Moves Afoot to Dump the Dollar?
British journalist Robert Fisk has published a rather sensational report in today’s The Independent that the Gulf Arab states are in secret discussions with China, Russia, Japan, and France on moves to dump the U.S. Dollar as the world’s chief trading currency. According to him:
Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.
The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.
Like much of Fisk’s reporting, the tale reads like something out of a compelling spy novel, and is sure to fuel further speculation (both intellectual and financial) concerning the demise of the Dollar and the rise of the Renminbi. But on serious reading, I find little in it that makes financial or economic sense.
Two points I would make. First, as my Peking University counterpart Michael Pettis has frequently and eloquently pointed out, the main challenges facing China and other countries do not stem from the role of the Dollar. Global imbalances in the flow of funds reflect fundamental patterns in production, savings, and consumption. For the past 30 years, China (and much of the rest of Asia) has pursued a growth model that involves maximizes investment and capacity expansion by exporting goods and importing capital. To do both simultaneously necessitates a net inflow of currency from abroad, which is accumulated by the government in the form of reserves. The currency used does not alter the net effect. Even if China conducted all of its trade in a “basket” of currencies, or even in Renminbi, its current payments imbalance would still require it to accumulate foreign reserves on a massive scale. Those reserves might not be as concentrated in U.S. Dollars as they are now, which could have its benefits in terms of risk diversification, but the net overhang would remain, and the country’s reserve holdings (in non-Dollars) might not prove nearly as liquid as they are now.
In fact, as long as the U.S. remains a major net export market for Chinese goods, China has a fundamental choice: it can either continue to sell in exchange for Dollars, or it can decline those Dollars (or demand more) and accept the consequences of foregoing the U.S. market, in terms of lower revenue and employment. The only way China can escape this dilemma is by reducing its trade surplus, by encouraging domestic consumption not only of Chinese-made goods and services, but importing more as well. It can also find better uses for the Dollars it does acquire by eliminating capital controls that prevent its citizens from investing abroad. Such changes will involve a major structural adjustment for China’s real economy. The problem cannot be “solved” merely by promoting the Renminbi or other currencies versus the U.S. Dollar.
The second point is that China has already accumulated massive holdings of U.S. Dollars (by most estimate, Dollars account for 70% of China’s $2 trillion foreign reserves), and as I’ve noted above, will likely continue accumulating more until some very profound economic changes can take place. In the meantime, China has every reason to want to use those Dollars, or at the very least retain their value. The fact that oil and other natural resources are priced in U.S. Dollars is actually a huge boon to the Chinese. It gives them a way to use their Dollars to buy something they need, and at least partially counter the inflow of funds, rather than just store them away in passive investments. The problem the Chinese have is they don’t enough uses for their Dollars. Why in the world would they want to cut off one of the major outlets they do have? So they could be stuck with more Dollars unspent, and worth much less overall because the Dollar has just been dethroned from key commodity markets? By undermining the U.S. Dollar in this way, the Chinese would incur huge financial losses in order to diversify away from the Dollar, a policy whose sole purpose in the first place is to avoid huge financial losses from a feared weakening of the Dollar. It would be a classic case of cutting off their nose to spite their face. The Chinese, despite their rhetoric, have every reason to want a Dollar that has as strong a role in as many markets as possible, at least until they can gradually restructure their economy and develop their own currency. In my opinion, they are only trying to goad the U.S. into defending the Dollar’s position.
It is true, as the article points out, that the Chinese appear to be trying to buy as much gold (and other commodities) with their Dollars as they can get away with without spiking the market or tanking the Dollar — which is actually not much, relative to the size of their reserves. But the whole point of these moves is that China wants to dispose of its Dollars without provoking a general collapse in their value. Organizing a global “cabal” (as Fisk terms it) to dump the Dollar collectively runs completely contrary to China’s interests. Nor is it clear, by any means, how Arab oil producers would be better off holding unconvertible Renminbi instead of widely-accepted Dollars.
I’m not trying to contest Fisk’s reporting. I’m sure the “Chinese bankers” and other inside sources who served as the basis for his story said what he indicates they did. But I wouldn’t accept their revelations at face value. Partly, I think it’s chest-beating on the part of some Chinese — including so-called bankers — who are proud of their country’s accomplishments but do not fully appreciate the true economic dynamics at work. Partly it’s a tactical bid by Chinese and Arab holders of Dollar investments to get the U.S. to take its debt situation and consequent inflation risks seriously. And partly, it’s a bit of wish projection that substantive economic problems could be solved so easily, with secret handshakes and clever conspiracies. If the answer were that simple, the Dollar would have been dethroned years ago. To the extent the Chinese and others place their faith in such “solutions,” they are wasting their time and shooting themselves in the foot. Personally, I think they’re smarter than that.