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China's Dollar Reservations

There is always a ready response to people who start worrying that the mountains of U.S. debt will endanger the dollar as world currency:  what currency could possibly replace the dollar as the world currency?  The Eurozone is currently a mess.  And Japan and China don’t want their currencies to rise in value, which would further endanger their exports – and an increase in value is the usual consequence of a currency becoming the world’s reserve. Indeed, China has not allowed its currency to float, which it would have to do if other countries and private investors from other countries were able to hold it.  So forget about the danger of debt and dollar.

Well, maybe not.  The Chinese have been sending signals lately that they are not happy with the dollars they are holding.  On March 13, Chinese Premier Wen Jiabao expressed his fears about his country’s holding in dollars. “To be honest, I’m a little bit worried,” he said.   

On March 23, Zhou Xiaochuan, the governor of the People’s Bank of China, published a statement urging reform of the International Monetary System.  Among his proposals was the creation of the new super-reserve currency, modeled on what are currently called “Special Drawing Rights.”  SDRs are determined by averaging a basket of leading currencies.  Zhou’s statement was clearly directed at the dollar.

Now there is word that China has taken the unusual step of swapping its currency with Argentina to allow Argentina to pay for China’s exports in renminbi instead of dollars. That’s not letting its currency float, but it is letting it out of the country to a degree that China has been unwilling to do.  And that follows similar deals with Belarus, Indonesia, Malaysia and South Korea.  Brad Setser has been following this issue, which could turn out to be of historic importance.

--John B. Judis