China's dollar trap
Paul Krugman, The New York Times
China is worried that US dollar may lose its value. But it was China's faulty policy that increased its dependence on dollar.
Back in the early stages of the financial crisis, wags joked that our trade with China had turned out to be fair and balanced after all: They sold us poison toys and tainted seafood; we sold them fraudulent securities.
But these days, both sides of that deal are breaking down. On one side, the world’s appetite for Chinese goods has fallen off sharply.
China’s exports have plunged in recent months and are now down 26 per cent from a year ago. On the other side, the Chinese are evidently getting anxious about those securities. But China still seems to have unrealistic expectations. And that’s a problem for all of us.
The big news last week was a speech by Zhou Xiaochuan, the governor of China’s central bank, calling for a new “super-sovereign reserve currency.” The paranoid wing of the Republican Party promptly warned of a dastardly plot to make America give up the dollar. But Zhou’s speech was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.
Some background
In the early years of this decade, China began running large trade surpluses and also began attracting substantial inflows of foreign capital. If China had had a floating exchange rate — like, say, Canada — this would have led to a rise in the value of its currency, which, in turn, would have slowed the growth of China’s exports. But China chose instead to keep the value of the yuan in terms of the dollar more or less fixed. To do this, it had to buy up dollars as they came flooding in. As the years went by, those trade surpluses just kept growing — and so did China’s hoard of foreign assets.
Now the joke about fraudulent securities was actually unfair. Aside from a late, ill-considered plunge into equities (at the very top of the market), the Chinese mainly accumulated very safe assets, with US Treasury bills (T-bills) making up a large part of the total. But while T-bills are as safe from default as anything on the planet, they yield a very low rate of return.
Without any logic
Was there a deep strategy behind this vast accumulation of low-yielding assets? Probably not. China acquired its $2 trillion stash — turning the People’s Republic into the T-bills Republic — the same way Britain acquired its empire: in a fit of absence of mind. And just the other day, it seems, China’s leaders woke up and realised that they had a problem.
The low yield doesn’t seem to bother them much, even now. But they are, apparently, worried about the fact that around 70 per cent of those assets are dollar-denominated, so any future fall in the dollar would mean a big capital loss for China. Hence Zhou’s proposal to move to a new reserve currency along the lines of the SDR’s, or special drawing rights, in which the International Monetary Fund keeps its accounts.
So what Zhou’s proposal actually amounts to is a plea that someone rescue China from the consequences of its own investment mistakes. That’s not going to happen.
And the call for some magical solution to the problem of China’s excess of dollars suggests something else: that China’s leaders haven’t come to grips with the fact that the rules of the game have changed in a fundamental way.
Paul Krugman, The New York Times
China is worried that US dollar may lose its value. But it was China's faulty policy that increased its dependence on dollar.
Back in the early stages of the financial crisis, wags joked that our trade with China had turned out to be fair and balanced after all: They sold us poison toys and tainted seafood; we sold them fraudulent securities.
But these days, both sides of that deal are breaking down. On one side, the world’s appetite for Chinese goods has fallen off sharply.
China’s exports have plunged in recent months and are now down 26 per cent from a year ago. On the other side, the Chinese are evidently getting anxious about those securities. But China still seems to have unrealistic expectations. And that’s a problem for all of us.
The big news last week was a speech by Zhou Xiaochuan, the governor of China’s central bank, calling for a new “super-sovereign reserve currency.” The paranoid wing of the Republican Party promptly warned of a dastardly plot to make America give up the dollar. But Zhou’s speech was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.
Some background
In the early years of this decade, China began running large trade surpluses and also began attracting substantial inflows of foreign capital. If China had had a floating exchange rate — like, say, Canada — this would have led to a rise in the value of its currency, which, in turn, would have slowed the growth of China’s exports. But China chose instead to keep the value of the yuan in terms of the dollar more or less fixed. To do this, it had to buy up dollars as they came flooding in. As the years went by, those trade surpluses just kept growing — and so did China’s hoard of foreign assets.
Now the joke about fraudulent securities was actually unfair. Aside from a late, ill-considered plunge into equities (at the very top of the market), the Chinese mainly accumulated very safe assets, with US Treasury bills (T-bills) making up a large part of the total. But while T-bills are as safe from default as anything on the planet, they yield a very low rate of return.
Without any logic
Was there a deep strategy behind this vast accumulation of low-yielding assets? Probably not. China acquired its $2 trillion stash — turning the People’s Republic into the T-bills Republic — the same way Britain acquired its empire: in a fit of absence of mind. And just the other day, it seems, China’s leaders woke up and realised that they had a problem.
The low yield doesn’t seem to bother them much, even now. But they are, apparently, worried about the fact that around 70 per cent of those assets are dollar-denominated, so any future fall in the dollar would mean a big capital loss for China. Hence Zhou’s proposal to move to a new reserve currency along the lines of the SDR’s, or special drawing rights, in which the International Monetary Fund keeps its accounts.
So what Zhou’s proposal actually amounts to is a plea that someone rescue China from the consequences of its own investment mistakes. That’s not going to happen.
And the call for some magical solution to the problem of China’s excess of dollars suggests something else: that China’s leaders haven’t come to grips with the fact that the rules of the game have changed in a fundamental way.
