China Again Throws Weight Against Dollar as Reserve Currency, Calls for IMF Solution

The optimists that have long assumed that the dollar will continue to reign supreme due to lack of alternatives have just have their sanguine views challenged as China threw down the gauntlet on coming up with an alternative, non-country-specific, reserve currency.

The US in fact had this option at the time of Bretton Woods and opted instead for a dollar fixed rate standard with the dollar backed by gold. You know how that movie ended. Being the reserve currency requires that the sponsoring nation run current account deficits to get enough currency in circulation for it to serve as a trade vehicle. That’s why China and the EU are not keen about the idea of someday having the reserve currency. Both are wedded to being exporters, or at least not being importers.

But the Bretton Woods system came apart due to gaping fiscal deficits in the 1960s: substantial military commitments, made worse by Vietnam, a big uptick in social spending, plus the space program. It was evident that we had issued more dollars than we had gold to back it up. So Nixon ended convertibility and floated the dollar, a defacto devaluation. Other countries, which faced a big drop in exports engaged in compensatory government spending. That plus the oil shock, and the result was inflation in most advanced economies in the 1970s.

Many had assumed that the China talk on moving to a special drawing rights regime, or a similar approach was just that, talk to serve as a bargaining chip in negotiations. Surely the Chinese would not jeopardize the value of their dollar holdings!

Well, that simply isn’t a rational view of things. The proper way is to construct a decision tree and look at the attractiveness of various moves going forward. The FX reserves are a sunk cost. Continuing to support the greenback long term is a losing strategy, It just digs the Chinese into a bigger hole. The Chinese want their cake of a continued trade surplus without the attendant costs of supporting the dollar, and more important, continued US hegemony (yes I hate that word, but it fits here), Even if they face FX losses in an SDR regime if they insist on continued large trade surpluses, they’d have much more influence over IMF than they do over the US policies.

The practical impediments to an SDR regime is the lack of deep trading markets for investments, But the transition from sterling as reserve currency to the dollar was a protracted, messy, and disorganized affair. The Chinese prefer order and particularly want a fixed rate (or at least narrow float as they have now) regime. They see floating rates as destabilizing and as bad for trade. They increase uncertainty which deters investment.

Again, this may simply be more insistent posturing. The Chinese tend to be frontal. But if nothing else, the Chinese are signaling that they are not happy with the status quo and expect change. The US simply has not been with that program. And we don’t seem to have other ready ways to placate the Chinese. We’ve nixed deals we considered politically sensitive, to their outrage, and will continue to guard our advanced military technology. It isn’t clear what China wants in the way of gives and gets here. Again, this may be playing to a domestic audience, but negotiators can get locked into what was initially mere playing to the gallery.

This salvo coming now is also going to be perceived to constrain US fiscal deficits if we need a second stimulus package (likely). I tend to buy the analysis that the spending shortfall is large enough that this isn’t the inflationary monster that it is perceived to be. However, the fly in the ointment is first, that we have already thrown so much firepower into the sinkhole of the financial system with perilous little effect (restructuring debt, shorting up certain borrowers directly, reining in the banks, and smaller capital infusions would have been a much better course of action). In particular, the Fed efforts to create a zillion facilities to shore up TBTF markets that have become important channels for credit extension muddies the picture considerably. Monetary easing without fixing the financial system was unproductive in Japan. We would have been better off with less desperate monetary measures (dropping Fed funds to ZIRP land) and more fiscal stimulus, but that horse is out the gate and in the next county (before credit vigilantes protest, the object in my policy fantasy would NOT have been to offset teh demand fall, I see deleveraging as necessary, but to keep it from being violent and disruptive. We have achieved the latter end, or at least it looks that way now, but at an unduly high cost and with a difficult exit).

From Bloomberg:

China’s central bank renewed its call for a new global currency and said the International Monetary Fund should manage more of members’ foreign-exchange reserves, triggering a decline in the U.S. dollar.

“To avoid the inherent deficiencies of using sovereign currencies for reserves, there’s a need to create an international reserve currency that’s delinked from sovereign nations,” the People’s Bank of China said in its 2008 review released today. The IMF should expand the functions of its unit of account, Special Drawing Rights, the report said.

The restatement of Governor Zhou Xiaochuan’s proposal in March added to speculation that China will diversify its currency reserves, the world’s largest at more than $1.95 trillion. Chinese investors, the biggest foreign owners of U.S. Treasuries, reduced holdings in April after Premier Wen Jiabao expressed concern about the value of dollar assets….

“It’s extremely unlikely the dollar will be replaced as the reserve currency,” said Glenn Maguire, chief Asia-Pacific economist at Societe Generale SA in Hong Kong. “A currency needs to be internationalized and that requires a fully convertible capital account, which China doesn’t have. The second is that it needs to be adopted.”…

On June 13, Russian Finance Minister Alexei Kudrin reassured investors of the country’s confidence in the greenback by saying it was “still early to speak of other reserve currencies.” Brazilian Finance Minister Guido Mantega said on June 10 the government’s decision to switch some reserves into IMF bonds wasn’t aimed at weakening the dollar.

Federal Reserve holdings of Treasuries on behalf of central banks and institutions rose by $68.8 billion, or 3.3 percent, in May, the third most on record, Bloomberg data show.

China has started to pare its holdings, trimming them by $4.4 billion to $763.5 billion in April, the first monthly reduction since February 2008, according to U.S. Treasury Department data. Figures for May have yet to be released.

“There may be signs here of tensions mounting between the PBOC’s economic concerns over China’s holdings of dollars and the Chinese government’s diplomatic reasons for doing so,” Stephen Gallo, head of market analysis at Schneider Foreign Exchange in London, wrote in an e-mail…

IMF First Deputy Managing Director John Lipsky said on June 6 it’s possible to take the “revolutionary” step of making SDRs a reserve currency over time.

SDRs were created by the IMF in 1969 to support the Bretton Woods exchange-rate system that collapsed in 1971. They act as a unit of account rather than a currency. The cash is disbursed in proportion to the money each member nation pays into the fund.

The value of SDRs are based on a basket of currencies, shielding them from swings in a single currency. One SDR is valued at $1.54. China is proposing the basket be broadened. The current weighting is: 44 percent for the dollar, 34 percent for the euro and 11 percent each for the yen and the pound. It doesn’t include the yuan.

The dollar’s dominance of global finance buffeted developing nations last year. Investors abandoned emerging markets after the September bankruptcy of Lehman Brothers Holdings Inc. eliminated demand for all but the safest, most easily traded assets, such as Treasuries and the dollar. A shortage of the U.S. currency forced central banks to pump reserves into their economies.

“The excessive reliance on the credit of several sovereign currencies have added to the extent of risks and crises,” the central bank report said. “A currency with stable value in the long term is required.”

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49 comments

  1. bb

    be realistic. who really needs a world reserve currency?
    usa – has gold and prints dollars;
    uk – has nothing and prints sterling;
    eurozone – has gold and prints euro;
    suisse – has gold and prints franc;
    japan – has 'treasuries';
    china – has 'treasuries';
    saudi arabia – has oil and 'treasuries';
    russia – has gas/metals;
    brazil – has matals;

    who will be willing bend over to accomodate china's wishes for a world reserve currency?

  2. Brick

    This looks like an element of posturing and perhaps an attempt at strong arming the US authorities into reigning in the fiscal deficit. This can probably be looked at as the Chinese trying to protect their investment in the dollar. If the US government do not listen then I think you can see more forceful attempts to persuade the US, perhaps in cutting back in treasury purchases by say 30 percent for a month.
    The more noise we here about an alternative reserve currency the more I suspect it will eventually happen with all its consequences for the US economy. The question is rather in what timeframe and how quickly the transition will be and will the US economy have recovered by then. I guess it is not anytime soon but might be within a 5 year time frame especially if volatility in the US dollar picks up significantly.

  3. Aki_Izayoi

    I'll modify this

    usa – has gold and prints dollars;
    uk – has nothing and prints sterling;
    eurozone – has gold and prints euro;
    suisse – has gold and prints franc;
    japan – has 'treasuries' and Japanese anime;
    china – has 'treasuries' and cheap labor;
    saudi arabia – has oil and 'treasuries';
    russia – has gas/metals;
    brazil – has matals;

    Short sterling vs dollar. Too many people bearish on the dollar now, and sterling is worse than the dollar, but doesn't receive its "fair share" of hate.

  4. Independent Accountant

    YS;
    "Sunk cost". That's CPA talk. I think China has given up on the dollar and is making the most graceful exit it can. China's new reserve currency talk is just that, talk. An "alternative, non-country-specific reserve currency"? How about that four-letter word: gold! Krugerrands, American Eagles, Maple Leaves and Chinese Pandas are all worth the same. An ounce of gold is an ounce of gold. Stop there.

  5. frances snoot

    @bb:

    The IMF is already on board to deliver a new reserve currency. New reserve currency means power to direct trade for profit of IMF coordinating banks:

    http://www.forbes.com/feeds/afx/2009/06/22/afx6569595.html

    IMF is happy to accommodate BRIC countries at US expense:

    http://online.wsj.com/article/SB124463884266502011.html

    China has the checkmate move here:

    http://seekingalpha.com/article/144503-market-gold-action-and-chinese-owned-treasuries

    Fed Reserve looks to be insolvent:

    http://www.ft.com/cms/s/0/4a759a40-61a1-11de-9e03-00144feabdc0.html

  6. Gunther

    Another modification:
    usa – has gold, debt, agriculture and army, prints lots of dollars;
    needs energy, money, manufactured stuff
    uk – has debt, a love/hate relationship with the EU and prints lots of sterling;
    needs energy, money, manufactured stuff, food
    eurozone/EU – has gold and prints some euro;
    needs energy commodities, makes stuff, has agriculture
    suisse – has gold and prints some franc;
    japan – has 'treasuries' and Japanese anime; makes stuff, needs commodities, energy, food
    china – has 'treasuries,’ cheap labor, army; makes cheap stuff, controls water for half Asia, prints lots of yuan, needs someone to copy from, energy, commodities
    saudi arabia – has oil and 'treasuries'; needs manufactured stuff and food, needs military protection
    russia – has gas, oil, metals and military; needs food and infrastructure investment
    brazil – has metals, cheap labor, is self-sufficient in energy

    Imagine what happens to the various countries if
    1. The system operates without reserve currency and trade is settled in the currency of one trading partner.
    2. The system works with a fixed amount of currency that can not be inflated whatever that might be.
    3. Another ‘inflatable’ reserve currency is created; how will someone be willing to accept it as store of value?
    Who will benefit and who will loose?
    The situation looks messy on closer inspection.

  7. S. Myles S.-G.

    I want to smash someone's head the next time BRIC is mentioned as an entity.

    Let's be clear here, they are in no way in any way a coherent economic entity. The Brazilian economy is doing fine, but long-term, hopeless. The Russians have a mob economy. India is doing very well, and so is China, but China is doing somewhat better and has more economic firepower.

    Lumping the four together just confuses things.

  8. frances snoot

    Deep and wide:

    http://www.atimes.com/atimes/China_Business/KE29Cb01.html
    "SDRs were created by the IMF in 1969 to support the Bretton Woods exchange-rate system that collapsed in 1971. They act as a unit of account rather than a currency. The cash is disbursed in proportion to the money each member nation pays into the fund.

    The value of SDRs are based on a basket of currencies, shielding them from swings in a single currency. One SDR is valued at $1.54. China is proposing the basket be broadened. The current weighting is: 44 percent for the dollar, 34 percent for the euro and 11 percent each for the yen and the pound. It doesn’t include the yuan."

    Okay, what is "the cash is disbursed." Are they talking about a new reserve currency here, or is this an electronic credit? It says, "cash", but I think the IMF wants cashless.

    (article continues)
    "The creation of the SDR marked the most significant international financial agreement since the emergence of the Bretton Woods system at the end of World War II, which was based on the gold-backed US dollar. That system was created against the advice of John Maynard Keynes who, at the Bretton Woods conference of July 1944, proposed the creation of a synthetic reserve and settlement currency (which he named the bancor), based on the weighted average value of a basket of 30 commodities. In addition, Keynes proposed the establishment of an international financial clearing house with rules aimed at automatically redressing large international trade imbalances…

    Zhou proposes to enhance the use of the SDR as a reserve asset and to make it usable as an invoicing and settlement currency in international trade and financial transactions. With those objectives in mind, he proposes: 1) to make the SDR convertible into other currencies; 2) to promote the use of the SDR for commodity pricing, investment and corporate book-keeping; 3) to create SDR-denominated tradable financial instruments; 4) to update the formula used for the allocation of new SDRs by the IMF; 5) to update the valuation base of the SDR by including other currencies in its base (presumably including the renminbi); and 6) to promote confidence in the value of the SDR by shifting from a purely unit-of-account system to a system that is backed by real assets such as a reserve pool."

    What the heck are SDR denominated tradable financial instruments?
    http://www.themalaysianinsider.com/index.php/opinion/breaking-views/24327-systematic-push-to-make-the-yuan-international–ching-cheong

  9. Alex

    "That's why China and the EU are not keen about the idea of someday having the reserve currency. Both are wedded to being exporters, or at least not being importers."

    While I agree with the general gist of your post, i have to challenge the above statement.

    Control of a reserve currency is a natural outgrowth of military control, with significant levers and wealth accruing as to the controlling power.

    If this weren't the case, we would have seen mass demilitarization and a utopian, Randian world of people happily competing with one another on purely economic projects, with borders erasing and general worship of those most capable "producers" (*gag*)

    So a corollary is that, the desire of China , the EU and Russia to issue the reserve currency is directly related to their desire and capability for military power.

    The EU is too fractured to ever challenge the US in this respect, Russia is too weak, but China has all the necessary ingredients to do so, in time.

  10. Alex

    @Gunther: By your analysis, Canada is looking to be more and more of a safe haven that will benefit almost no matter what. At least that's what i tell myself!

    Has – water, resources (including gold, oil and diamonds), agriculture (with great potential as climate warms) educated population, reasonably free of corruption

    Doesn't have – good climate :(

    Needs – people/immigration

  11. Richard

    I think it might have been on Angry Bear or Zero Hedge who noted that China never particularly complained about the dollar as it declined from 2002-06 despite buying all those treasuries because it was part of their export boosting strategy and their exports (along with foreign investment) boomed in those years. But starting with 2007, as American consumers first paused, and then collapsed as their debts could no longer be serviced by their flat or declining real incomes, this export growth slowed and then collapsed. Although China still has a large surplus, its exports to the U.S. are now declining and this disrupts the deal. The Chinese are now flaying about, doing things like shifting their surplus dollars into commodities (which as they may discover subjects them to a sharp boom and bust risk, especially as contraction continues to bite). And its not just the Chinese that are discomfited with the breakdown of the U.S. consumer last resort. U.S. and other multinationals have structured their business plans on moving production to China (and other low cost countries) and import back into the U.S. And to outsource IT and back office jobs to India, Malaysia, Philipines, Bangladash, and even China where good educational systems produce large numbers of skilled, English speaking, workers. For the individual company of course, this business plan makes great sense. But since they all started doing it, they have ended up killing the goose (the American mass consumer middle class) that laid the golden egg. With the U.S. elites now deciding that social security and medicare are something the U.S. can't afford, want to you think will happen to savings rate in the U.S.? Until U.S. wages and incomes fall until they reach the level for like workers in India, China, Vietnam, and the Philippines, what engine of growth or investment exists in the U.S.? Finally, even they finally become competitive, will most workers in the U.S. still be considered educated or the U.S. infrastructure modern given that the U.S. elites, following the the Deep South and Latin American model filitrated through Ayn Rand, don't believe in sharing their worldly goods with all those contemptible losers who did not have the foresight to be born rich and privileged?

  12. marsha donner

    always amazing to me that we cannot visualize how positive this could be for the US/us. it would take US off the hook of having to be THE nation among all and allow the becoming of one nation among many.
    imagine not having to be the bully, the last refugee, the world police. what a freeing experience it could be..what an opening to another way of living.
    far better to have to 'negotiate' economically with all other countries then end the dollar slide with some huge war (we've been there done that please,oh please).
    might even force/encourage us to actually produce something useful for a change instead of 'producing financial innovation' that is hardly needed and greatly resisted at present as the pride of american export.
    imagine if the US got out in front of this effort, lead this effort to a world basket currency??
    now there is change i could get behind and what a vehicle for putting wall street in its place…change the arena completely instead of the moving the chairs around the deck of the titanic.

  13. frances snoot

    @Marsha:

    Wouldn't that be like the US passing the torch of global trade hegemony to a group of international bankers? Will the 'new pivot' (Obama's words) do a better job being nice-nice?

    The bankers removed the chairs from the deck of the US Titanic: they put the chairs in a little yacht and poop-pooped off to Asia and greener pastures.

  14. emca

    I would be inclined to dismiss these statements from China as mere posturing, except for the annoying fact Geithner has just journeyed to China to reassure China on U.S. trustworthiness. From the Washington Post:

    //BEIJING, June 1 — U.S. Treasury Secretary Timothy F. Geithner on Monday sought to reassure China, America's biggest creditor, that its hundreds of billions of dollars of holdings in U.S. government debt remain safe, even as investors dumped Treasurys amid signs that the global recession is easing//

    Why is China again talking global currency? Weren't they 'reassured'?

  15. gregory d.

    The dollar will continue to weaken as we print money to pay for retiring baby boomers and the emergency bailout of dying industries.

    The Chinese are already shifting purchases of Treasuries to the short end of the curve. They are setting up swap arrangements with other trading partners to avoid the US dollar.

    The financial crisis is NOT over, nor are the tough times for the dollar. The world will eventually shift away from using the US dollar as its reserve currency, replacing it with SDRs or another major currency.

    We are a declining power, paired up with a sinking currency. The developing world does not want to be held hostage to America's reckless ways any longer.

  16. marsha donner

    gregory above:

    exactly, US is a declining power with a declining currency. Imagine the power in recognizing that and getting out front and leading the story to a more balanced picture of a nation among many, a more global basket of currency.
    otherwise..the story is we continue along the lines of head in the sand and debt to protect the no. 1 place in the world and all the headaches that come with it…for what..pride? futile to fight it..so lead the change and make it more orderly. or, war of some sort as last resort of portection? military power has always gone hand in hand with reserve currency…tht is our fate if we cannot see an alternative and get ahead of the curve.
    AND the idea that China cannot afford to dump dollars or let the dollar fall is sear maddness. they think long term and in the long term a 1T hit is not much for them over a decade of visioning.

  17. Lord

    The Chinese may want the moon but that doesn't mean they will or even can get it. They don't want to become the reserve currency and who else is willing to be the next sucker? Let's just put Stanford back in business and the Chinese can deposit it all with him.

  18. frances snoot

    @marsha:
    you are talking about sovereign default you know…if the dollar is devalued according to the Charge of the Blight Brigade you invision…

  19. Hugh

    I can't say I have a lot of sympathy for the Chinese who have manipulated their own currency for years to enhance their export position and take advantage of the deficit spending characteristics of the US dollar as reserve currency. I am in no way excusing the idiot monetary and fiscal policies of the US in this either. I am just left cold that the Chinese who had no problem riding the export bubble up now are shocked, shocked to learn there is a downside to it too.

    I can't help thinking that this has less to do with establishing a new and more stable world financial order and more to do with another nationalist reaction to world depression.

  20. HoosierDaddy

    And of course the "free traders" are surprised that the endgame for outsourcing is the collapse of American power and influence.

  21. marsha donner

    F snoot….ok, so apparently you don't think a gradual move to a basket for global exchange is good. all i am saying is that the dollar is in huge trouble, the world is changing, countries have lost trust in US financal leadership, political leadership and military bullying.
    so, rather then pour countless trillions down the hole to resist the inevitable, why not get ahead of the curve, provide some real leadership to make the change that the world wants…more equal powersharing at a minimum.
    further, my point is simply that this is better for the good ole USA in the medium run. takes US off the hook for so much.
    i am not naive enough to think this is not going to be resisted tooth and nail by those few making mega bucks off the status quo…just planting a seed (green?) to see if we cannot visualize a different way of looking at the pressure that are coming economically..that might not lead to some war as a 'logical' outcome' in our defense of the 'american way of life…'consume way more then our share at the expense of the rest of the planet'
    let us get out in front of the process rather then imagine it can be resisted at huge social economic and spiritual costs to us all.

  22. Steve

    > "Surely the Chinese would not jeopardize the value of their dollar holdings!"

    This is a red herring. The main reason the Chinese need the dollar to be high is to preserve their export markets.

    So even if you could argue that the dollar holdings can be treated as a sunk cost you'd still need to show how they don't care about their export-driven economy.

    I think their threat is ultimately an empty one but their goal is to persuade us to take less risks with the dollar.

  23. skippy

    Whew, American exceptionalism sure is stinking up the planet these days, a putrid gas and if found to have UV capture quality's it may hasten global warming/waring exponentially.

    China has a cultural memory how long [?] attached to the same geographical location. China can and will out last all global interlopers, they are in the game for the long run not just short term power grabs, an inch at a time becomes a vast measurement given enough geological social strata. Some one above made the comment of china flailing around, in my observations the US is the one breaking all the china (pun intended) in the global shop not the other way around. Ask Vinny G about cause and effect. The first step to any recovery is accepting ones actions and their repercussions. Maybe its time for America to have a big healing child like cry, get over its self and move on with life. Marsha Donner makes some level headed observations, think new and not try and drag the past ranking of #1 into the future like an anchor around our necks.

  24. frances snoot

    "to make the change that the world wants…"

    Sounds like an ad for Coca-cola: "I'd like to teach the world to sing…" Good old America, always looking out after the 'world's' best interest; always ready to spread democracy!

    Ms. Donner, I appreciate your sentiments. But sentimental thinking makes for rash decisions. If we bow our backsides to the bankers, they will surely have their way with us. And the world will suffer, for cooperate profiteering is behind the move for "change".

  25. marsha donner

    f snoot i surely know and FEEl what its like to bow and have bowed our backside to the bankers. my thought was to imagine a larger context with different allies taht might take some control from the bankers.
    as it stands now…looking and working only within the US context and a narrow perspective of american exceptionalism (as stated above as well and so well) we have zero ZERO hope of winning or changing the bankster system of wall streets domination of main street and beyond (see my post on Yves' other stream today about how long before the middle class…etc)
    if we don't change the conversation from the boundries dictated by wall street and the msm then its really a lots cause.
    someone smart might even imagine aliening with the chinese and french etc to create a larger playing field where some flanking might be possible.
    no to mention the intended consequences of removing the shackles of power that is worse for us even then the world.

  26. frances snoot

    @Marsha:

    Okay, I agree wholeheartedly. But we must disband the IMF and the World Bank and give the UN a long extended holiday…really long and really extended. Then we can discuss what Americans really want; we can compromise; we can bring home the troops.

    I wish, but I gave up hoping long ago.

  27. eindbaas

    YS: "That's why China and the EU are not keen about the idea of someday having the reserve currency. Both are wedded to being exporters, or at least not being importers. "

    Really? In Q1, the eurozone actually ran a trade deficit of around 50% of the US'.

  28. sugarpuddin88

    Why don't the American sheeple vote with their feet?

    Obtain a 2nd citizenship & more your money out of US dollars?

    How hard is that?

    Answer: Not hard at all!

    (Everbank will even roll your money vehicles like IRAs into foreign currency IRAs)

    Why do the Americans take it like a little bit@h?!

  29. frances snoot

    @sugarpuddin88:

    Can't move all your money out: US Patriot Act, money laundering provisions. A certain amount will flag the authorities; it's not that easy.

    How does one obtain a second citizenship? Ever hear the term, 'ugly American'? We're not super popular overseas right now.

    Unfortunately, most Americans are in a state of DENIAL and attack any messages that are contrary to the MSM hype.

  30. Yves Smith

    eindbass,

    Being a substantial net importer for one quarter is a mishap, not a policy objective.

  31. frances snoot

    Yves:

    Do you know what a sdr-denominated tradeable financial instrument is? Are these imagined, planned, and how would they affect the bond markets of sovereign nations???

    You had a very good commentary today.

  32. Richard Kline

    So Yves, it’s a pleasure to have you back in the saddle and on song. This post is the kind of Yvesian sweeping, spot-on synthesis in pithy presentation which has made NC my ‘smart drug’ of choice. I have a smallish quibble with one thing, and then a few points to weigh in with my SDR .0025, here.

    First off, you folks pushing gold as the reserve medium, this idea is a rare earth fantasy which will never happen, and advocating it does nothing for your credibility. I don’t say that as a personal attack, but seriously y’all need to get real. To begin with, there is not enough base gold and recoverable metal _on Earth_ to serve as the payable base to the world’s economy, period. Not the real economy. Not remotely the financial economy, for better and worse. But no major country has used gold as its currency reserve in the true sense since the modern era began c. 1500, and really since the Middle Ages. Really, you read that right. In fact, one of the few defining criteria for the Modern Era is in fact the financialization of economic interactions. Currencies of account, letters of credit, and ledger-based commerce has been the norm on commercial exchange and the financing of domestic production since the 1300s in Europe. Oh, everyone _claimed_ to be metal-based. And in fact many claims were metal-on-demand recourse. And some transactions, or more accurately those between some counterparties, were specie-only. But there was never enough actual metal to go around, and the financial economy of Europe and gradually everywhere else depended absolutely on ledger-based leverage. Yes, shortages of actual metal have major impacts: gold and silver really did matter. But the basis for economic interaction as linked to them but not limited to them.

    No one has run on gold since the Middle Ages: is that what y’all are advocating, then? Only small countries with bad credit ran close to the gold in their vaults. It seems to have escaped you notice in this that they were consistently very poor countries, with many powerless peasants, not coincidentally because most people couldn’t get any credit, and only oligarchs and the upper class had any real access to capital. It’s a great idea to ‘think local,’ but if that means sinking back into a peasantry dominated by the local capital accessory, I’m not for it. I doubt that y’all are, either. I’m not saying don’t speculate in gold if that’s what lights you up. But the world economy will never run on a metal base again, and no regional economy will do so unless there is a local collapse of sovereign governance. And even then take a look, Somalia doesn’t run on gold, friends. Advocating gold as a macro-financial option is gold-foil hat stuff. I don’t want to be in your face but them’s the facts, friends.

  33. Richard Kline

    Yves: “Being the reserve currency requires that the sponsoring nation run current account deficits to get enough currency in circulation for it to serve as a trade vehicle.” I would say half yes, have no but yes to that. The function of a reserve currence is exactly to get in circulation as a trade vehicle. It has to be of reliable valuation, highly liquid, and ideally plentiful. Those ‘currencies of account’ just mentioned; they were serviceable, but a reliable reserve currency was and is much better because it eliminates counterparty risk. With ledger-based transactions, one has to be confident that ones counterparty is good for it; with a reserve currency, when it’s handed over you’re good to go. On the other hand, it is not necessarily true that the nation of a reserve currency run a current account. For example, the Dutch case is not fully explainable in this formulation. The Dutch were never a major industrial power; they had advantages, but dominated no industry . . . until _after_ they lost reserve currency status to Britain, and had to compensate. Dried fish was their own principal wholly produced export. The Dutch bought from one place and sold in another; that was the heart of it; moving timber and grain from the Baltic and sold it in Spain, for example, the backbone of their financial power. They financed this themselves—capturing the interest income—shipped it in Dutch tonnage—capturing the haulage fees—and sold it at a mark up—capturing the value-added. Oh btw they demanded specie from the Spanish and those that had it, giving them a great chokehold on hard-money flows in Europe, the sweetspot of their financial weight. Somewhat like controlling international trade in oil for the late 20th century global economy, say. But much of what they moved never came ashore in the Netherlands, so issues of ‘current account deficit/surplus’ are ambiguous; or more accurately to me are not terribly useful.

    The strategy of the post-industrial US was sort of to become this several orders of magnitude larger; to control the arbitrage of world commerce while producing much less of it ourselves. Why this failed for the US is a separate discussion I’ll skip now, but it has failed.

    And Alex, it’s a misnomer to claim that reserve currency status follows military dominance: this was never true even including the present instance of US acquiring the status of the sovereign issuer of the world’s reserve currency. We acquired it by default, when Britain couldn’t meet its debts and did a quasi-default/devaluation in the Thirties. And at the time, the US was not the world’s dominant military power, though certainly had the greatest power potential of any state of the time. Portugal briefly, the Genoese, the Dutch. These were never militarily dominant; even their naval success, while considerable, was insufficient to outweigh any large combination of other powers. Britain was never militarily dominant. This is a longer argument than any of you care to read, so I’ll stop there. All of the holders of the international reserve currency in the Modern Era were the major commercial arbitrageurs of their time, and as production considerations became increasingly important they have all been major real economic producers. All of them were militarily successful, but invariably as the spider-in-the-web of an alliance system created and sustained by their _financial wherewithal_. Consider that when you consider the future, friends.

  34. Richard Kline

    The world wants a reserve currency. It is manifestly _not_ in the interest of the rest of the world as a whole for that currency to continue to be the $US. This doesn’t mean that American loss of reserve currency status is inevitable, although in my view such a loss is highly probable. The questions then are three: How to push aside the US? How to get a stable new regime? Who controls said stable new regime? The first is already achieved. The US has ruined itself financially. We can recover, but are doing the wrong things to recover well or fast, and are, in my view, certain to recover with a loss of influence and status because our real production has declined and our key financial arbitrageurs are dead zombies living on money thieved from the next generation of taxpayers. I do not know that SDRs are the solution, but they are the readily available vehicle so they are pushed at present, yes. I think this is an opening bid rather than a final draft. Much of the world would love to dump the dollar. Latin America couldn’t drop it fast enough given a choice. SE Asia doesn’t need or want us. China has other plans. Russia knows the risks and costs, and would prefer another alternative. It wouldn’t surprise me in the least if the oil producers had a viable alternative they’d ditch or sorry, belligerent, destabilizing, carpet-bombing asses; if they thought they could get away with it. The Europeans will find that they can live very well with out it, but are weighed down by a backward-looking minority; another story. But a stable, common platform, a truly large and reliable ‘currency of account’ would be very valuable to the world as a whole. Now, one size does not fit all, and the transition will all but surely have repercussions for the existing macro-economic strategies of major players, there’s the rub. Once they are optimized to a new regime, most will prosper just fine, it’s getting there that’s the problem. Well, we have global recession at least and crisis, so instability is already in our face: no time like the present. How does it go, never let a crisis go to waste?

    The real nut with a different reserve currency is who controls it. SDRs are likely to be unstable because sovereign countries, dadrat ‘em, can issue to much or little of their own currency/debt, shifting the base around which SDRs are written. It would take something like ‘ratings board’ at some post-IMF to keep order. And who those guardians might be would matter very, very much. Now, ‘the markets’ move currencies. Although as we see, ultimately it is central bankers and sovereign fiscs who backstop the real movements, don’t fool yourselves folks.

  35. Richard Kline

    I’m convinced that China is totally serious on getting out from under the $. To me, they never expected to get stuck with as many pallets of Treasuries as they have now. The massive over issuance of global credit shoved the money upon them, is more how I would read trade and capital flows. What was a good strategy with a US deficit of a few hundred billion became a destabilizing strategy at two or three times that. And yes, currency loss is not a sunk cost. It’s coming, and they know it. And really, no one can do anything about it. The US stimulus is nothing in that regard; something the US real productive economy could offset, and even valuable if it puts a prop under demand at some stable level. It’s the massive issuance of guarantees and Feddy-bucks to the zombie financials which is truly destabilizing for the $, for the US, and for the global economy. The Chinese are thinking ahead; that’s to their credit. It’s not clear that the US is thinking at all, but if those who decide for us _are_ thinking, it’s clearly wishful thinking.

    And stop and think: supposing that in the shift to a new reserve currency regime China takes a 20% loss on de facto US currency devaluation. That’s a trillion dollars more or less at present. . . . That’s a cheap cost to get a new, stable, non-US controlled reserve currency. Really. The US has, so far, spent $3 trillion on a useless, endless occupation in the Near East which has done nothing but damage our mid-term strategic positioning. And China is already going to take that currency loss because the US clearly cannot politically restrain itself from issuing too much sovereign debt to the point that our currency must and will slide, quite aside from the desire of the many around the world to get an option for themselves which they would prefer. So why _shouldn’t_ the Chinese try to get another better choice out of something which is going to happen anyway? Dumping the $ gets them blamed and does more harm then good. Edging away while we slide down the wall in a puddle of our own drunken vomit: I mean, wouldn’t _you_ do that, friends? Especially if you could pick up the wallet on the table and walk away with it, no questions asked. Damn betcha.

    The present US macro-financial policy is, what’s a good adjective, Weimarish (Weimarische, does anyone know Deutsch?) That only speeds the probable change to the presumptive change, Chinese advocacy of it or not. And paradoxically, American may live better off the financial steroids of the reserve currency; yes, I’m with you on that, Donna. Our oligarchs will stand smaller, and they won’t like it. And our costs will go up, but our profligacy will likely go down; to me, that’s a win. If we can get there without a war or a civil war. I’d settle for a revolution in a pinch, but I’m not sanguine on a likely or good outcome there.

    Word verifications says 'lases pay.' Anyone know Francaise? Nuff fer the nonce.

  36. skippy

    @Ricard Kline said… This is a longer argument than any of you care to read, so I’ll stop there.

    Very presumptuous of you old boy, your on a roll, do go on when you have your breath back.

  37. frances snoot

    "And paradoxically, American may live better off the financial steroids of the reserve currency; yes, I’m with you on that, Donna."

    Skippy, I'll give Mr. Kline his breath back!

    Please, Mr. Kline, explain how sovereign default or our nation and the inability of the average American to fund import purchases will make life better over here? Are we looking to altruism for strength? Remember: Nietzsche warned that altruism is toxic.

    Here are those in Washington who prefer to pursue the sdr-based system operating out of the IMF. But you do realize, Mr. Kline, that the IMF is a creature of the BIS, which is licking it's chops right now in anticipation.

    http://inthesenewtimes.com/2009/06/11/china-discovers-value-in-the-imf/
    "Zhou invoked John Maynard Keynes, who proposed a supranational currency at the time of the Bretton Woods conference in 1944 as the most logical, multi-polar solution to international settlement of accounts. However, Mr Zhou probably derives his enthusiasm for the SDR from philanthropist George Soros and economist Joseph Stiglitz, enthusiastic cheerleaders for the SDR, rather than from a close reading of Mr Keynes.

    Both Soros and Stiglitz consider the US dollar an inappropriate currency for the international settlement of accounts because of the vast deficits the US has been running…

    Surprisingly, the dominant force in the IMF – the Obama administration – does not appear hostile to the SDR.

    Obama’s economic brain, Office of Management and Budget director Peter Orszag, is a follower of Stiglitz. There are signs that the Obama administration accepts the idea that being able to fund US deficits through creation of international fiat currency creates a moral hazard, and that China’s desire to move away from the dollar is understandable and, from a macroeconomic point of view, perhaps even desirable…
    The White House has not been able to frame or sell the IMF credit line very effectively. Domestic consensus building has largely been limited to the release of a letter from the Bretton Woods Association – albeit with an impressive bipartisan list of signatories including Henry Kissinger, Condoleezza Rice, Paul Volker, Brent Scowcroft, Colin Powell, and Robert Rubin – urging arrangement of the credit. [1]

    Instead of simply defining the $100 billion as a credit, Orszag awkwardly characterized it for budget purposes as a low-risk swap of assets whose risk, if it took place, had a 5% risk of default, that is a budgetary cost of $5 billion. [2]

    In order to speed approval of the credit line, the IMF credit line was tacked on to the Supplemental Appropriation for the Iraq and Afghan wars. The Senate passed the appropriation but House Republicans have seized on the issue – as they did the case of Guantanamo prisoners – as a way to defeat Obama both domestically and in the eyes of the international community."

    I don't agree that Zhou got his inspiration for the SDR idea from Soros. Zhou is brilliant, and he is a central banker sold into the system operating as a chimera for the profit of independent banks at the expense of national sovereignities.

  38. Edwardo

    Marcia Donner, you are naive. Your question, in essence, is, imagine the power in seeing one's preeminence fade away? That's not how elites think, anywhere, let alone here, I can assure you. The very powerful always seek to maintain their position, loathe the very idea of losing their lofty status, and generally do all they can to prevent such an outcome. And no matter what you may read, see, or be told, in the months and years to come, the U.S elites and their useful idiots in the press and elsewhere will seek to expand the use of their favorite blunt instrument, the military, to forestall the loss of global super power status. Of course it will fail, but that says nothing about the motivation.

  39. marsha donner

    yes, naive and hopeful and just presenting my ideas/feeling of some larger picture alternative.
    R. Klein said it all much better then i could. the hand writing is on the wall. why not read it and get ahead of the curve and start posturing for the best deal we can in a new currency regime.
    R. Klein listed how 'everyone' wants the US hegomomy dealt with and perhaps this crisis..or the one near to come (again) will give such an opportunity.
    BUT..if the 'elite' as mentioned above cannot bear to lose power into powersharing then what…some sort of largish war to merely postpone the inevitable.
    Certainly China and Europe have been happy to see US get bogged down in Iraq etc etc…and clearly China and EU will avoid getting involved in the next big military folly..and the only outcome will be a further stretched and weakened USA.
    so, if readers above can tell me what the outcome of continuing to bury one's head in the sand will be…some naive hope that somehow the world economy will turn miraculously around the dollar and good ole USA will remain the superpower/only power in the world for the next 20-30 yrs i am open to hearing it.
    i am open to hearing and seeing the path toward a successful reinflation of the US economy to 2005 standards without industry and zomie financial center…(not that i want a 2005 outcome..i do not!)
    the sooner we face reality about our tenuous situation and the unsustainability to hold on 'forever' the better.

    we will need/should want powerful allies, rich in natural resources.
    and IF folks look to Canada, for example, as the buffer, go to place for water and oil..have another think. I am currently living in canada and have been for 10 + and can tell you there is near zero appititite to be exploited and used much longer by the 'bully from the south' (as SA calls the bully of the north)..(disclaimer..dual citizen and dual taxed too)
    so, we admire the chinese for their long view and patience (and we hate them for it too) when will we get smart and patience too and look beyond the current Q and 24 hr news cycle..beyond michael janckson and who the next top model is?
    and THANKS RK for using word and clarity for all to see.

  40. frances snoot

    @Marsha:
    We've been brought to the brink, drug over the coals by our hair, by a small section of our country that has gambled recklessly, disregarded law and common sense, and to rectify the ills the financial barons caused (13 T dollars of our children's money: our children's future spent on the ground) we are to trust these same fools and thieves? We are to strengthen the position of the criminals? We are to sell ourselves into slavery and poverty? If we do not bow before the political slavering 'leaders' of our country and the bankers who hijacked our economy, we are burying our heads in the sand?

    I repeat: dissolve our union with international banking interests, cut off aide to the IMF and World Bank, the UN, and the banking institutions. Reinstate the laws that kept separate the savings of the people and the villains in finance.

    I did not recommend inaction, but the action you, Ms. Donner, recommend is inaction surely. WE have but to do nothing, the bankers will sew us up nicely for elite interest in bags designed to fit.

  41. Tim in Sugar Hill

    Richard Kline wrote:

    > the kind of Yvesian sweeping, spot-on
    > synthesis in pithy presentation which has
    > made NC my ‘smart drug’ of choice.

    Nice alliteration there. Superbly sibilant and provocatively plosive.

    Oh and what you spoke about? Terrific. Really great. I'm with Skippy. Please continue when you've got your breath.

    Tim

  42. The Rude One

    If the Yuan RMB were freely convertible, there would be no problem in the international trading regime. It's been held at about 6.8 per dollar for some time now. Having lived in China I have little doubt that a float would double its value and reduce the cost of exporting to China by a corresponding 50% – or more. Yet the Chinese regime resists this, for obvious reasons. A float takes away its control over finance and money flows and would undermine the basis of its rule. Given that the rest of the world works on the opposite principle, the SDR, which would presumably include the Yuan and the Ruble, is at present not a practical alternative to the dollar.

  43. frances snoot

    @TheRudeOne:
    What if the new system is cashless? Where did you read that China's policy would be to float the yuan? Stiglitz is the guiding force right now in laying a blueprint for the sdr-denominated credit system.
    Here is a UN directive to deal with the Global Financial Crisis put out last March:
    http://www.un.org/ga/president/63/letters/recommendationExperts200309.pdf
    " To resolve this problem a
    new Global Reserve System—what may be viewed as a greatly expanded SDR, with
    regular or cyclically adjusted emissions calibrated to the size of reserve
    accumulations—could contribute to global stability, economic strength, and global
    equity. Currently, poor countries are lending to the rich reserve countries at low
    interest rates. The dangers of a single-country reserve system have long been
    recognized, as the accumulation of debt undermines confidence and stability. But a
    two (or three) country reserve system, to which the world seems to be moving, may
    be equally unstable. The new Global Reserve System is feasible, non-inflationary,
    and could be easily implemented, including in ways which mitigate the difficulties
    caused by asymmetric adjustment between surplus and deficit countries." (Stiglitz was the chair behind the development of these proposols.)

    A lot of claims made in support of the Stiglitz agenda are that it will enable "global justice" and avoid "systemic iniquity" inherent in sovereign systems. It looks good to go as the US most probably has an insolvent central bank and cannot avoid default.

    New system will make national sovereignty a ritual rather than a practice and will lead to profound evil in the consolidation of trade power through currency control in the hands of a few. (UN led revision for Utopia is not uber-achievable, why would this be so?)

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