By Jason Simpkins
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.”
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