The Dénouement of the Dollar
By Jeremy Weltmer • Friday, June 25, 2010 11:23 am
Perhaps under pressure from US leaders like Sen. Chuck Schumer, perhaps under market pressure, the Chinese central government has decided to take the yuan off a dollar pegging and peg it instead to a more flexible basket of international currencies, as it had been before 2008. Now, initially, this will hurt US consumers by making imports from abroad more expensive in US dollars when purchased from China, and it will likewise hurt US retailer and some manufacturing firms.
In the longer run though, it also allows US companies invoicing in US dollars better access to untapped Chinese markets by making US goods comparatively cheaper and increasing the purchasing power of Chinese consumers. The Wall Street Journal reported that, in the long-term, this will likely help “consumer-focused companies such as beverage giant Coca-Cola Co., car maker General Motors Co., and cellphone seller Motorola Inc. It could also be a boon to companies that feed China's industrial demand, such as construction-equipment makers Caterpillar Inc. and Komatsu Ltd., and mining companies BHP Billiton and Rio Tinto.” Indeed, China already comprises the largest world market for cars, cellphones, beer, and iron ore, and the Chinese market now accounts for 16.6% of electronic components maker Intel’s revenue last year and 30% of Yum Brands Inc.’s revenue each quarter. Yum Brands, which owns over 3,500 KFCs, Pizza Huts and other restaurants in China, has been opening one new branch per day on average.
This shift towards a stronger yuan extends farther than exchange rate pegging though; the Chinese central bank has announced a shift towards settling trade deals in yuan. As the Journal reported separately, “Trade deals by companies in China have typically been done in dollars or other foreign currencies. The yuan-settlement program, started last July, allowed companies in Shanghai and the southern province of Guangdong to use yuan instead when trading with companies based in Hong Kong, Macau and a handful of foreign countries.”
In light of the US’s role in global economic destabilization, and whereas major European powers have pledged fiscal prudence in stark contrast to the US, Chinese officials have expressed concern over the worldwide reliance on the dollar as a reserve currency and as the currency of international settlement. Moreover, given the trillions of dollars that China now holds, Beijing has become more and more cognizant of the fact that ill-considered US fiscal and monetary policy could ravage the value of its currency portfolio. The precariousness of settling all trade in foreign currencies manifested itself recently with the slipping and yo-yoing of exchange rates with China’s biggest partner: Europe.
After a recent Asian economic policy summit, when Russian President Dmitry Medvedev was asked about the viability of the yuan as an international reserve and trade currency, he commented, “‘Three to five years ago, any discussion of this seemed like a fantasy that may never come true,’ he said. ‘Now we're discussing it in absolute seriousness with a number of countries, including our American partners, who are perhaps least interested in other currencies replacing the dollar.’”
Now, this transition towards a yuan more central to the operation of international commerce will not happen quickly. According to the Journal, “China's central bank made clear that any movement in the yuan will be gradual, and economists think it will be especially cautious while the status of the global economy remains uncertain. Analysts generally expect a rise of 2% to 5% against the dollar over the next year.” Moreover, at this point, the Chinese government remains unwilling to make the yuan fully convertible, which would be essential to promoting the yuan to investment-grade currency. Yet as the basket-pegged rate appreciates towards the market rate were the currency to float, this change to full convertibility becomes ever more plausible.
As the yuan becomes the currency of trade regionally and internationally, China will inherently reduce its hoard of US dollar reserves, usually held as US government bonds, for it generally accumulates the currency by settling deals with exporters in dollars. Plus, as China’s currency rises in value and no longer needs such significant reserves to remain devalued below the dollar and as the rest of the world embraces emerging-market currencies as investment-grade, the world’s central banks will have much less use for US currency reserves. From the US perspective, US government debt will no longer be nearly as attractive, and concordantly, the international sovereign debt markets will demand higher returns and will not absorb infinite amounts of debt.
Sen. Schumer and his ilk may not realize it, but thanks in part to their actions, the global currency market has taken steps down a path that leads to a US situation akin to Greece’s: a market that will no longer tolerate runaway spending and simply will no longer finance the debt. A shift away from the US dollar as the reserve currency should not be held to blame for these consequences; the US and its leadership continue to choose to borrow recklessly, and the market will correct for it if the US does not.
Comments (7)
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The stimulus and bailout spending was necessary and more yet is necessary. Having said that, the injection of so much money into the economy clearly raises the specter of inflation and China's monetary policy is one of the big reasons we haven't yet seen it and are even worrying about deflation. China's change in monetary policy will probably relieve concerns about deflation and ignite ones about hyperinflation. The question for all of us is how to position oneself simultaneously for both inflation and deflation as the world economy becomes increasingly volatile and erratic. Neither political party seems to have a solution although the Democrats seem to have a better grasp on reality.
>> Frans June 29, 2010 2:02 pm
What's to say that yet more stimulus spending is necessary? Perhaps the Keynesian school of economics that has had little correlation to the real and measurable economy since the early 1970s? The previous poster is correct though in that the US presently stands poised for either deflation or hyperinflation, and there is a clear way to hedge that risk: move assets and valuations out of dollar-denominations. The precarious position of the US and the actions of the Federal Reserve that enable unsustainable levels of borrowing do nothing but weaken US citizens and firms relative to international counterparts.
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