G8 signals end to dollar supremacy
Reports that China has asked for a discussion about reserve currencies at next week’s expanded Group of Eight summit in Italy has added to confusion about whether the country wants to dethrone the dollar from its status as the world’s sole reserve currency. But the very fact the issue has been pushed onto the agenda suggests that a fundamental shift is underway.
Given the U.S. government’s enormous borrowing requirements over the next decade to cover the bank bailout, fiscal stimulus and deficits in Social Security and Medicare, the dollar’s reserve status depends on emerging markets’ continued willingness to accumulate U.S. liabilities rather than switching to other stores of value, such as the euro or the IMF’s Special Drawing Right (SDR).
As the largest buyer of U.S. Treasury securities, China can break the dollar’s reserve currency status any time it wants. But it would risk large losses on the stock of U.S. debt that it has bought already. The resulting unstable stability is the foreign exchange version of the Cold War stalemate based on “mutually assured destruction”.
Senior Chinese officials have given off mixed signals about their intentions.
When pressed, officials have indicated China will continue to stand by the dollar in the short term and denied the country has begun to diversify its official holdings. But that has not stopped People’s Bank of China (PBOC) Governor Zhou Xiaochuan floating the idea of shifting to a super-sovereign currency based around the SDR.
Zhou’s call for diversification was repeated last week in the central bank’s annual stability report, which noted that “an international monetary system dominated by a single sovereign currency has intensified the concentration of risk and spread of the crisis”. It went on to urge the IMF to exercise closer supervision of the economic and financial policies of major reserve-issuing countries.
Chinese officials have bluntly expressed concern about U.S. fiscal and monetary policies that appear to contemplate inflation and devaluation as a way out of the debt crisis, or at least accept it with weary resignation.
China has started backing a variety of small projects designed to encourage greater “internationalisation” of its currency (such as an active RMB market in Hong Kong and bilateral discussions with Latin American countries on the use of RMB to settle trade transactions).
The question is whether China is preparing to deliver the “coup de grace”.
Pressing for a reserve currency discussion at the expanded G8 summit (which will also be attended by India, Brazil, Mexico, South Africa and Egypt) suggests China’s leaders are serious. They must have known that just pushing the issue onto the agenda would rekindle market fears about the dollar’s value.
But it could also be an attempt to create leverage and seize the initiative as part of wider efforts to shape the international financial agenda.
In the past, G8 summits have been structured as a monologue from the advanced industrial economies to the developing world. But following the debt crisis, the leading emerging markets are in no mood to be lectured.
By putting the dollar into play, China’s government may hope to pre-empt pressure from western countries for a revaluation of the RMB, and take exchange rate discussions off the table entirely.
It is also a sign China is ready to begin flexing its financial muscle and will have to be treated as an equal alongside the United States, EU and Japan, shaping as much as responding to the policy debate.
The dollar’s reserve status has become highly conditional, one of a number of items to be bargained over as part of the international financial agenda. Past experience suggests that when reserve currencies become highly contingent in this way, it marks the beginning of the end.
The dollar will not lose its reserve status completely. But it is set to become less “special”. In future it will have to share its reserve status with the euro, the yen and perhaps even in time the yuan.