Has the dollar had its day? Investors showed their concern on Wednesday last week when China’s central bank called for the greenback to be replaced as the world’s reserve currency and Timothy Geithner, America’s treasury secretary, appeared to agree. The dollar dived against other currencies.
However, it recovered rapidly as Geithner then made it clear that he expected the dollar to hold its dominant position “for a long period of time”. Economists dismissed China’s move as sabre-rattling ahead of this week’s summit of the G20 countries in Britain, but acknowledged its symbolic importance.
“It’s not going to happen,” says Gabriel Stein, an economist at Lombard Street Research. “The change from sterling to dollar took about 50 years. This is a dig at the United States. China is worried about its dependence on the dollar; $2 trillion [£1.4 trillion] of someone else’s IOUs is a problem. And the second thing is a call for recognition of China’s importance as a great power.”
China suggests using Special Drawing Rights (SDRs), based on a basket of currencies, as a reserve currency, but Stein points out that SDRs are dominated by the dollar in any case.
Stein says there is no need for China to be concerned about the value of the American treasuries it holds, despite the quantitative easing the country has embarked on. “That’s going to strengthen the dollar,” he says, “because that’s one of the reasons why the US economy is going to come out of its recession faster than, say, the euro area.”
However Simon Ward, the chief economist at New Star, says the Chinese are “concerned the US authorities will deliberately devalue the dollar”. Russia, which also holds significant amounts of American government bonds, has strongly backed China’s call.
Kevin Chau, a currency strategist at IDEAglobal, a market intelligence company, says: “It’s in China’s interest and in the US’s interest to work with each other, in the sense that if China keeps buying US treasuries that will keep yields low, so that the US economy can keep coming back to life. That helps world growth, and, of course, Chinese exports.”
Yet in the long term, he says that firing the dollar as the global reserve currency is “a great idea” – and that China’s renminbi may well become its replacement in “as little as 20 years”.
“Give them some more time to build up their domestic base and a strong middle class: it depends how their planned economy can progress,” says Chau. “It will take some time for people to believe this is not an emerging market.”
What about China’s “manipulation” – as described by Geithner earlier this year – of its own currency? Stein says that China has kept the renminbi trading within a limited range to ensure it stayed weak, boosting exports.
However, he adds, “if they didn’t manipulate it now, it would fall, which is what they would want.
“They still believe in things like export-led growth, so they aren’t going to let their currency appreciate. But actually, if the Chinese currency did appreciate, it would be a major boost to Chinese demand, since it raises the income of Chinese households.”
Chau likewise supports greater liberalisation of Chinese monetary policy. “There will be more and more millionaires in China and they will demand greater openness,” he says.
John Tamny, the editor of realclearmarkets.com, has a more surprising view. He says that deliberate devaluation of the dollar since America abandoned the gold exchange standard in 1971 was the cause of the economic crisis. “Our monetary mistakes are world monetary mistakes … [and] when Geithner says China is manipulating its currency, what he really means is that he wants a weaker dollar. Now, we’re borrowing money from the world to socialise our economy and that’s a recipe for economic decline.
“I hope that China continues to threaten the US about it,” he adds. “Either that will force us to get serious about issuing a stable currency or, I hope, China and Japan will form a currency bloc that will push out the dollar. I’d love to see China say: ‘You know what, we’re going to issue a stable currency that the world can use.’”
On the G20 summit itself, expectations are low, anticipating bland statements of unity – and perhaps movement towards China’s more immediate political goals, such as reforming the International Monetary Fund.
“Summits are a waste of time,” says Stein, whose best-case scenario for this summit is that export-dependent countries such as China and Germany commit to measures to boost domestic demand. “That will be a result,” he says.
In the short term, expressing unity may be the most the G20 leaders, who juggle a multitude of home-grown and global pressures, can do to fight the crisis.
In the medium to long term, it seems the global meltdown may hasten changes in the balance of global political power and its expression through monetary policy.