BAHRAIN: The great financial crisis, alongside the ascent of China and other emerging markets and the existential threat to the euro, is prompting policymakers in the West, too, to question the established monetary order. Change is in the air.
But with no obvious alternative to the dollar for now, the timing and extent of any shifts in the existing order are inherently unpredictable, much like exchange rates themselves.
While Beijing sees opportunities in using the yuan beyond its borders, others see risks - not least to China itself: relaxing capital controls so foreigners can reinvest their accumulated yuan in China’s securities markets is one of the preconditions of reserve currency status.
Yet allowing market-driven money flows to drive exchange and interest rates would weaken the ruling Communist Party’s tight grip on two of the main economic levers, potentially sowing the very instability it abhors.
John Williamson, one of the foremost academics on exchange rates, went back to basics and questioned the assumption that reserve currency status confers vast benefits.
Whereas China, Brazil and others have lambasted the United States for deliberately cheapening the dollar through loose monetary policies, Williamson argued that US exchange-rate flexibility is actually limited because the dollar is the anchor of the system. It is other countries that adjust their rates; the dollar then adjusts as a “residual”.
Of course, the United States gets to finance its payments deficits more cheaply because of demand for dollars from reserve managers, but this might not be enough to outweigh the loss of freedom to manage its exchange rate.
“It is not surprising that many economists have therefore concluded that a reserve currency role is not advisable,” said Williamson, a senior fellow at the Peterson Institute for International Economics in Washington.
He identified only two ways that US power in the world economy is enhanced by the dollar’s dominant role, which he does not expect to be challenged in the next quarter century.
First, the $3.2 trillion in official reserves that China has accumulated in maintaining the yuan’s semi-fixed peg to the dollar tie Beijing’s policy hands. That is because any hostile gesture, such as a threat to shift out of dollars, would destroy Chinese wealth.
Second, because of the extensive private use of the dollar globally, the United States is better able to enforce a financial blockade, such as the one now directed against Iran.
“I have the impression that the additional national power which stems from commanding an international currency tends to be exaggerated by strategic thinkers,” he wrote.
Yuriko Koike, a former Japanese defence minister, sees the power of currencies through a different prism. She said China was already using its economic might to build a “new model mercantilist imperialism” in Africa.
Turning to Asia, Koike said China’s rise was likely to continue to incite as many fears as it does hopes. Beijing’s economic clout was one more reason for Japan to put its financial house in order soon.
“So far, Chinese purchases of Japanese government bonds have been negligible, but the potential for China to gain influence over Japan in this regard is real and should be acknowledged,” Koike, who was not present to discuss her paper, wrote.
Not surprisingly, Zha, the Shanghai researcher, saw the blossoming of the yuan as the currency equivalent of China’s peaceful rise in foreign policy.
Before long, the renminbi would be the de facto common currency of a more economically and financially integrated East Asia that would thus speak with a “more consensus-oriented” regional voice in international affairs. The consensus, he implied, would be set out by China, whose economy would be at least twice as big as Japan’s within a decade.
Harsha Vardanha Singh, deputy director-general of the World Trade Organization, said the yuan was the currency most likely to acquire reserve status in years to come.
But, because of the changing patterns of trade and the increase in supply chains, other currencies important in regional trade would assume a much larger significance on the global stage, he argued.
“These various developments will create a much more extensive multi-polar currency world than is usually anticipated,” Singh said. What does it all mean for the markets?