China Herald: China Crisis Watch (12)

The mother of all financial crises might no longer be impossible, now so many other unlikely scenario's have become true in the past few months. The collapse of the US dollar as a dominant currency would cause a watershed that is not yet on the agenda of the meeting in November in Washington.
Naked Capitalism summarizes neatly the situation, and it quotes Victor Shih from the New York Times:

Victor Shih, a specialist in Chinese central banking at Northwestern University, said that when he visited the People’s Bank of China for a series of meetings this summer, he was surprised by how many officials resented the institution’s losses [on dollar assets].

He said the officials blamed the United States and believed the controversial assertions set forth in the book “Currency War,” a Chinese best seller published a year ago. The book suggests that the United States deliberately lured China into buying its securities knowing that they would later plunge in value.

Indeed, China has a vested interest in making the US dollar survive, since it has a substantial part of its foreign assets invested in US dollar denominated value papers. The exact figure is unknown, but would amount to more than half a trillion US dollar in value. Writing off that amount of foreign debt would be a tough act and China's troubled financial authorities would only do that if the alternative would be worse.
China has been subsidizing the US economy and its ongoing extravagance. The problem, the country has few alternatives. It is already investing much into other currencies, into its own country, but still needs an alternative for the US dollar.
The Renminbi could not replace the US dollar; the Chinese currency is not yet freely convertible and it looks equally tough - and maybe not even smart - to replace the US dollar with any other national currency.
One suggestion came up a few times during the ongoing financial discussions I have heard: setting up a truly global currency. There is already a system of bonds issued by international global institutions, and that could be extended to international trade, including the financial industry. Some initiative have been taken. Here you can find more about another alternative. The currency would need to be supported by the IMF, the major central banks and the major economies, need the kind of supervision the US has been lacking, but would offer an alternative for the US dollar.
Consumers worldwide would still deal with their own currencies, but they could be traded by national governments, central banks and less central banks for the new currency. The current catch-22 situation where countries like China cannot afford to leave the US dollar would disappear, and it would avoid a major kladderadatsch of the US dollar, since the US economy would have a few years to learn to live within its means. It would still be tough for the American economy, but there does not seem to be an easy way out. This at least would possibly avoid the Mother of all financial crises.
Sounded like an ideal suggestion for the November meeting in Washington.

Links
AllroadsleadtoChina: First China Ripples of Global Financial Crisis Come Ashore - Part 1 - Trade
BBC: Leaders urge world finance reform
Naked Capitalism: China Launches Salvo Against Dollar Hegemony
China Bystander: Wen Supports Europe’s Call For Global Financial Regulation

William Overholt
by Fons1 via Flickr
Commercial
Discussing the new financial world order, and China's position in it, is going to be a major discussion in the coming months and years. At the China Speakers Bureau we fortunately have leading speakers on those issues. When you are interested in having one of them as a speaker, do let us know.