With the emerging economies consistently contributing about two-thirds of incremental global output, and the OECD block slipping into a long-term sub-optimal growth mode, the possibility of a multi-polar currency world, marked by a qualitative shift away from the US dollar, seems very real. This debate has intensified in recent times with the Chinese government taking a series of measures to internationalise the yuan by entering into RMB-based currency swap arrangements with many developing economies, which were hit badly by the global financial crises of 2008 and its continuing aftermath. China is also encouraging global companies to raise funds through yuan-denominated bonds listed in Hong Kong. It is gradually denominating a lot of trade with Asian and African trading partners in the yuan. Some Indian infrastructure companies have begun accessing yuan-denominated loans to import equipment from China. The Chinese government has embarked on a new project to set up a mega-international financial centre in Shanghai that will have the scale of Hong Kong in conducting financial transactions. Hong Kong has been assured this will only supplement its efforts and not threaten its existence. It is not so widely known that the commodity exchanges in Shanghai and Dalian in China have overtaken the legendary Chicago Commodity Exchange and the London Metal Exchange in daily volumes. In all likelihood, future global price discovery on commodities could be led by the Chinese exchanges.
However, China?s dream of internationalising its currency cannot materlialise unless it creates open and transparent capital market institutions and becomes convertible on the capital account, letting the rest of the world buy and sell its financial assets at will. This is easier said than done. Will the Chinese Communist Party ever give up control over its financial market institutions and let them follow the dictates of the markets? If so, how will China play this out over the next decade or so?
Some of these questions, including the geopolitics of currencies and the monetary system, were debated by scholars, economists and policymakers at a two-day global seminar in Bahrain organised by the International Institute of Strategic Studies in its new geo-economic programme. Of course, the majority of the participants felt the present Communist Party system will never give up control over financial institutions. China, therefore, cannot possibly aspire to building the yuan into a reserve currency that invokes inherent trust as a store of value, like the dollar does.
However, there is a flip side to this argument. True, reserve currency status works essentially on trust created over decades as a reliable store of value. But this trust cannot be taken for granted either by the US or the eurozone economies, which seem to have got into a deep funk, structurally speaking. Trust can dissipate very fast, too.
James Rickards, the author of Currency Wars: The Making of the Next Global Crisis, did not paint a very good picture for the dollar and euro either. He said developed economies? ?central bankers have now taken the world to a place from which there is no exit. By cutting interest rates to zero or close to it, and by expanding balance sheets with unprecedented amounts of money printing, they have for now forestalled a more severe contraction, something that might have resembled the Depression of 1929 in its intensity. Yet, in doing so, they have destroyed markets and merely delayed the day of reckoning.?
The Federal Reserve balance sheet was about $950 billion in 2007 and is close to $3 trillion today. A three-fold expansion in the central bank balance sheet in a matter of four to five years is unprecedented. The European Central Bank balance sheet has also expanded in the same period from $1.6 trillion to nearly $4 trillion! How can the value of any currency be preserved if it expands on such a scale by the simple act of printing more money?
Economists say such large-scale debasement of reserve currencies in such a short period of time has not been seen in history. James Rickards says policymakers in desperation are turning to currency wars, trying to cheapen their currency against those of their trading partners. By cheapening currencies, they want to boost exports, jobs and GDP growth. But the gains in such cases are temporary, as the trading partners soon retaliate by cheapening their currencies too. This is how currency wars take place.
Rickards argued that if central banks continue on this dead-end path, they will erode confidence in all paper currencies and cause the collapse of the monetary system.
Just as the US and eurozone economies are threatened by fiscal and monetary excesses, the Chinese economy too may get severely bogged down by its big transition from being an infrastructure-investment-led economy to a largely domestic consumption story. This transition is not without risks either. So, there are multiple risks faced by the global economy at this juncture.
From a geopolitical perspective, former World Bank chief economist John Williamson questions the extent of political power that a reserve currency confers on a nation. Actually, a reserve currency brings a lot of responsibility, too, which can become onerous, at times. Besides, the loss of freedom to manage the exchange rate can also have its costs.
Williamson said there is one way in which the US power is enhanced due to the dollar?s dominance as a reserve currency. He quoted Keynes as saying: ?When I owe my bank a million dollars, the bank fears me.? The US owes China around $2 trillion dollars, which the latter holds as US treasury bonds. So, China, as a lender, should fear the US. China can?t do anything to the US that will not end up destroying its own wealth.
However, a Chinese speaker countered this argument by saying China can very well inflict losses on itself by dumping US treasury in the market if America hurts its core national interests on an issue like Taiwan. So, the use of monetary instruments for political purpose can be very potent.
It is also possible that, in the first phase, China may just want to spread the influence of its currency by becoming a net financier of nations in the Asia-Pacific region where the US plans to shift the bulk of its sea-based military infrastructure which are currently located in the Middle East and Atlantic. This could be a geopolitical objective.
While economist Surjit Bhalla argued that China had reached the current dominant position in the global economy by largely undervaluing its currency, a former IMF executive director said the Chinese currency is not so undervalued any more as it is compelled to build on its domestic consumption story.
Chinese scholar Zha Xiaogang argued that Beijing wanted to see a better-balanced international monetary system consisting of at least the dollar, euro, yuan and other currencies such as the yen and the rupee.
The deputy director general of WTO, Harsha Singh, said that going by the way the Chinese have conducted themselves at the WTO and taken advantage of the global trading system, they will definitely aim at becoming a reserve currency in the next 10 years. The Chinese are known to gradually and systematically work towards these market-based goals and they are capable of making fundamental shifts in strategy if it suits their national interest.
mk.venu@expressindia.com