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Geithner Opens Up Debt Dialogue With China, but the Dollar Still May be Doomed

Jason Simpkins — Wed, 03 Jun 2009 18:47:50 +0000

Two days of talks between U.S. Treasury Secretary Timothy F. Geithner and Chinese officials culminated yesterday (Tuesday) with both parties reaffirming their confidence in the value of the dollar, and the viability of U.S. debt.

Despite this public posturing, however, concerns remain about the dollar’s near-term strength. And given the United States’ precarious financial position, many observers question the dollar’s long-term ability to remain the world’s main reserve currency.

Chinese policymakers expressed “justifiable confidence in the strength and resilience and dynamism of the American economy,” Geithner said during his first official visit to China.

China is the world’s largest holder of U.S. Treasuries, with $768 billion of U.S. securities in reserve as of the end of March. In recent months, however, Beijing has increasingly voiced concerns about the value of its foreign-currency holdings, even going so far as to suggest the world adopt a new international reserve currency.

While Geithner’s visit was initially described as an effort to promote stable, balanced and sustained economic growth, Geithner made sure to allay the concerns of China’s leaders, including Premier Wen Jiabo, who just months ago called on the United States “to guarantee the safety of China’s assets.”

In remarks to China’s state media, Geithner said the United States would “do everything necessary” to preserve the value of the dollar and to ensure that “the deepest, most liquid Treasury markets in the world” remain flexible.

For its part, China acknowledged the U.S. effort to open up a dialogue about fiscal responsibility that wasn’t aimed at its own currency, the yuan. In January, Geithner accused the Chinese of “manipulating” its currency, keeping it artificially low to boost exports.

“You have established good working relationships with your Chinese colleagues and you are committed to increasing China-U.S. cooperation in tackling the international financial crisis,” President Hu Jintao said at a meeting at the Great Hall of the People. “I appreciate that.”

Still, not everyone was convinced that Geithner or U.S. Federal Reserve Chairman Ben S. Bernanke, are serious about shoring up the dollar. After all, the U.S. budget deficit is expected to balloon to $1.75 trillion in the fiscal year ending Sept. 30, a sizeable increase from last year’s $455 billion shortfall. That figures to be about 13% of U.S. gross domestic product (GDP).

“We are going to have to bring our fiscal deficit down to a level that is sustainable over the medium term,” Geithner said during his visit to Mainland China. “This will mean bringing the imbalance between our fiscal resources and our expenditures to the point – roughly 3% of GDP – where the overall level of public debt to GDP is definitely on a downward path.”

Still, Geithner failed to elaborate on how exactly he and the Obama administration will accomplish that feat. And that’s something that worries some Chinese economists.

“I worry about details,” said Yu Yongding, a former central bank adviser who interviewed Geithner for the China Daily newspaper. “We will be watching you very carefully.”

On Monday, Yu told Bloomberg News that he was hopeful Geithner would provide specifics about his plan. He also warned that despite its sizeable commitment to U.S. debt, China has other options.

“I wish to tell the U.S. government: ‘Don’t be complacent and think there isn’t any alternative for China to buy your bills and bonds,’” said Yu. “The euro is an alternative. And there are lots of raw materials we can still buy.”

Is China Ditching the Dollar?

Recent data supports Yu’s position, as China appears to be putting more distance between itself and the dollar than ever before.

China bought less than a sixth of the Treasuries issued by the U.S. government in the 12 months through March, according to The New York Times. That stands in stark contrast to the Treasury market of two years ago, when China’s demand for U.S. securities actually exceeded the United States’ own borrowing needs.

Additionally, when China has purchased Treasuries, it has done so by swapping them with other U.S. assets, rather than exchanging foreign currencies or commodities. China has increased purchases of short-term Treasury notes – those that mature in a year or less – while at the same time unwinding its position in Treasuries with longer maturities. The takeaway: Beijing believes the dollar is safe for now, but has serious doubts that the greenback can shrug off the inflationary pressures that are certain to grow out of the United States’ financial situation, and avoid major erosions in its value as a global reserve currency.
China has also paid for its recent Treasury purchases by selling off debt from such U.S. government-sponsored enterprises (GSEs) as mortgage giants Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE).

Last year, China was the world’s biggest buyer of GSE securities, spending about $10 billion a month, The Times reported. And last fall, as much as one-fifth of China’s $2 trillion in currency reserves was invested in Fannie and Freddie debt. But in the year ended in March, China actually sold about $7 billion of GSE debt.

In yet another move to safeguard its massive currency reserves, China has boosted its investments in commodities. China imported record amounts of copper and iron ore in April, and has been stocking up such commodities as oil and grain. China said last month that its gold reserves have soared to 1,054 tons, up from just 600 tons in 2003.

“While companies in the United States, Great Britain and Europe are being forced to shed promising assets in order to compensate for massive losses or to pay down debt, cash-rich China has been able to operate as a buyer in a buyer’s market,” said Money Morning Investment Director Keith Fitz-Gerald. “While the rest of the world has interpreted this as a sign that China’s interested in buying the things it needs to grow, what they have not understood is that China’s also interested in using physical assets as a source of ‘currency’ that offsets an increasingly eviscerated U.S. dollar.”

According to Fitz-Gerald, China isn’t simply stocking up on raw material to fuel its massive $585 billion stimulus plan, but instead use those commodities to bolster its currency. Indeed, Beijing’s ultimate goal is for its currency to supplant the dollar as the world’s most widely accepted transaction currency.

Replacing the World’s Reserve Currency

Ahead of the G20 Summit in April, Zhou Xiaochuan, Governor of the People’s Bank of China, released an essay titled “Reform of the International Monetary System.”

Without specifically mentioning to the U.S. dollar, Zhou asked this basic question: What kind of international reserve currency does the world need in order to secure global financial stability and facilitate economic growth.

According to Zhou, the dollar’s unique status as the world’s primary reserve currency has resulted in increasingly frequent financial crises ever since the collapse of the Bretton Woods system in 1971.

“The price is becoming increasingly higher, not only for the users, but also for the issuers of the reserve currencies,” Zhou said. “Although crisis may not necessarily be an intended result of the issuing authorities, it is an inevitable outcome of the institutional flaws.”

Zhou called for the “re-establishment of a new and widely accepted reserve currency with a stable valuation” to replace the U.S. dollar – a credit-based national currency. The central bank governor noted that the International Monetary Fund’s Special Drawing Right (SDR) should be given special consideration.

After questioning the dollar’s viability as the world’s main reserve currency, Beijing took another step in its quest to expand the role of its own currency, the yuan, by agreeing to a $10 billion (70 billion yuan) currency swap with Argentina.

Including that deal with Argentina, Beijing has signed about $95 billion (695 billion yuan) of currency deals with Malaysia, South Korea, Hong Kong, Belarus, and Indonesia over the past few months. And China and Brazil recently acknowledged that they are in the early stages of a currency swap agreement of their own.

These deals eliminate the need for China and its trading partners to buy dollars to facilitate cross-border transactions. It also gives China’s currency a more prominent role in the global economy, and moves the yuan one step closer to supplanting the dollar as the world’s main reserve currency.

“For Westerners who are struggling to come to terms with the notion of a disarrayed dollar, the thought of oil, gold or other commodities being priced in yuan instead of dollars has to seem about as likely as having another country put a man on the moon,” said Fitz-Gerald. “But the Chinese yuan is already well on its way to becoming that globally accepted standard unit of exchange and the proverbial genie, as they say, is out of the bottle.”

[Editor's Note: Thirteen trades. All profitable. Since launching his Geiger Indextrading service late last year, Money Morning Investment Director Keith Fitz-Gerald is a perfect 13 for 13, meaning he's closed every single one of his trades at a profit. And he did this in the face of one of the most-volatile periods since the Great Depression. Fitz-Gerald says the ongoing financial crisis has changed the investing game forever, and has created a completely new set of rules that investors must understand to survive and profit in this new era. Check out our latest insights on these new rules, this new market environment, and this new service, the Geiger Index.]

Source: Geithner Opens Up Debt Dialogue With China, but the Dollar Still May be Doomed

China Flexes its Muscles and Finds Support in a Bid to Dump the Dollar as the World’s Main Reserve Currency

Jason Simpkins — Mon, 13 Apr 2009 13:40:08 +0000

Finance officials from Beijing in Moscow on Thursday held a videoconference to discuss the creation of a “supra-national reserve currency,” the latest evidence of the support China is getting from developing countries as it seeks to replace the U.S. dollar as the world’s main reserve currency.

This controversial proposal – and the support that it’s getting – also underscores China’s continued emergence as a growing global force in both the financial and political arenas. That’s a trend that successful global investors won’t be able to ignore.

The recent torrent of criticism to swirl around the dollar began with remarks by Chinese Premier Wen Jiabao. Speaking last month at a press conference leading up to the recent Group 20 meeting in London, Premier Wen voiced his concern about the value of China’s large holdings of U.S. Treasuries.

“We have lent a huge amount of money to the United States,” he said. “Of course, we are concerned about the safety of our assets. To be honest, I am definitely a little bit worried. I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”

Of China’s $2 trillion in foreign currency holdings, about $1 trillion is invested in U.S. Treasuries and notes issued by other government affiliated agencies, such as Fannie Mae (FNM) and Freddie Mac (FRE).

“They are worried about forever-rising deficits, which may devalue Treasuries by pushing interest rates higher,” JP Morgan & Co. (JPM) analyst Frank Gong told The Associated Press. “Inside China, there has been a lot of debate about whether they should continue to buy Treasuries.”

Earlier this year, the Congressional Budget Office (CBO) projected that the U.S. budget deficit would nearly triple from last year’s $455 billion – and would reach a staggering $1.2 trillion. And that was even before U.S. President Barack Obama unveiled his $787 billion in stimulus, bank-rescue and anti-foreclosure plans. And that massive projected shortfall also doesn’t include other fix-up initiatives that are sure to surface in the months ahead.

But rather than sit idly by and watch the value of its reserves be eroded by the U.S. government’s economic policies, China is trying to lay the foundation for future change.

China and the SDR

On the eve of the G-20 summit, Zhou Xiaochuan, governor of the People’s Bank of China, released an essay entitled “Reform of the International Monetary System” on the BOC’s Web site.

Without explicitly mentioning the U.S. dollar, People’s Bank Gov. Zhou asked what kind of international reserve currency the world needs in order to secure global financial stability and facilitate economic growth.

According to Zhou, the dollar’s unique status as the world’s primary currency reserve has resulted in increasingly frequent financial crises ever since the collapse of the Bretton Woods system in 1971.

“The price [of relying solely on the dollar] is becoming increasingly higher, not only for the users, but also for the issuers of the reserve currencies,” Zhou said. “Although crisis may not necessarily be an intended result of the issuing authorities, it is an inevitable outcome of the institutional flaws.”

Created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system, the SDR was redefined in 1973 as a basket of currencies. Today, the SDR consists of the euro, Japanese yen, pound sterling, and U.S. dollar.

“The SDR has the features and potential to act as a super-sovereign reserve currency,” said Zhou. “Moreover, an increase in SDR allocation would help the Fund address its resources problem and the difficulties in the voice and representation reform. Therefore,efforts should be made to push forward a SDR allocation.”

Zhou proposed the following actions to move the SDR in a direction that could better accommodate demand for a more stable reserve currency:

Set up a settlement system between the SDR and other currencies. Therefore, the SDR, which is now only used between governments and international institutions, could become a widely accepted means of payment in international trade and financial transactions.

Actively promote the use of the SDR in international trade, commodities pricing, investment and corporate bookkeeping. This will help enhance the role of the SDR, and will effectively reduce the fluctuation of prices of assets denominated in national currencies and related risks.

Create financial assets denominated in the SDR to increase its appeal. The introduction of SDR-denominated securities, which is being studied by the IMF, will be a good start.

Further improve the valuation and allocation of the SDR. The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies, and the GDP may also be included as a weight. The allocation of the SDR can be shifted from a purely calculation-based system to one backed by real assets, such as a reserve pool, to further boost market confidence in its value.

China Rallies BRIC Allies

While China has been the most vocal proponent of a new – less-dollar-oriented – global currency system, other countries around the world have taken up the cause.

Russia, as Thursday’s videoconference illustrated, is working with China to push for an overhaul of the current currency system. In fact, the creation of a new reserve currency to be issued by international financial institutions was one of the measures Russia proposed to the G-20 on March 16.

Russia and China have also been joined by India and Brazil. Representatives from each of the four BRIC countries met in the weeks before the G-20 summit, and an unnamed source told Reuters that a shift away from the dollar was discussed.

“They (China) did not formally put forward their position for the G-20 summit but unofficially they had distributed their paper regarding the same ideas (the need for the new currency),” the source told Reuters, speaking on condition of anonymity.

Shortly after the G-20 meeting, Russia proposed that the IMF or G-20 study the creation of a new international reserve currency.

“The new global reserve currency has not been discussed at the summit. We only discussed it at several bilateral meetings,” Russian President Dmitry Medvedev’s chief economic aide, Arkady Dvorkovich, told a news briefing.

Weeks later, China agreed to a $10 billion (70 billion yuan) currency swap with Argentina. That deal will allow China to receive yuan, instead of dollars, for its exports to the Latin American country.

Including the latest deal with Argentina, Beijing has signed about $95 billion (695 billion yuan) of currency deals with Malaysia, South Korea, Hong Kong, Belarus, and Indonesia over the past few months.

These deals undermine the status of the dollar as the world’s leading trade-and-reserve currency, but they also broaden the status of the yuan – something policymakers in Beijing see as being vital to China’s economic success, particularly in light of the current financial crisis.

“Beijing has its eye on raising the status of the yuan,” Ben Simpfendorfer, an economist at the Royal Bank of Scotland Group PLC (ADR: RBS), told The Associated Press. “They are the world’s second-largest exporter and the third-largest economy, so it is in their interest to handle trade in the yuan.”

While it continues to push for reform, China is also realistic about a timetable for achievement.

“”When a problem comes up, it’s always better to discuss it than not. But important reforms take more than one or two days,” Sun Zhongtao, a professor of international strategy at the Central Party School in Beijing, told the AFP. “Under the new system, the dominance of the dollar is set to be challenged. But it’s impossible to reach consensus on such issues overnight.”
But for many analysts, the support that China has been able to drum up in just a short matter of time is evidence of the nation’s growing economic and political clout.

“In the Asian financial crisis, China kept a relatively low profile and it didn’t assume any kind of leadership role at that stage,” Brian Bridges, a political scientist at Hong Kong’s Lingnan University, told the AFP. “Now the contrast is very significantly different in terms of China being much more open and involved in the financial system.”

For Bridges China’s determination to flex its financial muscle and expand political influence is what sets it apart from other would-be success stories, like the Japan of 1980s.

“In the case of China, you have a power which is almost simultaneously both becoming a rising economic power and also [becoming increasingly] involved in political and security issues around the world,” said Bridges. “It’s slightly different from the Japan model, because Japan was first an economic power and there was expectation it would become important in political and security issues. But it never actually fulfilled that role.”

Source: China Flexes its Muscles and Finds Support in a Bid to Dump the Dollar as the World’s Main Reserve Currency