China's Dollar Problem
With extraordinary speed, China has morphed from a diffident player in international finance into an impatient table-banger. Six months ago, one could muse about whether the Chinese were interested in a larger role within the International Monetary Fund or in helping to rebuild the crisis-battered global system. Now, the Chinese are pumping almost $40 billion into a new East Asian version of the IMF, browbeating trading partners into using the yuan, and floating fantastical ideas about a new international reserve currency. Visiting Beijing last week, Brazilian President Luiz Inácio Lula da Silva picked up on his hosts' changed mood. Calling for a "new economic order," he suggested that it was time to stop denominating trade in dollars.
It's great that China is speaking up. The country accounts for a large share of the world's savings and much of its growth; if a stable economic order is to emerge from this crisis, it will need Chinese buy-in. But there's a not-so-great side to China's transformation, too: Its contribution to the global debate is mostly muddled.
Why have the Chinese found their voice? Put simply, they have bought so much of the international system that they can no longer be indifferent to it. By running colossal trade surpluses, they have accumulated vast holdings of bonds and shares denominated in dollars, the currency at the core of global finance. If the greenback declines, China's government stands to lose a fortune.
The political backlash from such a loss could be brutal. Already, Chinese bloggers have ripped into the officials who invested $3 billion in the U.S. private equity group Blackstone, only to see the stock plummet. "They are worse than wartime traitors," one online chatter fumed, according to the Financial Times. A large fall in the dollar would make the Blackstone loss look like a picnic.
So Chinese authorities are searching for a way to reduce their exposure to the greenback. The surest method would be to stop buying so many U.S. Treasury bonds, but that would mean allowing the Chinese currency to rise against the dollar, which would hurt Chinese exporters when they are already suffering. So the government is scrabbling around for something -- anything -- that can spring it from the dollar trap without driving up its currency.
China's ideas come in two categories. The wackiest popped up unexpectedly on the Web site of the Chinese central bank -- itself a stunning sign of the nation's ambitions to shape the new order. It proposed that the IMF greatly expand its issuance of "special drawing rights," the multilateral quasi-currency it dreamed up in the late 1960s. The notion is that the IMF would trade these SDRs for some of China's dollars, and -- presto! -- China's dollar exposure would go down. But the hitch is that either the IMF or one of its member governments would be left holding the bag. The idea is a non-starter.
China's other approach is to promote the global use of its own currency. Its central bank has offered yuan to Indonesia and Argentina in return for rupiah and pesos. It hopes more trade will be denominated in yuan. Its contribution to the new IMF-like East Asian reserve fund may one day mean that a crisis-prone country in the region borrows partly in yuan.
All this is intended to buy China's currency some respectability. But as an escape from China's dollar trap, it is laughable. The idea is that once the yuan goes international, foreigners may be willing to borrow in it. That way, China can keep running a trade surplus and exporting capital, but instead of accumulating bonds denominated in dollars it would be able to accumulate bonds denominated in yuan. Again -- presto! -- China's exposure to the greenback would be reduced. But the hitch is the same as with the IMF idea: The currency risk would be transferred, in this case to China's borrowers. Given that the yuan is artificially held down by Chinese policy and will almost certainly rise over the medium term, a foreigner would have to be desperate (or intimidated) to help China out of its impasse by borrowing in its currency.
So neither the IMF idea nor the scattershot attempts to internationalize the yuan will rescue the Chinese from their dilemma. China has accumulated at least $1.5 trillion in dollar assets, according to my Council on Foreign Relations colleague Brad Setser, so a (highly plausible) 30 percent move in the yuan-dollar rate would cost the country around $450 billion -- about a tenth of its economy. And, to make the dilemma even more painful, China's determination to control the appreciation of its currency forces it to buy billions more in dollar assets every month. Like an addict at a slot machine, China is adding to its hopeless bet, ensuring that its eventual losses will be even heavier.
It is easy to appreciate China's sudden appetite for bold new ideas about international finance. But Beijing's leaders look less like the architects of a new Bretton Woods than like aspiring Houdinis.