Yu Qiao, an economics professor at Tsinghua University in Beijing, says the best way for China to rescue itself from a dollar trap is to gradually transform the renminbi into a regional currency on par with the dollar and the euro.
Speaking yesterday at AsianInvestor's fourth annual investment summit in Hong Kong, Yu also called for the creation of a "crisis relief facility" to ease China and America out of the current financial and economic crisis.
Yu says the establishment and then break up of the gold standard taught the world that prosperity is dependent upon global economic integration; that globalisation in turn is dependent upon a universal money; and that such a currency based on sovereign fiat is unstable.
The establishment of the Bretton Woods system, based on the dollar, set the stage for globalisation after World War II, and provided the framework for China to integrate and become the world's manufacturing centre. But the financial crisis has highlighted how fragile globalisation can be. China can no longer be a free rider in this world system, Yu says.
China, Japan and other Asian countries face a dilemma -- how to safeguard the real value of their financial assets while helping the world economy recover. Ultimately Asians need to extend their economic boundaries and realise their full growth potential, while addressing the current macroeconomic imbalances.
Of the roughly $10 trillion of outstanding US debt, East Asia holds about 25% of the notional outstanding and perhaps as much as a third in total, if you include indirect holdings. China alone has an exposure of $1.2 trillion, directly and indirectly, Yu says.
The US is addressing the current crisis through fiscal and monetary means, the result of which is to blow out its debt-to-GDP ratio in excess of 100%, a side effect of which is a bubble in Treasury securities. However the Obama administration's fiscal projects are for social programmes, not for investment, which doesn't address the long-term issue of consumer borrowing. To this end, the US has injected $2 trillion, either through stimulus packages or via the Federal Reserve's balance sheet, and the Fed is buying long-term Treasury bonds to help finance it.
Yu notes that Fed chairman Ben Bernanke has long made clear his willingness to inflate his way out of crisis. "The Fed is subordinating the stability of the dollar to the national interest," Yu says. This puts the international monetary system at risk and China in danger, as its portfolio of reserves risks devaluation.
This is where Yu's idea for a central relief facility (CRF) comes into play. He says the ideal, simple solution is to create a mechanism in which Asian reserves engage in a debt-for-equity swap and invest in American industry, which is so desperate for capital. Equity claims in US infrastructure projects, for example, would provide a hedge against inflation. And American industry, including banks, healthcare and environmental technology companies, find a new source of finance.
To make this work, Yu says Asian central banks would insist their equity investments were insured against loss, as they remain dedicated to preserving their capital. He says this could work if a syndicate of insurance companies provided cover, with the US Treasury as the guarantor.
Economically it's elegant; politically it's unlikely, Yu admits. But the fact that such ideas are being aired demonstrates how decision makers in Beijing and elsewhere are thinking.
In the long run, Asia needs to wean itself off dollar dependence. Yu says one idea, recently floated, is using the IMF's special drawing rights. But this is impractical: SDRs are accounting units using a basket of currencies, and there's no way to calculate their supply or their price against other currencies outside of that framework. Although the use of SDRs may rise for accounting purposes, Yu likens these to Esperanto, the global language that nobody actually uses.
Another option is to revive the gold standard. Again, it's not feasible. Even if major economies were ready to surrender their dollars, returning to gold would disrupt all asset prices. There's only about 1 billion ounces of gold in the world, versus $30 trillion of currencies. So you can quickly see how much a unit of gold, or a dollar, would be. Moreover, Europe and America together own 65% of the world's gold reserves, versus only 7% for Asia, including Japan. So returning to the gold standard would impoverish the East.
This leaves only what Yu calls triangularity: the creation of a renminbi bloc that is on par with the euro. The dollar would likely remain the top currency but the euro and RMB would also be significant global units, with sterling and the yen in supporting roles.
The current crisis has prompted Beijing to change utterly the way it manages its monetary policy, forcing it to take a more active role in cross-border flows. The People's Bank of China has signed six currency swap arrangements with other monetary authorities, to encourage the RMB's role in trade, and commenced trade settlements at a number of Chinese cities on RMB terms. It is also enlarging the share of loans to African governments or through the Asian Development Bank made in renminbi.
Longer term, however, the core of a regional RMB bloc must include the integration of it with the Hong Kong and New Taiwan dollars, Yu says. He says within 30 years there could be "one currency, two versions" for Hong Kong, in which the Hong Kong dollar serves as the international avatar of the renminbi. The Taiwan dollar, meanwhile, would be tied to the RMB via a currency board.
Achieving this requires China to develop its capital markets so they are capable of recycling its outstanding overseas RMB, which implies full capital and currency convertibility and a large portion of foreign capital moving freely throughout Chinese markets.
Another condition is enhancing the dynamism of China's financial institutions and regulatory bodies, and the development of a framework that Yu describes as enforceable and binding -- which sounds a lot like the rule of law, although Yu does not use that phrase.
The bottom line is that the renminbi must evolve into a regional currency, one of three main global units, if China is to continue to benefit from, and encourage, globalisation. This may not offer much solace to Asian investors currently stuck in a dollar trap, but it does provide a roadmap to a potentially more stable currency framework for China and the world.