The year’s first acknowledgement of discontent came during the visit of US Secretary of State Hillary Clinton to Beijing in February. “I appreciate greatly the Chinese government’s continuing confidence in United States Treasuries,” she said. “I think that’s a well-grounded confidence.”
Confidence may have been too strong a word. Had the US no doubts about Beijing’s confidence in its Treasuries, Clinton’s comments would have been unnecessary.
China has long had a taste for US Treasuries, and is the single largest holder of the bonds, with U$727.4 billion to its name as of December 2008. As the American economy has faltered, however, Chinese officials have become less eager about dollar-denominated assets as an investment option. That has been exacerbated by the US Federal Reserve’s decision to support the Treasuries market by making purchases itself. Rather than save the US economy, some believe the strategy will lead to a deepening of the financial crisis.
Beijing’s increasingly pointed rhetoric culminated in late March with the publication of an essay by People’s Bank of China Governor Zhou Xiaochuan. While he didn’t mention the US dollar by name, the governor’s target was clear.
Zhou floated the idea of an international reserve currency, disconnected from individual nations and therefore more stable in the long run. He named special drawing rights (SDRs) – a synthetic currency used by the IMF – as a possible foundation. The SDR, a composite of major reserve currencies and therefore insulated from fluctuations, is used within the IMF to denominate loans.
When US Treasury Secretary Timothy Geithner responded that he was open to discussion, markets reacted with consternation. That was the result of a misreading of official intentions, said Brad Setser, a fellow at the Council on Foreign Relations and former staff economist at the US Department of the Treasury.
“The market overreacted … The use of the SDR inside the context of the IMF need not come at the expense of the dollar,” said Setser.
Out of the closet
Nevertheless, the reaction had some basis in truth: Zhou had publicly called for a new global reserve currency, which Zhang Jun, director of the China Center for Economic Studies at Fudan University, says was a long-held desire in Beijing.
“The Chinese government really hopes that global leaders will consider the possible replacement of the US dollar as a reserve currency in the future,” he said. “It’s not something we can do right now, but maybe we should think about this problem for the future.”
The exact composition of China’s foreign exchange reserves is murky, but most estimates place about 60-70% of the country’s reserves in US dollar holdings. Beijing has continued to buy Treasury bonds for several reasons: to stave off a rapid appreciation of the renminbi against the dollar, to help shore up the value of its existing dollar holdings, and in the interests of Sino-American relations. This means that while Wen was expressing doubts about Treasuries, the State Administration of Foreign Exchange was in fact moving its dollar reserves more heavily into the bonds.
“If China stopped now to continue to buy large amounts of US treasury debt, the US will hate us. And China cannot afford for its overall domestic and international interests to spoil Sino-American relations in this way,” said Shi Yinhong, a professor of international relations at Renmin University in Beijing.
But Logan Wright, an analyst with Medley Global Advisors in Beijing believes there is a “political undercurrent” questioning the wisdom of financing the US current account deficit, and expressing concern about what the US budget deficit means for depreciation and the price of Treasury bonds.
Informed by that undercurrent, Beijing is taking steps to gradually reduce its reliance on the dollar. At the end of March, China and Argentina signed a US$10.24 billion currency swap deal to allow Chinese exporters to receive renminbi instead of US dollars for goods shipped to Argentina. Similar agreements have also been reached with several Asian nations. In April, the State Council chose five cities – Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan – for a trial program to conduct trade entirely in renminbi. In addition to promoting the use of the renminbi, the move is expected to insulate domestic companies from dollar exchange fluctuations.
Zhang at Fudan cautions against reading too much into the moves.
“[The five-city trial] is actually a natural result of the circulation of the Chinese yuan in neighboring economies … Even with no financial crisis and no American problems with the dominance of the dollar as the global reserve currency, China would definitely move on to this stage,” Zhang said.
If the timing of these moves was coincidental, the attention that they have attracted indicates a growing global role for China. At the meeting of the Group of 20 nations in London in March, much was made of China’s attempts to push for reform of both the G20 and the IMF in a way that would give it a greater role. Damien Ma, an analyst with political risk consultancy Eurasia Group, contrasted the way Zhou approached the idea of establishing a global reserve currency with that of Moscow, which has suggested a partial return to the gold standard.
“China is saying ‘We’re not going to abandon international institutions … [But] if you want us to be more involved … we want more of a voice,’” said Ma.
As the various official comments indicate, China is still trying to find that voice. Setser at the Council on Foreign Relations characterizes the emerging tone as one of a country taking its interests as a creditor more seriously. However, there are reminders that major obstacles remain. Even as China expresses concern about its dollar exposure, the renminbi remains closely tied to the dollar.
“[That] doesn’t suggest any change is imminent,” said Setser of the Council on Foreign Relations. “It suggests rather that China has been unwilling to make the kinds of choices needed to realistically transform the architecture. It’s very hard to move the global reserves off the dollar if China, one of the world’s largest economies, is still pegged to the dollar.”