China: Predator or the Great Reflator?
Is the US dollar still the world’s reserve currency?
In 2009, the People’s Bank of China governor Zhou Xiaochuan published an essay arguing that the US dollar was no longer working as the world’s reserve currency. “You’re fired!,” is the way Donald Trump would have put it.
Zhou was writing at a time when the dollar-dependent trade financing system was still recovering from the shockwaves caused by the Lehman Brothers bankruptcy in 2008. That event led global banks to call in their trade financing and brutally cut off liquidity to producers in countries like Korea or China. Goods were stuck at the factory door, or in some cases unloaded from cargo ships and dumped at ports.
Many enjoyed the spectacle of the new power China lecturing the US, which had, after all, caused the global financial crisis. Still, investors ran to shelter under the US dollar, and this underlined the intractability of the greenback as the world’s top savings currency. Far from perfect, but what’s the alternative? As the economist Eswar Prasad explained in his book The Dollar Trap, the US has deep financial markets, a powerful central bank and a trustworthy legal system.
Moreover, it has the right temperament to intermediate global savings because of its expansionary tendencies, as evidenced by its perpetual trade deficits.
But now it is 2016, and US monetary policy looks almost conservative, compared with other major countries or blocs. Is this appropriate in light of tepid global growth? Andrew Sheng, former head of the Hong Kong Securities and Futures Commission, says the answer is no. He is trying to revive the idea that dollar should be fired as the world’s reserve currency.
Sheng, a prolific commentator on global financial issues, compared the strong dollar — caused by the gradual normalisation of US monetary policy — to the straitjacket produced by the gold standard during the Great Depression.
“In a zero-interest-rate world, a strong dollar plays the same deflationary role in global markets as the gold standard did during the 1930s,” Sheng said last week in an article co-written with University of Hong Kong professor Xiao Geng,
The authors’ solution to the problem echoes Zhou’s plan as outlined in 2009. Build a new reserve currency out of the International Monetary Fund’s existing special drawing rights system. And expand use the of the SDR balance sheet to launch a major, globally coordinated quantitative easing programme. And since the IMF recently admitted China as one of the reserve currency backers into SDR system, Sheng is basically saying — let China step up to the plate.
It is a new twist on an old theme. In a roundabout way, Sheng is defending China against the charge that it is a predator country stealing business and jobs away from the developed world, a theme heard in US presidential campaigning.
China in fact has been a huge reflationary force in the past two decades. It is a massive importer, especially of commodities. Its newly enriched citizens are spreading tourist and investment dollars far and wide and its companies have been on a global hunt for assets.
The Asia-Pacific region in particular remains dependent on Chinese demand. Just last week, in a report on Asian sovereigns by Moody’s, the ratings agency focused on how “China’s financial firepower” will play in stabilising regional economies. “Some Asian sovereigns are poised to benefit from substantial [foreign direct investment] from China,” Moody’s wrote.
Still, it is not clear that this alone should qualify China for a lead role in a new-fangled global reflation project. Is the world really short of such stimuli? As Sheng acknowledges, the four main global central banks – Europe, the US, Japan and the UK’s –expanded their balance sheets by a combined US$7.2 trillion from 2007 to 2014, yet private sector credit increased only by US$1.8 trillion.
His essay, linked here, has a solution to this problem as well: let global governments borrow the SDR reflationary funds. They can use the funds to combat climate change, by investing in alternative energy infrastructure. In this way we solve global warming and boost growth.
One issue that might raise eyebrows, however, is that China happens to be one of the world’s largest producers of these very alternative-energy goods. Some six of the world’s 10 largest solar panel companies are Chinese, for instance. It would seem there is a thin line between predator and a reflator.
Cathy Holcombe is a Hong Kong-based financial writer