update: Paul Krugman's excellent piece on China's dollar trap half contradicts and half supports what I've written. Krugman believes that governor Zhou's call for a "super-sovereign reserve currency" only shows the T-bills Republic's mistake in over-accumulating the dollar. so yeah, I may have been off suggesting that it's a sign of China's economic might. But my counter-argument that China's not ready to up the ante on the dollar any time soon still holds. on another note, I am totally in line with Krugman on China's desperation for trade.


me and Lusi were on a quick lunch, and we were on the topic of China's international clout vis-a-vis the U.S., from the perspective of the yuan-dollar relative importance. that is some serious talk (which rarely happens between the jolly us), and so this is a complementary piece to my recent opinion on the increasingly relevant US-China rivalry. but instead of a general, multi-faceted picture, this time there'll be a focus, on the yuan-dollar balance as a proxy for US-China competition.

Barry Eichengreen has just dismissed the G-20 as a too diverse grouping for consensus-building and effective crisis management, contending that the rich world, i.e. the U.S. and Europe and Japan, cannot quite align their interests with those of Indonesia and Argentina. but China seems to be offering an innovative solution: on the eve of the G-20 London summit, China and Argentina have agreed on a yuan swap facility of up to 70 billion yuan to allow dollar-tight Argentina to directly trade with China without the usual intermediary U.S. dollar. This should help prevent a further drop in trade volumes, thus stemming the adverse effects of the financial crisis on export-driven China.

China has already inked yuan swap agreements with many other countries before Argentina. there is a recent 100 billion yuan swap line with Indonesia, and another 20 billion with Belarus, in addition to earlier arrangements with South Korea, Malaysia and Hong Kong that in all total 650 billion yuan, or US$ 95 billion. and so what's significant about the Sino-Argentina swap deal is that China is extending its sphere of influence into Latin America, the traditional backyard of America. here's a large country in a large continent right next to the U.S., where many countries either officially dollarise or practically prefer the dollar to their domestic currencies. and yet Argentina is taking the option to bypass the dollar and trade directly with China on the yuan.

this, coupled with the recent assertion by China's central bank governor Zhou Xiaochuan that the world needs a new reserve currency in place of the dollar, should prompt Obama & Co. to have an economic Cox Report on China, as the assault has now entered a new realm of currency supremacy, besides cyber-war and aircraft carrier and space race.

nevertheless, when the going gets tough, the tough usually gets going, for the United States of America. many people thought Japan was going to overtake the American economy in the 1980s, the same way Germany was believed to be on its way to surpass America after World War II. the U.S. and its people have this quality that brings the country to where they are today, a quality that has trumped Germany's "soziale Marktwirtschaft" and the Japanese perfectionism. of course China can bring a different ballgame altogether. but there's no obvious reason why the U.S. cannot respond with its trademark American enterprise.

also, China can, but whether it is ready to bring the dollar to task is a very different thing. as recent as November 2007, governor Zhou was still supporting a strong dollar as the subprime crisis emerged in America. and the yuan cannot replace the dollar as long as it is still pegged to the dollar, although China seems to have allowed minimal yuan movements since 2006, and the peg is at its lowest level since inception (See chart). in addition, China is currently the largest holder of American bonds, and the Chinese Communist Party cannot afford to have 70% of their foreign reserves eroded away following the collapse of the dollar. this is no wild guess: China's central bank assistant governor Yi Gang said in November 2007 the dollar must remain the key component of the country's then 1.4 trillion dollar reserves because it was "the largest currency that we use" for trade and FDI as well as other international financial settlements.


let's also note that for every country in need of a yuan swap agreement with the People's Bank of China, there are almost three who are on dollar swap lines with the Federal Reserve. my guess is that China is extending the yuan swaps not with the primary intention to signal the coming of age of the currency, but for the practical reason of trade. China needs trade to prevent further economic slowdown, and so it is simple logic to provide swap facilities to Asian countries who trade extensively with China, as well as Argentina, of which China is the second largest trade partner.

I suppose the most important fundamental question to ask when assessing the declining role of the U.S. dollar is, what are the alternatives? the dollar may be unreliable, and it gives America too much financial and political leverage over the rest of the world, and it is almost immoral to have third-world savers fund the American consumer who lives on credit. but China is not ready to do it. Japan is not ready to do it. and the EU is not prepared to slam Benjamin Franklin any time soon.

well, instead of a single supreme global currency, we can have the best of all worlds. but that is going to take real long before the U.S. and the EU and China and Japan and the UK and Russia and India and Brazil come to a consensus on the relative weights of their currencies.

can China go it alone? Lusi thinks 2009 year-end would reveal something interesting on that. and so she was totally surprised when I said, give China 20 years. at the least.