Despite the Doubters, It’s Still Top Dollar (The Chinese Yuan is unlikely to be reserve currency)

The American ^ | 6/29/2009 | Desmond Lachman

[SeekAndFind]

There’s much chatter that the Chinese renminbi will eventually replace the U.S. dollar as the world’s preeminent international reserve currency, but this supposed inevitability is highly questionable.

There has been much chatter of late in the media about the inevitability of the Chinese renminbi eventually replacing the U.S. dollar as the world’s preeminent international reserve currency. Fueling this chatter have been recent pronouncements by Chinese officials of their dissatisfaction with China’s large U.S. dollar reserve holdings and their suggestion that the world needs a more stable international reserve currency than the U.S. dollar. Also fueling this chatter is the belief by many analysts that, like the British economy before it, the U.S. economy is now in relative secular decline and that the 21st century will belong to the Chinese economy.

Those arguing that the days of the U.S. dollar as the world’s major reserve currency are numbered seldom mention that, despite all the U.S. economy’s purported weaknesses, the U.S. dollar still accounts for almost two-thirds of the world’s international reserve currency holdings. Also not mentioned is the fact the euro, the pound, and the Japanese yen account for almost the entirety of the remainder of global international reserves. And no central bank holds the Chinese renminbi as a reserve currency, despite all of the renminbi’s purported strengths.

Underlying the U.S. dollar’s predominant usage as an international reserve currency are advantages that the Chinese currency presently lacks and that the Chinese currency is unlikely to garner for many years to come. Amongst the most important of these is the fact that the U.S. currency is fully convertible in the sense that there are no governmental restrictions on movements by citizens and foreigners alike into and out of the U.S. dollar.

By contrast, China’s currency is anything but convertible, with Chinese citizens forced to hold their domestic currency savings in a highly underdeveloped Chinese banking system. And the sorry state of the Chinese financial system will not afford China the luxury of moving towards full currency convertibility for many years to come until its banking system is truly reformed and recapitalized.

Another basic support for the U.S. dollar is the fact that the United States has the deepest of financial markets, which offers investors the widest selection of financial assets. The advantages of this depth were most plain to see during the worst of the recent global economic crisis when the U.S. dollar was viewed by markets as the safe haven currency. By contrast, Chinese financial markets remain largely underdeveloped and there would seem to be little prospect that they will become more developed anytime soon.

At a more fundamental level, one has to seriously question the supposed inevitability that the Chinese economy is destined to eclipse the U.S. economy. How sure can one be that the Chinese economy will continue to grow at the extraordinarily rapid pace at which it grew over the past 15 years? In particular, should one not be questioning whether China can continue to rely on an export-led growth model to supercharge its economy at a time when unemployment is rising to double digit levels in both the United States and Europe and when protectionist sentiment is now on the rise? This has to raise the very real possibility that as Western unemployment stays stubbornly high China will suffer a similar fate to that suffered by Japan in the1980s when Japanese exports were significantly shut out of Western markets.

China’s present response to the global economic crisis would seem to underline the risk that it will stoke protectionism abroad and further damage its financial system at home. For rather than taking measures to promote domestic consumption that would help reduce its unusually large external current account surplus, the main thrust of the Chinese government’s stimulus package is to promote investment in general and investment in the export sector in particular. These policies are almost certain to exacerbate global payment imbalances by increasing China’s export capacity that could pose risks to globalization down the road.

Those skeptical about the U.S. dollar remaining the preeminent international reserve currency in the years to come are certainly right to point to the prospect of U.S. budget deficits in excess of $1 trillion a year for as far as the eye can see. They are also right to point to Congressional Budget Office estimates, which suggest that the Obama administration’s budget proposal will lead to a doubling in the U.S. public debt from 41 percent of GDP in 2008 to 82 percent of GDP in 2019. However, in supposing that the dollar will be eclipsed by the Chinese renminbi rather than by the euro, they are very likely to be picking the wrong horse.

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Desmond Lachman is a resident fellow at the American Enterprise Institute. He was managing director and chief emerging market economic strategist at Salomon Smith Barney and a deputy director in the International Monetary Fund’s policy and review department.

[Mister Muggles]

Why don’t the Chinese either UNPEG the RMB or STFU?

[yldstrk]

the yen is a yawn lol
nobody trusts the heathen chinee anyway

[SeekAndFind]

Why don’t the Chinese either UNPEG the RMB or STFU?

They are looking at an alternative, but no other currency seems attractive.