from Follow the Money

The heavyweights chime in …

May 21, 2009

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On China, the dollar and China’s call for a new global reserve currency.


Pettis. He though is more focused on the ways China hasn’t changed than on its suggestions for global change.


O’Neill (Goldman), hat tip FT Alphaville. O’Neill and Roubini don’t seem that far apart; both believe that the RMB could become a global reserve currency faster than many think possible. Drezner is a bit more skeptical -- and Dyer (the FT’s Beijing Bureau Chief) notes that China’s recent efforts to promote the RMB’s international use have danced around the real issues. Dyer writes:

" China’s huge exposure to the dollar is partly a trap of its own making. If the Chinese currency had appreciated more rapidly in recent years, the economy might not have experienced such turbo-charged growth rates, but its reserves would not have exploded so quickly and the much-needed shift to domestic demand would be more advanced. ....

If China wants a bigger international role for its currency, it will have to make other difficult shifts. For a start, the renminbi is not yet fully convertible and there are still a battery of restrictions on bringing funds in and out of the country. Why would a Brazilian exporter to China choose to be paid in renminbi, when the dollar is so much easier to trade and hedge against?


Geithner (via Leonhardt):

Geithner argues that the influence of the US in China will largely be a function of the quality of its ideas. Of course, it also helps to have a receptive audience. Leonhardt argues that the recent crisis – which highlighted the costs of relying on exports for growth and the risks of holding too many dollar-denominated assets – has created a real opportunity for dialogue. Let’s hope that is true. The crisis also has made many countries more reluctant to listen to American policy advice. Remember that less than a year ago a key component of the United States policy toward China was convincing China to lift restrictions on investments in China by large foreign banks ...

I suspect that the US has a bit more leverage with China than Geithner -- almost always a diplomat -- lets on. The problem is that it can only exercise its points of leverage at a high cost to itself. China in some sense is in a similar position. It too has options – it actually doesn’t have to finance the US if it changes its exchange rate regime. But it doesn’t have cost-free options. That, at least, is my understanding of the balance of financial terror.

Krugman argues though that at least for the moment, the balance of financial terror has changed. Why? Simple: right now, the US currently doesn’t need Chinese financing. There currently is too much demand for safe financial assets and too little demand for goods. And China is putting its spare savings into safe assets (notably T-bills). If it bought more goods instead, it would be a win/ win.

Right now we’re in a liquidity trap, which, as I explained in an earlier post, means that we have an incipient excess supply of savings even at a zero interest rate .... In this situation, America has too large a supply of desired savings. If the Chinese spend more and save less, that’s a good thing from our point of view. To put it another way, we’re facing a global paradox of thrift, and everyone wishes everyone else would save less.

Krugman’s argument is – thankfully – fairly consistent with my argument that the world needs Chinese demand for its goods more than Chinese demand for its bonds.** That quip, alas, never really caught on ….

But, you say, right now Treasury prices are falling and Treasury yields are rising, suggesting a shortfall in demand?

True enough. But compared to say a year ago, the US Treasury is selling more bonds at a higher price (lower rate).***

And if China bought more goods – and net exports could be counted on as a source of US growth – the US wouldn’t have to worry as much about a fall off in demand as the impact of the fiscal stimulus wears off …

* Krugman’s response to many questions about China’s dollar holdings on his grand post-Nobel China tour -- more or less, China bought dollars and US assets knowing the risks because it wanted to hold its exchange rate down -- seem pretty close to my answers. And I gather many in China would have preferred that Krugman focus on the United States financial failings, not China’s role in financing the US as those vulnerabilities rose.

** Global rebalancing implies that China’s current account surplus needs to fall -- which in turn implies that China will be buying fewer of the world’s financial assets (I am setting aside the questions that arise when capital inflows are balanced by capital outflows). A fall in China’s demand for the world’s bonds implies that China is importing more relative to its exports --which helps those parts of the economy that produce "things" rather than pieces of paper. To date, the global contraction hasn’t reduced China’s surplus, though there are some tentative signs that China’s stimulus (or perhaps Chinese commodity stockpiling) is starting to push China’s imports up a bit before China’s exports recover. If that is the case, China’s surplus might start to fall a bit.

*** One of the challenges that the US Treasury’s debt mangers face is that central banks -- China included -- aren’t buying ten year Treasury bonds at their old pace, only short-term bills. At some point though I would bet that higher yields on longer-term notes tempt central banks to switch out of bills and into longer term notes.

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