China's Plan to End the Era of the Dollar

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China's Plan to End the Era of the Dollar

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In advance of next week’s gathering of the Group of 20 China has fired a shot across the bow of global finaiciers. They want an end to the era of the dollar as the world’s reserve currency.

This follows a similar call from Russia and a comment by Premier Wen Jiabao this month publicly expressing “worries” over China’s significant holdings of U.S. government bonds.The Chinese have a stock of about $769 billion of U.S. Treasuries. This ties China to America’s good times and its bad times. By calling for the creation of another reserve currency China, Russia and other nations seek to create an insurance for the their economy against the problems generated when one country’s economy goes bad. It also seeks to end the American dominance of the world economy. America’s decline and China’s rise fits their geopolitical ambitions.

Ending the dollar’s role in the world economy is not an easy matter. The Wall Street Journal says, …

“…the technical and political hurdles to implementing China’s recommendation are enormous, so even if backed by other nations, the proposal is unlikely to change the dollar’s role in the short term. Central banks around the world hold more U.S. dollars and dollar securities than they do assets denominated in any other individual foreign currency. Such reserves can be used to stabilize the value of the central banks’ domestic currencies.”

Before the dollar it was British sterling that formed the underpinning of the global economy. It took two world wars and several decades to change from the pount to the dollar as the world standard. Since the end of World War II the dollar has been king. Although the current financial problems, ignited in America, have led to a global meltdown it will take more than what we have seen to topple America from its current role. That is not to say it could not or will not happen. At the current pace of events it seems it will not happen tomorrow–or next week.

Creating another world currency requires several factors to be in place. Stratfor has a piece today (China’s Calculated Currency Rhetoric) that outlines what that would be…

As to a world beyond the dollar, the issue is that a reserve currency is not decided upon; it creates itself. Two things are needed to create a reserve currency. First, there must be sufficient liquidity to support a global system. That requires a central bank with an enormous amount of autonomy from a state government, and the U.S. Federal Reserve is unparalleled on this count. Not even the European Central Bank can compete. Second, the economy upon which the currency is based must be large enough to withstand fluctuations caused by other economies buying and selling its assets in massive amounts. Again, the United States is the only economy that potentially could qualify.

Part and parcel of any replacement of the U.S. dollar would be a large-scale abandonment of U.S. T-bills as the core of Chinese currency reserves, which — as the conventional wisdom holds — would force intractable economic problems upon the United States. But a closer look reveals that this is not the case. First, selling U.S. T-bills en masse simply is not possible. Every seller requires a buyer, and the volumes at hand cannot be exchanged quickly. Second, starting down that road would cause the value of the securities in question to plummet, destroying the savings the Chinese have been building up for years. The so-called “nuclear option” really is not an option at all.

China has its own problems. The huge middle class created by their recent boom is beginning to expreince layoffs and financial setbacks. The ruling Communist Party cannot afford discontent from this segment of their society. Once people have tasted materialism they won’t go back. For now it is in China’s interest to blame a foreign power (America). It dflects attention from the home front.

What would it mean for you if the dollar was no longer the world’s reserve currency? I’ll cover that in my next post.

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