China's message to the G8 unlikely to go down well
When President Hu Jintao joins his opposite numbers from the Group of Eight club of rich countries next week at their summit meeting in the medieval Italian city of L'Aquila, he will be keen to push Beijing's proposals for a new international reserve currency.
Mr Hu's eagerness is understandable. After years of running massive trade surpluses and intervening heavily in the foreign-exchange market to prevent the yuan appreciating against the US dollar, China is now sitting on a vast pile of foreign-currency assets.
At the end of March, Beijing's official foreign-exchange reserves were worth US$1.954 trillion. But even that huge amount is only a part of the story. Add in funds managed by the country's sovereign wealth fund and state banks and, according to research by Brad Setser at the Council on Foreign Relations, a US think tank, Beijing's total foreign-currency assets come to about US$2.3 trillion (see the first chart below).
Most of those assets are in dollars. If China's foreign reserves break down in line with global reserve holdings (see the second chart), then about two-thirds of its holdings are in dollars, or about US$1.5 trillion.
With the US Federal Reserve printing money and the government in Washington running ever larger deficits in an attempt to keep its crisis-struck economy afloat, Chinese officials are naturally worried about the dollar's merits as a store of value.
'We have lent a huge amount of money to the United States. Of course, we are concerned about the safety of our assets,' Premier Wen Jiabao admitted in March.
Beijing would dearly like to diversify its reserves away from dollars to lessen the risk of valuation losses should the US currency fall. But any attempt to shift its stock of assets into other currencies, or even any move to stop accumulating dollar debt, would risk triggering exactly the dollar collapse that officials fear. China is caught in a dollar trap.
To escape, central bank governor Zhou Xiaochuan wants the world to adopt the special drawing right (SDR) as a global reserve currency.
Used by the International Monetary Fund, the SDR is an obscure unit of account made up of 63 US cents, 41 euro cents, 9 pence and 18 yen. Its composition is reviewed every five years, and when the next review falls due next year, Mr Zhou would like to see the basket expanded to cover the currencies of major developing economies - including, no doubt, the yuan - and the SDR adopted as a reserve currency.
It's a sensible-sounding idea, and very likely Mr Hu will be promoting it next week in L'Aquila with the support of Russia's President Dmitry Medvedev and the leaders of the other developing countries who will be attending the summit.
Unfortunately, however, there are a few big problems with the plan, which means the SDR is very unlikely to be adopted as a global reserve currency any time soon.
For a start, the IMF stipulates that SDR basket currencies must be freely convertible, which immediately bars the yuan - and many other developing-country currencies - from membership.
What's more, although the IMF has plans to issue SDR-denominated debt, it would take years, if not decades, to develop SDR money markets deep and liquid enough for the SDR to be attractive to the world's central banks as a reserve asset.
And with the SDR currently restricted to official holders, there is zero chance that it will be adopted by the private sector as an invoice currency for international trade and as the denomination of choice for international investors, as Mr Zhou would like to see.
As a result, despite Mr Hu's enthusiasm, any talk about a new international reserve currency at L'Aquila next week is unlikely to lead anywhere for the foreseeable future.
That leaves Chinese officials who are worried about the dollar as a store of value with another option. As Owen Humpage, senior economic adviser to the Federal Reserve Bank of Cleveland, has commented, if countries want to reduce their exposure to the dollar, all they have to do is stop intervening in the foreign-exchange market and allow their currencies to appreciate.
