Currency focus: Questions over greenback's supremacy won't go away

Monday 3rd August 2009

In 1963, American folk group the Kingston Trio went to number 21 on Billboard with their single "Greenback Dollar". The chorus line "...and I don't give a damn about a Greenback Dollar, spend it fast as I can" was ominously prescient for their generation of baby boomers and subsequent millions of Generation X, Y and today's ‘Next Gen' teenagers, all of whom followed suit until the music stopped in 2008.

The global markets crashed, triggering the biggest recession the world has seen since the 1929-32 Depression.

Perhaps Venezuelan President Hugo Chavez had been listening too, when he suggested in 2004 that oil prices should be benchmarked in Euros rather than the U.S. dollar. At the time his remarks were greeted with a mixture of disdain, disbelief and criticism that proposing such a scenario was both destabilising and unnecessary.

But few appeared surprised at the rumblings around last month's G-8 + 5 Summit in Italy, when reform of the global reserve currency system was mooted, even if the official statements were sanitized of such sentiment. Chinese State Councilor Dai Bingguo stepped up to the plate to deliver the message. With expressions of support of the initiative from French President Nicolas Sarkozy, along with Brazil, India and Russia, unquestioned support for the status quo was noticeably absent.

Industry observers are already speculating that the U.S. dollar may ultimately be replaced as the global reserve currency by a basket of major international currencies similar to the International Monetary Fund's Special Drawing Rights (SDR), a unit of account that is effectively a mix of dollars, euros, sterling and yen.

In any new system it is doubtful if the current SDR formula will be maintained. India and China, which hold more than 30% of the international reserve, and represent more than 40% of the global population, have been allowed a share of only about 5% in the aggregate value of SDR. It is not the first time China has indicated its desire for a change. Its proposal was on the table for discussion at the G-20 summit in London in April, but the meeting ended without arriving at a conclusion.

The Chinese government has already called the Federal Reserve's decision to print money to buy Treasury Bonds a "policy mistake" and analysts point to a shift from Chinese investment in long-dated securities to shorter-dated paper whose value will be less at risk from quantitative easing.

Combined with China's recent decision to allow international trade settlements in the yuan for Taiwan, Hong Kong and most recently Brazil, you begin to sense a change is underway. Of course, no one is pushing for change in a hurry. After all, many of these countries are some of the largest holders of US government debt. China itself holds an estimated 70% of its US$1.95 trillion in official foreign exchange reserves in the dollar.

The future of the dollar as the global reserve currency is hardly what you would expect to be compelling local news. Everyone knows all politics is local. But it has now become a hot issue in the forthcoming election in Japan. The opposition Democratic Party of Japan, leading in polls ahead of the August 30 election, said the nation should consider shifting its $1 trillion of foreign reserves away from the dollar and buying International Monetary Fund bonds.

"In the medium to long term, we need to do what we can to avoid the risk of currency losses or economic turbulence that could result if the dollar were to swing," Masaharu Nakagawa, the shadow finance minister, said in an interview in Tokyo on July 9. "Many countries are starting to diversify their reserves."

Given the size of Japan's dollar holdings and the damage a drop in the greenback's value would deliver, diversification of Japan's reserves is likely to remain gradual, Nouriel Roubini, a professor at the Stern Business School at New York University, wrote in a column for Forbes.com on July 23.

"But the chance of political change come August 2009 raises uncertainty on this point," he wrote. As seeping confidence in paper currencies sees increasing focus on commodities, there is evidence of moves in other areas which point towards broader strategic interests being pursued.

Martin Spring wrote in the June edition of privately circulated newsletter ‘On Target' of increasing signs that China is investing part of its foreign trade surplus in commodities such as copper, platinum and other rare metals, and in rights to buy a whole range of raw materials. Despite the global slowdown China is still accumulating around US$40 billion in additional foreign reserves every month. Buying resources for stockpiling reduces the trade surplus, secures strategic access to much needed raw materials for the future and deflects arguments that China is manipulating its currency.

According to analyst Jack Lifton, whose research is published on the seekingalpha.com website, 90% of output of rare earth metals - vital in industrial products from iPods to auto engines - is now under Chinese control.

If this is true then the July 8 announcement by Ericsson that it had signed contracts with two leading mobile phone operators, China Mobile and China Unicom worth $1.7 billion was both auspicious and good timing. The two operators, who serve more than 620 million subscribers, will buy 2G and 3G mobile communication equipment and related services from the Swedish telecoms group.

On the financial front, the People's Bank of China announced a staggering increase in lending in June to 1.53 trillion yuan ($224 billion), doubling the lending of the previous month. The bank began the year predicting lending growth of 5 trillion yuan for the year. Now, with only half the year gone, it has already lent an astounding 7.4 trillion yuan.

While some of this lending has resulted in new car sales rising 36% YOY, there has also been significant easing of credit to SMEs. As the official policy of encouraging banks to SMEs begins to gain traction a recent survey reported 39% of SMEs found it easier to obtain bank credit compared to 6% at the beginning of the year.

Whatever conclusions you draw from these events one thing is clear. China has been a global leader in trade, culture and commerce for four of the last five millennia. After the uncharacteristic blip associated with the industrial revolution, you can't help get the feeling, they are on the way back.

Justin Barnett is a communications executive based in Thailand

Businesswire.co.nz

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