Reserve Currency: China Says Move Beyond the US Dollar, Calls for a New Super-Sovereign Currency

Beijing, China, 29 June 2009. It’s no secret that for some time now, China has toyed with the idea of moving away from the US dollar as its reserve currency. And that desire has probably never been stronger as China shudders at the thought of US dollar inflation which would slash the value of its $1.3 trillion in US reserves.

China is overexposed on the US dollar, and in these uncertain times, it wants to move to a super-sovereign currency.

Beijing, China, 29 June 2009. It’s no secret that for some time now, China has toyed with the idea of moving away from the US dollar as its reserve currency. And that desire has probably never been stronger as China shudders at the thought of US dollar inflation which would slash the value of its $1.3 trillion in US reserves.

China is overexposed on the US dollar, and in these uncertain times, it wants to move to a super-sovereign currency.

The Governor has suggested prevoiously that the IMF issued SDR, or Special Drawing Right, should become the international foreign reserve currency. The SDR is a basket of major IMF-member currencies – the euro, the yen, pound sterling, and you guessed it – the US dollar. The concern is not so much the US dollar itself, as that no one country should be able to dominate international finance as a by-product of its own national policies.

The People’s Bank of China published a report saying, “An international monetary system dominated by a single sovereign currency has intensified the concentration of risk and the spread of the crisis,” obviously in reference to the US dollar.

“To avoid intrinsic shortcomings in using a sovereign currency as a the world’s foreign reserve currency, we need to create an international reserve denomination that is divorced from sovereign states or nations and can maintain a stable value over the long term.”

“When a national currency becomes the global price-setting currency for primary products, the trade settlement currency and the reserve currency, that national currency has great difficulty attending to both domestic monetary policy goals and the reserve currency needs of various countries,” the report added.

“The economic development model of debt-based consumption is most difficult to sustain,” the report stressed, implying that the US debt is being propped up by the Chinese reserves in US dollars.

This conclusion is largely correct: Chinese products are sold to the US and other places around the world, and the dollars China receives go to buy US Treasury Bills.

The 1.3 trillion dollars flooding into the US then finances the US lifestyle of excess and credit. China and the US have been likened to two drunks staggering down the road propping each other up – China with its ready supply of dollars buying treasuries, and the United States using those ‘loans’ to buy ever more cheap Chinese manufactured products.

The problem for China is that it cannot start to pull all its money out. A US dollar crash would wipe out hundreds of billions of dollars worth of Chinese wealth.

China has so much vested interest in the dollar that it must tread very carefully.

The Chinese Central Bank hopes that it will have options to move some of its investments out of the US dollar in the future. It will do that very carefully, and only once it is clearer that domestic demand, and demand outside the US, is growing sufficiently to replace the lost orders that reduced US treasury buying would imply.

“The market is watching cautiously to see if China will keep making comments on the reserve currency,” noted Minoru Shioiri of Mitsubishi UFJ Securities.

“If it does, that will likely start having more of an impact on the market. But at the moment market people seem to think China is unlikely to change its policy right away, considering the size of its U.S. debt holdings.”

Yet the amount of US Treasuries holdings by central banks around the world rose a hefty $115 billion in the past two months. Demand for the US dollar is still strong, but the writing is on the wall for a waning of influence as we pull out of this recession.

Umberto Osman, EconomyWatch.com