In mid-2009, with American finance reeling from the Lehman Brothers collapse, the nation's Treasury Secretary addressed his prestigious alma mater Peking University. 'How safe are China's investments in US Government debt?', challenged one student. 'Very safe', the Secretary answered to derisive laughter.
At the time, cynicism was understandable. But many Chinese experts still doubt the security of Beijing's official reserve holdings, which have been growing ever larger. These same people fret about the dollar's dominance and they reasonably wonder why the world can't be more multipolar, with several reserve currency alternatives.
A recent issue of the journal Red Flag Manuscript features a paper complaining that the US 'reaps profits without sowing' and lists no less than ten 'harvests' from the US dollar's reserve-currency status: seigniorage, 'inflation tax', foreign investment income, underwriting and transaction fees, unfair trade gains, currency manipulation, derivative and commodities profits, and IP royalties. The paper says that over 500 years, Portugal, Spain, Holland, England and then the US have successively exploited 'state hegemony' which has 'gradually developed from traditional territorial conquest to modern financial colonisation.'
A book recently launched at Renmin University, Sanctions and Global Asymmetric Power, makes a more direct warning that Western monetary power 'kills without a shot.' This concern is not unjustified, given that American pundits discuss 'weaponised finance' and how Russia and China are 'circumventing' the dollar system.
Such critiques are quintessentially Marxist-Leninist. But Beijing's real problem is not that America's imperialism (to use Marx's term) is unfair or immoral, but that China doesn't also enjoy such spoils. Beijing's perspective is straightforward: China wants what America has got. It is unhappy with its relative position rather than with its own vulnerability.
Take Red Flag's first point, seigniorage, a reward for all currency issuers. It is most easily understood as the interest rate not paid on cash. The banknote in your wallet is a 'zero coupon perpetual' instrument: it pays no interest and can only be redeemed in kind. The Federal Reserve gets a free ride on all those bills it has issued. But then, so does every central bank. And the biggest of all money issuers by far is China, which fleeces its citizens of several percent of GDP in foregone interest annually. The 'exorbitant privilege' of the People's Bank of China's seigniorage is wholly at the expense of the Chinese people.
But what stings Beijing most is that America extracts its seigniorage from anyone holding greenbacks, including Chinese.
How the US dollar became so dominant is splendidly depicted in Adam Tooze's book The Deluge. A hundred years ago, the British Empire was stumbling towards insolvency. The Deluge explains how a reluctant, isolationist Wilsonian America shrugged off the mantle of global leadership, leaving behind a vindictive Versailles peace, a rampant Soviet Union, a bereaved China in chaos, and a predatory Japan. Bad things ensued. World War I had 'bequeathed an unprecedented problem of economic and political order, but no historical model of world hegemony with which to address it.' Only 30 years later, at Bretton Woods, did Washington acknowledge and self-interestedly embrace its financial pre-eminence, possibly for fear of any alternatives. America didn't initially seek the crown but got it by default when all other contenders lay shattered.
The British themselves recognised their shaky hold (then on the gold-pound). A Foreign Office memo in 1928 described the challenge starkly:
Great Britain is faced...with a phenomenon for which there is no parallel in our modern history -- a state twenty-five times as large, five times as wealthy, three times as populous, twice as ambitious, almost invulnerable, and at least our equal in prosperity, vital energy, technical equipment, and industrial science. This state has risen... at a time when Britain is still staggering from the effects of the superhuman effort made during the war, is loaded with a great burden of debt, and is crippled by the evil of unemployment.
Is there a senior adviser cautioning the American president with a similar assessment today? Possibly within several decades, but not yet. For the British, their zenith was already upon them. Chinese experts, too, know the history of hegemonic transition. Some have called for 'the management of America's decline.' Others are more circumspect, well aware of the burden of reserve issuers. As the late Ronald McKinnon has said, dissatisfaction with the dollar is widespread, including in the US itself.
No doubt there is potential demand for new reserve currencies in the world, and the establishment of a international renminbi – with a free capital account – would be welcome. De-pegging the renminbi from the dollar would afford Beijing greater monetary independence in the long term. Recently capital outflows have accelerated, and Beijing is selling dollars in order to hold its currency relatively firm.
After years of sterilising inflows, the Chinese now have an historic opportunity to escape their dollar dependence and attain the reserve status they crave. Even Peking University students, the future elite of the nation, know US T-bonds are unsafe. So keeping the Chinese currency strong and stable is easy: just sell them.
Photo courtesy of Flickr user Sharon Drummond.