I’ve been watching China’s brilliant maneuvering of its currency into position to seize the US dollar’s place as the world’s major trading currency for some time now, but up until now most of the discussions around the topic have been fairly general.
This state of affairs has been changing quickly, however. At the beginning of April, I noted that China had initiated a currency swap with about half a dozen of its trading partners that was worth $95 billion. This essentially meant that those countries would be able to buy Chinese goods in Yuan rather than dollars, which in turn would mean that the Chinese Government would have $95 billion less that it would need to roll over into US Treasury Bills (at a time when the Government will be attempting to fund a record deficit).
Shortly after reading the article, Thomas Naylor of SVR mailed me a copy of a recent issuer of the American Conservative. In it was an amazing article that first lays out a very believeable worst case scenario, but then backpeddles to accept the conventional wisdom that the Chinese are as codependent on the Sino-American economic system as America is. The assumption is this: if either breaks the status quo of Chinese savings subsidizing American overconsumption, the whole world economy goes down in flames.
I don’t fully buy this viewpoint. Yes, China would lose a metric fuckton of wealth if the dollar crashed, wiping out the value of its T-bill holdings (which presently stand at around a cool $1 trillion). However, everyone seems to forget the magnitude of the rent that possessing the world’s reserve currency allows a sovereign government to extract from the rest of the world. We as Americans seem especially apt to forget about it, seeing as we’re its primary beneficiaries. Politicians like to cloak post-WWII American economic dominance in terms of American Exceptionalism: we’re the greatest country in the world, have the most innovative people, yada yada yada.
The real reason for our prosperity is far less grand and ego inflating: since everyone else in the world uses dollars to trade amongst each other, we can export our inflation. We can print money at a rate that would cause hyperinflation in any other nation, but in our case the pool of money in circulation is much larger than our own economy would ever require, as every country that wants to buy foreign goods must have dollars. The newly created money enters into the American economy first, when it has the most value, and by the time it trickles to the rest of the world its value has begun to decline. This process transfers real wealth (in trans-monetary terms) from the countries that use dollars to the United States.
I don’t know the exact figures for how much this rent translates to each year, but it must be enormous, and I’m going to do some research in the coming weeks to see if I can find a hard figure. However, understanding this process casts the Sino-American relationship in a wholly different light; one that leaves China with a strategy with which to make an end run around the supposed economic mutually assured destruction that protects both American hegemony and the “American Way of Life”.
Essentially, I envision in my mind’s eye a very simple spreadsheet somewhere in a bland concrete office building nestled in an obscure suburb of Bejing. In one column is the total losses China would incur if the dollar crashed. In the second column is the total losses they’d incur if they instigated the dollar crash (column two would be substantially less than column one). And in the final column would be the yearly inflation-export rents that China would accrue should the world substitute the Yuan for the Dollar as the reserve currency. Unrest and unemployment is increasing in the Middle Kingdom as the government fails to meet its growth targets; that column 3 subsidy is starting to look more and more appealing.
This would functionally work out because the Chinese government has kept the Yuan artificially below the value that a free market would bear. As such, if the dollar crashed it would make sense for the Chinese government to stop subsidizing the Yuan. In a world where most wealth is stored in dollars, people would be desperate for some safe haven from the T-Bills that turned into time bombs. A rising Yuan would fit the bill, and as more people fled to it, the value would further increase, letting the Chinese government export its inflation in EXACTLY the same way that we have been for the last thirty years.
Now, the fact that this hasn’t happened yet means that there are still barriers to the Yuan effectively functioning as a global reserve currency. However, some of China’s best economic minds are hard at work, as this article from the Asia Times demonstrates. They have started a pilot program for certain export regions to settle their trade balances in Yuan rather than dollars. While this program is limited in scale, when combined with the PRC Government’s currency swaps with other countries, it seems the prototype for a Sino-Centric economic order is becoming quite robust. Let’s just say I’m glad I have some very trustworthy friends who speak Mandarin.
Update: The Chinese Government just released their gold reserve numbers for the first time since 2003, and they’ve been buying.