China not fooling in call for review of dollar's status

By Chris Oliver, MarketWatch

China's calls for a new international reserve currency to replace the U.S. dollar are more than mere bluster and could likely lead the debate over the future of the global foreign-exchange system, analysts say.

"By proposing such a sweeping reform, China is demonstrating its growing influence in reshaping the global monetary system, and is now on offensive in the debate of who is responsible for the global imbalances," Deutsche Bank's chief economist for Greater China Jun Ma said in a note to clients Wednesday.
The comments by People's Bank of China Gov. Zhou Xiaochuan are setting a framework for talks on how to resolve the huge trade imbalances between China and the U.S., analysts said.
In the past, China has been blamed for its large trade surplus by officials in the U.S. and elsewhere, who see the yuan as undervalued.
"China has effectively set the agenda for the G20 leaders' summit," wrote SocGen economists in a note Tuesday, referring to next week's meeting of finance chiefs from the Group of 20 leading economies in London.
In an essay published on the central bank's Web site Monday, Zhou proposed the creation a new international reserve currency, a call rejected by U.S. officials Tuesday. See full story on Zhou's statement and U.S. reaction.
A super-sovereign reserve currency managed by a global institution could be used to both create and control global liquidity, Zhou wrote.
Analysts said the comments also signal China's growing concern over preserving the value of its trillion-dollar plus hoard of Treasurys in light of potential swings in the value of the dollar or a probable rise in U.S. sovereign credit risk.
"It has the potential to lead one of the most profound reforms of the global monetary system in the coming decades," said Deutsche Bank's Ma about Zhou's proposal.
No Treasury unwinding
Zhou did not, however, say China's central bank had any plans to diversify its U.S. debt holdings. China has the world's largest foreign exchange reserves, and it is also the biggest holder of U.S. Treasury securities.
In fact, Zhou's proposal came as his No. 2 -- People's Bank of China Deputy Gov. Hu Xiaolian -- was quoted as saying U.S. government debt is "an important element of China's investment strategy of its foreign currency reserves." See full story on Hu's comments.
Meanwhile, Japan, the U.S.'s staunchest ally in Asia, said Wednesday it too does not have plans to change its policy of investing a majority of its foreign reserves in U.S. Treasurys.
But Zhou's comments were seen by some as offering the Chinese currency as a possible alternative to the dollar as a medium of settlement for international trade, analysts said.
"The PBOC is more actively promoting the Chinese yuan itself as a reserve currency," said RBS economist Ben Simfendorfer. "The ability to settle in Chinese yuan offers export manufacturers a way to hedge against large currency moves in the U.S. dollar and, increasingly, the euro."
China's central bank has recently signed currency-swap agreements with central banks in Hong Kong, South Korea, Malaysia, Indonesia and Belarus, Simfendorfer said.
A senior Chinese official speaking in Hong Kong Wednesday said global capital flows need to be monitored and regulated to limit potential damage on developing countries, citing the Mexico peso crisis of the mid-1980s, the 1997 Asia financial crisis and the 1998 Russia default as examples of crises that resulted from rapid capital outflows.
"We should monitor capital flows, and monitor leverage, and this information should be reported to the countries where (institutions) are investing," Fan Gang, director of China's National Economic Research Institute, was cited as saying in an interview with the Wall Street Journal Asia.
Fan also said that China needed to further develop its financial infrastructure and its legal system before opening the country in a more significant way to international fund flows.
Separately, Hong Kong Chief Executive Donald Tsang said Tuesday the city would consider altering its now U.S.-dollar linked currency to a system with "linkage" to the Chinese yuan, once that currency becomes freely traded on global exchanges.
Tsang acknowledged, however, that such a move could take years.
Standard Chartered Regional Economist Kelvin Lau said Wednesday he doesn't expect much to come of the recent talk of change in the currency regime if the U.S. dollar weakens on a gradual basis.
"A weaker currency could be inflationary (via higher imported prices), but that is the last thing policy makers in Hong Kong are worried about right now," Lau said in a note.