IF you owe your bank $1,000 you have a problem, but if you've borrowed $1 million it's the bank that has the problem. Going by that old maxim, then China, which has lent the United States upwards of $1.3 trillion, has a very big problem. And it knows it. As a consequence, Beijing is diversifying its overseas investments and pressing US officials for an “exit strategy” from the ultra-loose fiscal and monetary policies that China fears will eventually inflate away the value of its US bond holdings and fell the dollar. But China's pragmatic policymakers also know there is no practical alternative to the dollar as the world's main reserve currency. Which is why bankers say any rhetoric from Tuesday's inaugural BRICs summit in Russia about the need for the United States to cede power in global financial institutions should not be taken as a signal that Beijing is positioning the yuan to challenge the dollar's supremacy. The BRICs summit in the Urals city of Yekaterinburg will bring together the leaders of Brazil, Russia, India and China. “We have seen the growing integration of the Chinese financial system into the global economy, and over time we will see a gradual enhancement of the role of renminbi,” Charles Dallara, managing director of the Institute of International Finance (IIF), told a meeting of his group in Beijing last week. “Will it replace the dollar?” Dallara asked. “The fact is that I don't think this is what Chinese officials want.” The SDR feint For sure, Zhou Xiaochuan, the governor of the People's Bank of China, caused a stir with an essay in March arguing that the Special Drawing Right, the International Monetary Fund's unit of account, might one day displace the dollar. But diplomats and bankers who have recently visited the central bank say Zhou admits the proposal is unrealistic. They say his aim was to draw attention to concern expressed by Premier Wen Jiabao about the safety of China's vast dollar holdings. In particular, these people said, Zhou wanted to revive a debate over the so-called Triffin Dilemma. Belgian-born economist Robert Triffin argued in 1960 that the United States could not supply enough dollars to satisfy the global appetite for reserves without triggering inflation, which in the long term would erode the dollar's value. “Issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries' demand for reserve currencies,” Zhou wrote. “The Triffin dilemma ... still exists.” Concretely, bankers said Beijing was acting on its concerns by urging the US government to issue more Treasury Inflation Protected Securities. Unlike conventional bonds, TIPS shield their owners in the event of a rise in inflation. Shrewd swaps Don Hanna, acting chief economist at Citibank, said China had less to fear from the inflationary potential of the Fed's quantitative easing than from the dire US fiscal outlook. Faced with huge future pension and health care liabilities, America's debt profile was not sustainable, Hanna said. But other rapidly ageing developed countries were in the same boat. “It means that if you're going looking for other assets that would be ‘safer', there aren't many of them out there,” he told the IIF conference. “So we should not expect any rapid alteration in the allocation of resources by the Chinese – or aggressive changes by anyone else for that matter.” Still, China is striving at the margins to diversify a national overseas investment portfolio that is massively concentrated on dollar claims on the United States. u Beijing has said it will buy up to $50 billion worth of SDR-denominated bonds to be issued by the IMF. u The government is pressing Chinese firms to invest overseas, especially in the natural resources sector; it has extended $45 billion in credit to Russia, Brazil, Venezuela and Angola in return for long-term oil supplies; and it has been frantically building up stockpiles of commodities. u The PBOC has arranged currency swap deals with six countries since December totalling 650 billion yuan ($95 billion) so that trade and investment with China can be conducted in yuan, not dollars. Hanna said these swaps were a shrewd move as they would allow China to accumulate claims on the rest of the world without increasing its exposure to the US currency. “To the extent that it expands the invoicing of its trade in yuan, it is trading FX risk for credit risk,” Hanna said. In a related policy innovation, China will soon allow selected firms in the southern province of Guangdong that trade with Hong Kong to settle their transactions in yuan, or renminbi. Fang Xinghai, director-general of the Shanghai municipal government's Office of Financial Services, said the initiative was an important step towards making the yuan convertible.
