In These New Times

A new paradigm for a post-imperial world

China determined to end the reign of the US currency

Posted by smeddum on April 28, 2011

India Times

28th April, 2011

Earlier this month the BRICS countries (Brazil, Russia, India, China, South Africa) agreed at their summit meeting in Sanya, China, to establish mutual lines of credit in local currencies. On the face of it, this is an innocuous effort by the world’s fastest growing countries to strengthen their mutual relationship . However, in the context of the emerging global power relations , this is yet another important step in the Chinese initiative to end the reign of the dollar as the world’s single reserve currency.

Two years ago I wrote in these columns about the Chinese campaign to dethrone the dollar. Shortly before the G20 London summit , China’s central bank governor announced that the dollar should be replaced by SDRs. This was a shrewd approach. About half of China’s foreign exchange reserves of $2 trillion are reportedly held as dollar denominated assets, as indeed are large chunks of the reserves of many central banks. This large exposure implies that any major depreciation of the dollar would severely erode the value of these assets.

At the same time, large diversification of these reserves away from the dollar is not an option. Such a move itself would trigger a sharp depreciation of the dollar. But the exchange rate of SDR is a weighted average of a basket of convertible currencies, and a swap of dollars for SDRs at a predetermined exchange rate would allow China, and other countries , to significantly reduce their dollar exposure without any erosion of the value of their reserves. Of course, it would also end the reign of the dollar.

At the time, most analysts dismissed the Chinese initiative as impractical and unworkable. However, China has taken several strategic steps to carry forward its agenda through alternative routes. It has established currency swap arrangements with several developing countries , which protects their trade with China against the risk of their currencies depreciating. The initial value of these arrangements was quite modest, less than $100 billion.

However, during the past two years, the volume of these arrangements would have grown significantly and could eventually cover the entire trade of these countries with China. Reportedly, Russia has also adopted the same approach. China is also leading the initiative for an Asian Monetary Fund. The IMF vehemently opposed the idea when it was originally mooted by Japan during the Asian financial crisis.

However, the idea was revived a year later as the Chiang Mai initiative of the ASEAN + 3 (China, Japan, Korea), and finally became a reality when the fund was launched in 2009, this time with IMF support. The initial capital of the fund was quite modest. However, this fund could eventually be scaled up to cover the entire foreign exchange risk of total intra-ASEAN + 3 trade.

On top of these earlier moves, China has now led the latest initiative to establish mutual lines of credit in local currencies to protect intra-BRICS trade from foreign exchange risk. The volume of this trade is only around $230 billion at present, but as a measure of potential, it is noted that the BRICS countries together account for over 15% of world trade, worth over $4.5 trillion.

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