China's plan to end the dollar era


Financial Times
Published: March 25 2009


Zhou Xiaochuan, China's central bank governor, has delivered a powerful message to the world this week. He wants an end to the dollar era. This is not sabre-rattling. He has made serious proposals for a reserve currency to rival the greenback and he deserves a hearing.

During the 1997 crisis, Asia's emerging market economies learnt a painful lesson: do not run out of foreign reserves. China, in common with many other Asian emerging market economies, built up towering mounds of foreign assets to give itself a backstop against future emergencies.

The People's Republic has, however, over-exposed itself to the US, piling up dollar-denominated securities. In January, its stock of US Treasuries was about $739bn - a startling leap from $535bn in June last year. Yet Washington puts domestic economic needs before its creditors; the Beijing authorities now worry that possible future inflation could cost them dearly.

Chinese attempts to diversify into other currencies lost them money and efforts to buy higher-yielding US assets ended badly. It would be in China's interests to have another safe reserve asset - but this does not mean that it would be against America's. It would, of course, make it more difficult for the US to finance its deficits. But America should not want the world to be yoked so tightly to its willingness to generate demand. Such imbalances are at the root of this crisis.

As Mr Zhou says, a reserve supercurrency could be created through further issuance of the International Monetary Fund's Special Drawing Rights - the IMF's in-house reserve asset. To enable and encourage take-up, he proposes wider uses for the SDR and giving some surplus countries' reserves to the IMF for it to manage. Married with other necessary reforms, this plan would also empower the IMF to act more flexibly. Good.

But China's dollar-heavy reserve accumulation was not just insurance - it supported an aggressive, mercantilist trade policy. Beijing kept its currency weak to bolster exports and measured success in terms of how export-dependent it became. Mr Zhou's proposal is useful and constructive - but China should still raise domestic consumption. It must not just replace its mountain of dollar assets with heaps of other currencies.

China has acted wisely in the recession, expanding demand with government spending. Beijing now wants to play an active role in reshaping the world monetary order. This outward-looking view should be welcomed. But China still has work to do at home.
Copyright The Financial Times Limited 2009

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