Dollar's status under attack from China

By Sean O'Grady, Economics Editor

March 24, 2009

World leaders gear up for reform of global system
Another skirmish in the war of words in the most important economic relationship in the world – that between the US and China – broke out yesterday, as the Governor of the People's Bank of China called for reform of the IMF and the promotion of the fund's own longstanding but underused "world currency"– special drawing rights (SDR).

His remarks come as the managing director of the International Monetary Fund said that any plans, such as those being pursued by the G20, to stimulate the world economy would fail unless the banking system is repaired.

Dominique Strauss-Kahn said: "You can put in as much stimulus as you want. It will just melt in the sun as snow if, at the same time, you are not able to have a generally smaller financial sector than before but a healthy financial sector at work."

Zhou Xiaochuan, the governor of the Chinese central bank, implicitly criticised the status of the dollar as the world's sole reserve currency. "The price is becoming increasingly high, not only for the users, but also for the issuers of the reserve currencies," Mr Zhou said.

He added: "The role of the SDR has not been put into full play due to limitations on its allocation and the scope of its uses. However, it serves as the light in the tunnel for the reform of the international monetary system.

"The goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies."

SDRs were developed by the IMF in the 1970s as a method of increasing funding for international trade, at a time of rapid growth and a shortage of public and private liquidity. In recent years, however, the SDR has been neglected, in part because of the Chinese "wall of money" lubricating the world economy.

The central bank governor's intervention can be viewed as a counter-attack to the attacks on China – most recently by the US Treasury Secretary, Tim Geithner – for her refusal to revalue the yuan upwards. The gaping US-China trade deficit – running to $266bn last year – is widely regarded as the most important of the "global imbalances" that underlie the current crisis.

Currently the SDR is backed by a "basket" of the world's leading currencies, of which the American dollar is the most important, accounting for 44 per cent of its weight. The euro (34 per cent), the pound and the yen (11 per cent each) make up the rest. A downweighting of the dollar in the SDR and the "creation" of more SDRs by the IMF – in the same way that a commercial bank multiplies customer deposits through lending – would signal a further rebalancing of world economic power in favour of China.

It would, presumably, be accompanied by an increase in the voting power of China within the IMF, which is roughly the same as Italy's, despite China being perhaps the third largest economy in the world, and Italy the seventh.

Reform of the IMF's governance, long promoted by Gordon Brown, has been a running sore for many years. Over the weekend the Prime Minister of Australia, Kevin Rudd, backed China's claim for a bigger role at the IMF. Australia is co-chair of the G20's group on reform of international institutions.

However, at the G20 Summit in London on 2 April, a large increase in the funds available to the IMF, from $250bn to $500bn, seems set to be one of the few concrete achievements – without reapportioning voting rights. The European Union agreed in principle to the move last week.

The calls from China for IMF reform are echoed by George Soros, who said that the IMF should use new SDRs to "protect the periphery countries from a storm created in the developed world".



Central bank: China to continue investing in U.S. Treasury bonds

China will continue investing in U.S. government bonds while paying close attention to possible fluctuations in the value of those assets, said a deputy governor of China's central bank here Monday.

"Investing in U.S. Treasury bonds is an important component of China's foreign currency reserve investments," Hu Xiaolian, deputy governor of the People's Bank of China, told a briefing about President Hu Jintao's participation in the Group of 20 financial summit in Britain scheduled for April 1 to 2.

"We are naturally relatively concerned with the safety and profitability of U.S. government bonds," she added.

China's reserves hit a record 1.95 trillion U.S. dollars at the end of 2008, the largest in the world and far exceeding those of Japan, the second-largest foreign exchange holder, which had 1.03 trillion U.S. dollars.

China has invested its huge foreign exchange reserves in low-risk but low-yield assets, such as U.S. government bonds. Treasury bond assets fluctuate during different periods, according to Hu.

Treasury bond purchases would remain key to China's investment plans, but China would keep close watch on them, Hu said.

Given that the U.S. dollar is still the leading currency used in the settlement, valuation and payment of international trade, China will pay closer attention to the supervision of the international monetary system based on the U.S. dollar, Hu said.

Source: Xinhua