from Follow the Money

Forget multilateral coordination; let China do it

March 13, 2007

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Fred Bergsten has long advocated in favor of a bit more exchange rate coordination – both to limit volatility and to try to avoid large misalignments among the major currencies.   Right now, the most misaligned major currency is the yen.  Even after today's move, the yen remains quite weak, especially v. the euro.  Yet Japan’s economy is now relatively strong and its current account surplus is growing.

But the G-7 hasn’t shown much interest in Bergsten’s proposals.   The major central banks don’t like exchange rate coordination very much.   Not all the finance ministries are on board either. 

The G-1 (G-7 slang for the US) has traditionally led the opposition to multilateral exchange rate management.  The Fed doesn’t want to subordinate domestic monetary policy to an external target.  All those lending to the US take note: that means the Fed feels no obligation to defend the dollar should the dollar start to fall.   And there is broad skepticism within the US about the effectiveness of intervention.   At least small scale intervention.  Right now, it is pretty hard to deny impact of large scale intervention –

But the G-1 isn’t what it is used to be, at least in foreign exchange and bond market.   When it comes to those markets, China is the new superpower.  

Scratch China.     Per Niall Ferguson, call its east Chimerica.   Or perhaps “new” Chimerica.   The government of “new” Chimerica (headquartered in Beijing, with a regional financial capital in Shanghai) subsidizes low-end consumers and high-end financiers in “old” Chimerica (headquartered in Washington DC, with a regional financial capital in New York), at a growing – but still hidden -- cost to itself.  

Bergsten thinks the government of "new" Chimerica doesn’t just set the RMB/ dollar exchange rate.   The allocation  of its reserve portfolio also sets – or at least heavily influences – the euro/ dollar, the dollar/ yen and the yen/ euro.    

The fact that the yen hasn’t been a big reserve currency (the euro and pound are the main alternatives to the dollar) is one reason for its weakness.  And in a stroke, China could change it.  Bergsten:

Chinese diversification of several hundred billion dollars into yen would promote both systemic and Chinese national interests. It is almost universally agreed, including in Japan, that the yen is substantially undervalued against all currencies, except the renminbi itself and perhaps a few other Asian monies, even after its recent modest rise….

Chinese purchases of yen with a significant portion of their dollar hoard, by strengthening the yen against the dollar in an orderly manner over a sustained period, would thus help correct one of the most important currency misalignments now contributing to the global imbalances. As the markets become aware of such official action, they would probably magnify the extent of yen appreciation and thus promote the needed realignment. This particular form of diversification would probably minimise the inevitable capital losses that China will experience in renminbi terms because the yen is one of the few currencies that needs to rise in value almost as much as the renminbi itself.

Yesterday’s trade data suggests “official” China will be adding between $400 and $450b to its foreign assets this year, depending on the scale of private capital inflows – even some bank forecasts, which generally tend to lag a bit, now have China’s current account surplus at $320b and net FDI inflows of over $50b, which puts foreign asset growth as close to $400b.    There is a bit of a difference between adding $350b to your dollar portfolio and putting $100b in euros, and say putting $150b in dollars, $100b in euros and $200b in yen.      $200b is real money – it is an inflow comparable to Japan’s current account surplus.   

And China could buy $200b of yen this year it without even selling any of its existing dollar or euro reserves.  Indeed, with a new investment agency, China wouldn’t have to buy yen-denominated bonds with low yields.  It could buy a (minority) stake in Toyota instead --

Indeed, I suspect Bergsten thinks China already has, if not set, at least heavily influenced the yen/ dollar and yen/ euro, without really consciously planning to.   As the scale of emerging market reserve growth has increased, the low yen weight in the reserve portfolios of most emerging economies (relative to both the dollar and relative to the euro) has contributed to yen weakness … 

$1 trillion plus in the bank (1.2 trillion, counting a broad range of official assets, by my calculations) and $400b plus in annual foreign asset growth gives you a certain power.    Remember, the global current account surplus, once you net out various European countries, is in the vicinity of a trillion bucks.   Official China now intermediates a very large share of that.

Welcome to the new global financial order.  Multilateral exchange rate coordination is now superfluous.  The world’s new financial superpower can do a lot unilaterally.

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