Even with a slowing economy and export markets slowing faster, China has a lot of trade surplus dollars to recycle. Its foreign-exchange reserves are in excess of $1 trillion and they sit mostly in U.S. dollar-denominated assets.
The American currency depreciated steadily for the past four years, though it has rallied recently. This may be a technical rally due to a rare combination of unwinding of derivative positions at a time when shorting the dollar is nigh impossible because of the lack of liquidity; though the flight-to-quality rally school will remind you that, though counterintuitive, there is precedent for the dollar to rise during recessions.
Regardless, the losses on China’s dollar-denominated assets have grated with some officials. So has the fact that China has been subsidizing what is now seen as American extravagance and a broken U.S. financial system — while all the while being lectured about how China’s markets should become more like the U.S.’s; schadenfreude alert.
China has started to diversify its foreign-currency holdings, though that has perils of its own as some of the recent foreign exchange losses by Chinese companies have shown (see:”Two More Chinese Firms Reveal Forex Losses“) And more trade in recent years has been denominated in currencies other than the dollar, such as oil in euros. A lot of oil producers would be happy to undermine dollar hegemony, and a world where the dollar shares trade shelf space, so to speak, with the euro and the yen looks more like the multipolar world of the global economy.
But there is no substantive alternative to the U.S. dollar as the world’s default reserve currency. Neither the Europeans nor the Japanese want it. Nor can the renminbi, still not fully convertible, aspire to the role.
The notion of creating a non-national global reserve currency has been floated many times before, and will no doubt be giving another airing during the forthcoming run of proposed world leaders’ summits on the financial crisis and a new regulatory regime.
There was some corridor chatter about the idea at the Asia-Europe summit in Beijing at the end of last week. But it would be a brave punter who bet on it coming about. Indeed, the substantive move to come out of the summit on this front was a Chinese-Japanese agreement to support the dollar jointly. They just can’t afford otherwise.