so dramatic. The CCP made their own calculations and decided to favor export growth, a fixed currency, and pile on USDs. There are plenty of other things they could have done, and plenty of ways they could have done the same thing in a more nuanced and prudent way.
Sadly, and understandably, the CCP is driven by short-term political interests (like any government).
I never said that the Chinese lost half of their money. I used the expression once in a rhetorical example. I know this is clear to you, so no need to have this discussion again.
In addition, the waste is not of money, but of capital. When money is taken productive people/enterprises and given to non-productive ones, capital is being destroyed. When this is done on a large scale - lots of capital is being destroyed.
America has its own shortcomings. They do not even out or justify China's shortcomings. The key benefit the American people have compared to the Chinese is that their government is smaller (for now...). So, even though both governments are destroying the people's wealth in order to serve their own short-term interests, at least in America the government has less capacity to cause damage.
Either way, both governments are not doing a good job. The Chinese, by the way, are at least trying to do a good job. I have no idea what Obama is trying to do or who sent him to do it . . .
There are plenty of other things they could have done, and plenty of ways they could have done the same thing in a more nuanced and prudent way.
I think the argument would be settled if you were to say what this would be, exactly. They didn't particularly favor export growth, it's just that the overseas Chinese (from whom 85%+ of initial FDI came from) favored exports because they were close to the coast and it's something they're familiar with.
Almost all of China's GDP growth is now domestic growth- exports are massive but of course much of that is imported raw materials being assembled in China for the labor costs and then exported out. Again, China's exports are probably a better indicator of Japan and Korea's economic health than her own.
There are many answers, and - unlike most bloggers - I do not pertain to know everything.
The basic answer for both of your questions boil down to free trade. Protectionism is bad for China and prevents it from moving up the food chain of the global supply chain (which also means better wages, better working conditions, better education).
China did choose an exports-driven model, and is still trying very hard to protect and expand it through currency manipulation and additional investment in the export sector. I guess this is a political imperative, since letting the country go up the value chain too quickly would have political consequences. In practice, the CCP is in a bind: it has to provide continued economic growth, but doing so also means having a more educated population and decentralized power. Will be interesting to see how this works out for them.
As a matter of fact, private consumption's part of China's overall GDP has been in decline over the past year, and consumer savings have been going up.
Protectionism is bad for China
I don't believe this entirely. If China were to lift all restrictions, foreign speculators would buy up China with their ill-begotten capital and gradually destroy China's culture with Hollywood and other such garbage. China would become a nation of permanent renters while the landlords in foreign countries extract yearly tribute.
Developing countries need protectionism to keep suspicious foreigners, who have no love for the nation and people, at bay.
China did choose an exports-driven model
China, again, is no longer export-driven: most of China's growth and GDP comes from domestic demand and investment. Dividing the total value of exports by total nominal GDP is too simplistic- it's better to take the balance and compare it to GDP, but even then there is no telling how much of that is just Japan and Korea exporting raw materials to be exported again.
I guess this is a political imperative, since letting the country go up the value chain too quickly would have political consequences.
I guess you could accuse the governments of Russia, India, Brazil and in fact every large developing country of doing the same, because they have been crawling up the value chain at a snail's pace compared to China. China is also posting the most significant patent growth, already exceeding America's patents per dollar of R&D spent.
Patent applications in China have grown by 15-40% a year, outpacing GDP growth (unlike India or Brazil).
In that case, the Brazilian, Indian and Russian attempts at "democracy" and free trade would have to be condemned as a human right's disaster... but of course you will never hear the democracy gestapo say this.
As a matter of fact, private consumption's part of China's overall GDP has been in decline over the past year, and consumer savings have been going up.
Yeah, but when the government spends money on roads (that are needed) highways (needed) sanitation (needed) green energy (needed) public health and education (desperately needed) it's also considered domestic growth (investment).
When you say savings are going up do you mean as an absolute or as a percentage of their income? Keep in mind that the per capita net worth of China is around $4,000, if I only had $4,000 dollars in the bank I would save too.
IMO the best thing for Chinese people to do would be to spend money on stuff they really need (i.e creates wealth and well-being in the future).
Captcha! Sorry for getting back to you so late. I need to work every now and then.
As for your comments:
- I do not believe that protectionism is good for anyone. China is already being drowned in hollywood garbage, as well as in China's locally produced cultural garbage. On the other hand, the fact that the RMB is kept artificially weak actually makes it easier for foreign investors to pour hot money into a variety of Chinese industries. Furthermore, a lot of this money goes to the wrong parts of the economy, so instead of leveraging foreign investment for viable growth, China is using it to further inflate the real estate, manufacturing, and stock exchange bubbles.
-China's growth model is driven by exports and capital investment. The share of these two out of China's total GDP is much higher than it ever was for Japan and South Korea. Government investment is the most wasteful and misguided type of investment over the long term. This means waste.
- As for Brazil, India, and Russia - they definitely did make their own mistakes, which is why they are still unable to provide their citizens most of the things people in developed countries take for granted. Using them as an excuse is not good. China does not want to be like any of the countries you mentioned and should not look at their actions as a guidance for its own policies.
- You are making a huge assumption about the efficiency of China's government investment. In reality, a lot of this money goes to all the wrong places. I have seen it with my own eyes.
- Savings as a % of income is going up. If people save more, you cannot have an increase of consumption as a % of GDP. So, to say that China's economy is now driven by private consumption is not correct. It will remain incorrect for many more years.
- Agree with you that 'he best thing for Chinese people to do would be to spend money on stuff they really need'. This is not what they are currently doing.
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China is already being drowned in hollywood garbage, as well as in China's locally produced cultural garbage. On the other hand, the fact that the RMB is kept artificially weak actually makes it easier for foreign investors to pour hot money into a variety of Chinese industries.
Considering the Chinese government outright blocks them in many cases (thankfully) that's not always the case.
As for exports, China's profits from exports still don't even match Japan's now, much less the ratio that was present in the past.
Brazil, India, and Russia are all "democracies", but my point is that apparently China is going up the value chain a lot faster than they are, even though two are relatively "free market".
There is a quota on foreign films, but Chinese are bombarded with enough foreign and local garbage on TV, online, and in cinemas. I am sure you are aware of that.
As for foreign investors, they are indeed being blocked, but on political basis, so - again - even the ones that do go in, do not invest in areas that are suitable, but only invest where the government wants them to. The government blocks makes things worse, not better. A free market - and a free currency - would regulate these things much more efficiently.
As for Brazil, India, and Russia - they have their own problems, which we can discuss some other time. In addition, their citizens also have much more freedom than those of China, which to me is a far greater achievement than China's bloated GDP figures. In addition, Russia is roughly a democracy.
And most importantly - I was not saying that China should become a democracy, or that it should do so tomorrow. I am talking about the failure of central planning and the need for free trade. Political freedom will grow out of that in due time.
By the way - my first point above also shows you that a lot of the so-called private or even foreign investment is actually driven by the government, and not by free market considerations. This is a critical point.