Mactaggart Research Chair of the China Institute at the University of Alberta
With the global economy continuing to shrink and the outlook for a U.S. recovery still gloomy, world attention has turned to China. Its projected 6.5-per-cent growth and $2-trillion (U.S.) foreign reserve make it appear as the likely saviour. But the Chinese government is preoccupied with a different agenda: how to protect its hard-earned savings from depreciation.
For most of the past three decades, the government has set a fixed exchange rate by pegging the renminbi to the U.S. dollar and periodically intervening to keep it low. As long as GDP continues to grow by almost double digits every year and exports expand further with a low currency value against the dollar, both central and local authorities can claim success in creating jobs.
China's trade and capital "twin surpluses" led to the accumulation of more foreign reserves over the years. Seeking safe investment returns, Beijing began to purchase more and more U.S. treasury bills, financing the persistent U.S. trade and budget "twin deficits" and, in the process, becoming the largest creditor of the United States.
But the current U.S. economic crisis and the Obama administration's large-spending approach in combatting it have made China's long-dreaded nightmare come true: The United States' huge foreign debt, its huge budget deficit and its large infusion of printed dollars, the Chinese are convinced, will lead to inflation and the eventual depreciation of the dollar. And the process will drag down Chinese holdings in U.S. treasury bills and other assets, totalling well over $1-trillion now.
The People's Republic has become the T-bills Republic, and as Nobel Prize-winning economist Paul Krugman put it, China has fallen into a "U.S. dollar trap" and cannot get out of it. Nor will anyone come to its rescue. So the Chinese are trying to rescue themselves by experimenting with two major measures.
The first is to take steps to change the rules of the game altogether. Only days before the London G20 summit, the governor of China's central bank, Zhou Xiaochuan, penned an article blaming the U.S. dollar's position as a structural cause of the financial crisis and calling for the use of SDRs (Special Drawing Rights, created by the International Monetary Fund) as a global super-currency to replace the greenback. It stirred up some support and some controversy, with even the Chinese acknowledging that it is a long shot.
But Beijing is not all talk and no action. Its first step in realizing such a fundamental change in the global financial order is to strengthen the renminbi's position. At the G20 summit, China indicated that it would inject $40-billion into the IMF, possibly in the form of the purchase of IMF bonds, thus pushing for reform on its voting share.
And since the second half of 2008, it has carried out currency swaps with many countries worth more than $120-billion, with more to come. This means many of China's trading activities will be using the renminbi as a settlement currency instead of the dollar.
Another effort by China to pull itself out of the dollar trap is to diversify its global investment from low-return T-bills and volatile securities to energy and resource assets around the world.
Leading the way are large Chinese mining companies, and the targets are primarily in Australia. In three separate deals since February, the Chinese acquisition of Australian mining assets totalled more than $20-billion (U.S.).
In the energy sector, China has entered a new wave of large deals with major global players: It just signed a $25-billion agreement with Russia, getting 15 million tons of crude annually for 20 years beginning in 2011 while providing loans to Russian oil and pipeline companies. Beijing has just concluded a $10-billion oil-for-loan deal with Kazakhstan. Another $10-billion agreement with Brazil's Petrobras is under way. And similar deals have been signed with Venezuela's oil companies, Exxon-Mobil and other Western oil companies.
It looks as though Beijing is more determined than ever to avoid the trap of a "T-bills republic" and to become instead a hard-asset republic. Its challenge is to take just enough steps to walk away from the dollar but not too fast or too dramatic that it may hurt its dollar holdings.
China may not be the financial rescuer of the world, but its gradual moving-away from the U.S. dollar may well serve a long-term public good in the reorganization of the global economic order.
Wenran Jiang is a senior fellow at the Asia Pacific Foundation of Canada.