Why is Beijing all of a sudden acting like the greenback’s new best friend? After all, in recent months, Beijing’s prominence in leading a global charge against the greenback has been to say the least, evident. The Weekly Standard explains:
The Chinese government in the last few weeks seems to have radically changed its tune on this issue.
[They]realize they would sustain massive losses if they triggered a global flight from the dollar, and they do not appear to have any good ideas as to what should replace the world’s financial architecture, now built on the American currency. Yet there is more to their newfound sense of responsibility. They are starting to understand that they have little ability to change the dollar-based international system.
Their fundamental problem is that the Chinese economy, for all the talk of “delinkage,” is still tightly bound to America…The country exports to many nations, but there is one market on which it is particularly dependent. In 2007, 97.7 percent of China’s overall trade surplus related to sales to the United States, and in 2008 the figure was 90 percent. In short, China runs a trade deficit with the rest of the world, buying raw materials and components, and a surplus against the United States, selling finished goods. Beijing, therefore, is locked into buying Treasuries and will remain so until Chinese manufacturers either find new foreign markets–something they are only having moderate success in doing–or they can sell to Chinese consumers. And consumption growth, despite rosy government statistics, appears to be anemic.
This extraordinary reliance on the American market means that China had–and still has–no real choice but to continue to purchase dollar-denominated obligations with its export earnings.
Beijing has, moreover, a more fundamental problem: Chinese officials cannot at this stage afford to turn their back on the dollar and thereby constrain the American economy. If they constrain the American economy, Americans will not be able to continue to buy Chinese goods. If Americans cannot buy Chinese goods, the Chinese economy will precipitously decline, and if the Chinese economy precipitously declines, the country’s political system, dependent on the ongoing delivery of prosperity, will be destabilized. So Beijing, despite its incessant carping, continues to buy dollar-denominated debt. As Dai Xianglong, former central bank chief and now head of the national social security fund, says, China has no choice but to purchase U.S. Treasury obligations. In Beijing, it is known as the “dollar trap.”
And the Chinese realize something else. They have been, over the last two decades, the biggest beneficiary of the dollar-based international financial system that Washington maintains. [Weekly Standard]
China and other BRIC members may keep challenging dollar’s dominance as they seek greater international clout while pushing for new reserve currencies at international summits. The question is, when considering global market dynamics and what these dynamics dictate, how realistically implementable is the notion of another currency capable of challenging greenback’s status. In trade the dollar is virtually unchallenged. Even with the introduction of the euro as the first, real potential rival, world trade continues to be conducted overwhelmingly in dollars.