Saturday, July 18, 2009

Dollar Dominance & RMB

Any cursory reading of the news these days indicate that the Chinese authorities are not letting up on their to-your-face attacks of the dominance of the US$ as the global reserve currency.

The unspoken subtext is the time has come for China's own currency, RMB, to assume a role of a global reserve currency.

All professionals understand that it is premature for the RMB to take on such a role. Several well-known pre-conditions need to be met before the RMB could become a serious contender as a reserve currency.

They include high quality of governance of the banking system, transparency of monetary and economic policy making, rule of law not -- only in commercial but also in just about all other areas including criminal laws. The recent sudden arrests of 4 top Rio Tinto executives is one example of how commercial disputes could quickly morphed overnight into a state-to-state crisis. This is more the stuff of George Orwell than that of globalization.

And then the currency must be a totally convertible one before it can go global.

There is little doubt sometime in the future China would be able to meet those requirements.

The issue is not whether, but when. It is also clear "when" is not quite here yet. Not even close.

Yet there is another level on which the Chinese attack is entirely apropos.

The ability of the US to print any amount of money it wants -- as it has been doing since Vietnam where both guns and butter were considered ok -- without creating a classical "third world" currency crisis is because the US$ is the only reserve currency every country uses it as the basic unit of accounting and exchange.

If the US had had to watch out for current account deficits, like any "normal" country, it would not have been able to borrow its way out of financing unbounded consumer appetite for goods and for its leaders to finance overseas ventures mindlessly. The flooding of the US$ in the world economy has been the major source of financial instability the latest of which is still being played out.

China's attack on the US$ has a geopolitical dimension that has not been sufficiently aired in the public domain.

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