Cat's Out of the Bag: China's Currency Challenge
On the eve of their meeting with the G8 in Italy, the G5 group of major emerging economies -- Brazil, China, India, Mexico and South Africa -- discussed the use of their own currencies to settle trade accounts among themselves. According to Indian Foreign Secretary Shivshankar Menon, the suggestion to explore this possibility came from Brazilian President Luis Inacio Lula da Silva.
Reflecting the caution that Delhi has shown toward the international currency issue, and its balancing act between Washington and Beijing, Menon wanted to clarify that this does not mean the G5 having a new currency or alternative reserve currency.
China, Russia, Brazil, France, and to a lesser degree India had expressed interest in the talks between G5 and G8 leaders to include debate on seeking long-term alternatives to the US dollar as the global reserve currency. Brazil and China have, of course, already established arrangements to settle a portion of their trade in their own currencies. China and Russia are doing the same.
In the "G5 Political Declaration" issued at the end of their Day 1 meetings in L'Aquila, "the 5" gave a strong message calling for the "full, immediate implementation of the G20 Summit Declaration of London, with no delay." The G5 also emphasized their joint intention to "continue promoting the reform of the international financial system," and "establish a new international financial order" that will be "just, fair, inclusive, and well-administered."
The G5 pledged to "dedicate the necessary efforts to resolve the issue of the inadequate representation of developing countries in international financial institutions" which, they added, "must be carried out immediately."
What makes the G5's currency discussion -- at the G8 Summit -- all the more relevant is that certain G7 members had tried to block the currency issue from being added to the agenda for the G8/G5 meeting on Day 2 at L'Aquila, namely Japan, Canada and Britain.
In the lead-up to L'Aquila, statements from a top Chinese diplomat that it would be "normal" if the Summit dialogue unfolded to include currency issues had set off a reaction from the established members of the Club.
Japanese representatives retorted that the currency issue is a side issue that could be discussed at "side meetings" of the emerging economies. Canadian Finance Minister Jim Flaherty and UK Prime Minister Gordon Brown both questioned the appropriateness of raising the global currency at a time when the global economic crisis demanded stability.
US President Obama is known to have remarked this May, at a White House press briefing, in a rather uncharacteristic fashion: "There is no need to discuss the currency issue." Two days later, his Treasury Secretary tried to smooth over the diplomatic waters by noting that China's central bank governor, the author of the proposal, is a thoughtful official and that any ideas from him deserved serious consideration.
The reality is that the currency and macro imbalance challenges are systemic issues that demand the attention of the truly global powers. The G8 met this year in an atmosphere of global uncertainty. In the lead up to the L'Aquila Summit, leaders from Russia, Brazil, China and other countries expressed concerns about the stability and role of the US dollar and the world economy's dependence on the dollar as the global currency.
By raising the reserve currency issue, China is now returning fire at the US, and the veiled criticism of China's massive trade surplus and tight grip on the RMB exchange rate in the talk of macroeconomic imbalances, by implicitly calling into question whether the United States is fit to be the anchor of the global economy.
What lends the debate more immediate relevance is that the Chinese government has gone beyond rhetoric, and is now undertaking a series of concrete measures that indicate that Beijing is interested in gradually expanding the role of the Chinese renminbi (RMB) as an international currency -- and potentially reducing its reliance on the US dollar.
Beijing has become increasingly nervous about maintaining its large dollar denominated holdings. Despite their awareness that it would be no small feat to shift beyond the dollar system, Chinese authorities have nonetheless started to take hesitant and measured steps to "internationalize" usage of the RMB.
They have established: 1) currency swap agreements worth $95 billion with Indonesia, South Korea, Hong Kong, Malaysia, Belarus, and Argentina; 2) an agreement with Brazil to encourage trade settlement in each other's currencies; 3) plans to buy SDR-denominated bonds; 4) "settlement trials" to allow a small number of export firms in the trade-heavy Shanghai and Guangdong areas to settle their trade in RMB; and 5) a "net settlement system" to increase liquidity and trading volume in the domestic interbank currency market and for select Hong Kong-based banks to sell RMB-denominated bonds in Hong Kong.
These concrete steps build, of course, on the statements from central bank governor, Zhou Xiaochuan on March 23 this year, calling for currency diversification in international trade and foreign reserves toward a supra-national reserve currency based on the IMF's Special Drawing Rights. If Beijing was just talking, or if it was alone in raising the currency concerns, it would be easier for the G7 to divert. But China is not alone.
So far these diversification steps have been rather tentative. However, the longer-term concern of those resisting the debate is the prospect of the RMB rising to challenge the pre-eminence of the US dollar.
This would be a ways off. Certainly the euro and the Japanese yen are further ahead in becoming pre-eminent reserve currencies. But it is not out of the realm of the possible that a more "internationalized" RMB will become a major settlement currency for international trade, a vehicle currency for foreign exchange transactions, and a unit of account for commodities pricing. This reality may be closer in the future than many think.
Despite the reservations expressed by members of the traditional Club of rich powers, at the meeting between the G8 and the G5 emerging powers, China's stand-in representative, State Councilor Dai Bingguo, unequivocally raised Beijing's concerns regarding the global currency situation in his presentation to the combined meeting.
Though he did not specifically name the dollar, Dai called for the world to consider diversifying the reserve currency system and aim at relatively stable exchange rates. He would have done so looking across the room to the US President and the G8 members who had resisted putting the currency on the agenda.
French President Nicolas Sarkozy gave the proposal a boost from the other side of the table, saying he hoped major industrialized and emerging nations would discuss currency systems when the global economy had largely moved beyond the crisis.
This was the first time that a high-ranking Chinese leader has raised the currency issue in an official speech at a meeting of the world's top state leaders. Previously, China's ideas for changing the system had been mentioned only in fairly technical reports from the central bank.
And in case anyone was wondering whether Beijing was waffling on the issue, China's foreign ministry spokesperson confirmed at the press briefing after the G8/G5 meeting that this is the "official position" of the Chinese government -- thus overriding earlier attempts from within China's own foreign ministry to downplay the currency debate.
Now that the issue has been brought to the fore at a high-level meeting, a precedent has been set. Some type of response from the rich nations would be "normal." The cat's out of the bag. On to the Pittsburgh G20!
Gregory Chin is assistant professor of political science at York University and senior fellow at CIGI.
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