On the eve of his visit to Washington, Chinese president Hu Jintao has criticized the international monetary order based on the US dollar as "a product of the past." Hu went further and said he's working to replace the greenback with the Yuan as the world's reserve currency.
It's the "Golden Rule" - he who (or should that be "Hu"?) has the gold, rules. The US has reaped enormous advantages by having its dollar the world's reserve currency. It allowed American monetary policy to influence world trade and commerce while also somewhat insulating America from the potential repercussions of its reliance on foreign lenders. An example of this was when the Federal Reserve recently put into circulation another 600-billion dollars, calling it a "quantitative easing," a term Paul Krugman explains thusly:
QE is basically expansionary monetary policy, no different in its effects (if it works) from reducing the policy interest rate. Yes, it tends to weaken the exchange rate; but it also increases domestic demand.
China is engaged in currency manipulation, that is, buying foreign currency to keep the yuan weak; meanwhile, it is actually moving to reduce domestic demand, among other things raising interest rates.
So the United States is moving to expand world demand, with a policy that may weaken the dollar; China is moving to reduce world demand, with a policy of deliberately weakening the yuan. America’s policy may annoy its trading partners, but they are not the target; China’s policy is predatory, pure and simple.
If Krugman's explanation is too confusing, you might prefer The Guardian's take on quantitative easing:
There are two ways of looking at quantitative easing. One way is to see it is as an unorthodox tool for loosening monetary policy by intervening in the bond market to hold down long-term interest rates. But that doesn't really do the process justice. A more useful way is to see it as the opening of a golden casket in which are housed billions of tiny money pixies who fly over financial markets sprinkling sparkly confidence dust. Invisible trader elves gather the dust and distribute it to institutional investors. They then take the dust in magic flying sleighs and stuff it down the chimneys of all the good citizens who go out and spend money and stimulate the economy. But it only works if people truly believe. If you don't believe, you won't get any confidence dust this Christmas and your economy will stay in the doldrums.
So yes, Dorothy, there is a currency war underway and China believes it holds all the aces. Hu's statements are his way of reminding Washington that China isn't giving up until Uncle Sam yells "uncle."
Which won't be anytime soon. China is itself in a precarious economic situation, a housing bust away from initiating another world wide financial crisis. It doesn't hold all the aces, but it does have a jester.
Hi Troy. If it was just the Chinese demanding a new reserve currency I would agree with you. However China isn't alone. The Euros are clamoring for the same thing as are the OPEC states. It won't be long before the entire BRIC bloc (Brazil, India, Russia, China) will be demanding a switch. Being the currency of global trade largely depends on being the dominant global creditor. Reagan flushed that down the drain in just two terms, transforming the US from the largest world creditor into the world's largest debtor nation. America's inability or unwillingness to rectify that probably was the writing on the wall for the supremacy of the greenback.
It does fit a patern, though.
Japan begins to dominate global currency, but then its real estate bubble bursts.
The Euro begins to dominate, but its bubble bursts (at just about the same time as the US).
China's yuan begins to dominate, but right as of now, its real estate economy looks terrible unreal.
It's too soon to call, right now. Countries will begin changing the pecking order after the next crisis (or the one following that). What might emerge is a grab-bag of currencies until one wins out (probably the Yuan, but not until it's clear China's economy is sound, which currently it definitely isn't (but it shows a lot more promise than any other, except probably India)).
The US probably has the advantage right now, because the Chinese can't re-evaluate their currency without serious consequences whereas the US can just continue printing more and more money.
Until the Chinese suffer the consequences of re-evaluating the Yuan, which it is going to eventually have to do, it remains trapped by the US' quatitive easing.
China is bluffing. The US is happy right where it is, unless the Republicans mess up what Krugman calls the only thing the US government is doing well to ease the depression pains for the US.
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