Tag Archives: dollar

The Future of U.S-China Relations

President Obama and Chinese Premier Hu Jintao

President Obama and Chinese Premier Hu Jintao

While most of the (political) world was transfixed on the spectacle of the health care summit yesterday, the U.S.-China Economic and Security Review Commission was holding hearings on the current and future status of U.S.-China relations. The hearings, which interestingly included testimony from two of my favorite bloggers, Daniel Drezner and Simon Johnson, as well as about a half-dozen other experts, provides a compelling analysis of the challenge of U.S. debt for China.

The basic issue under consideration was the degree to which China, which boasts a massive currency reserve held mostly in U.S. dollars, could leverage its fiscal resources into achievements in its other foreign policy goals. China currently holds at least $755 billion in U.S. Treasury Securities as part of its estimated $2.5 to $3 trillion in dollar-denominated assets. This massive financial reserve was garnered primarily as a result of China running massive trade surpluses with the United States. Ironically, however, those trade surpluses led to a situation of mutual dependence, in which the United States depended on China’s willingness to buy U.S. Treasury certificates and other dollar-denominated assets in order to finance its large trade deficits, which in turn allowed China to continue to increase its exports to the United States.

So what of the future? Sino-American relations have suffered some setbacks in recent months, as witnessed by the Google-China incident, the Obama administration’s decision to move forward on arms sales to Taiwan and meet with the Dalai Lama, the inability of the two countries to negotiate a meaningful outcome at the Copenhagen summit, various bilateral trade disputes, and continued and repeated rumblings in the United States regarding the perceived overvaluation of the Chinese renminbi.

In his testimony, Drezner argued that despite the widespread rumblings about the threat posed by China’s massive trade surpluses, it has generally been unable to covert its massive financial wealth into other foreign policy goals. With the notable exception of a couple of very minor cases (for example, using the promise of aid and assisting in the financing of government debt to Costa Rica in exchange for switching its diplomatic recognition from Taipei to Beijing), the Chinese government has been limited in its ability to use financial resources to achieve other foreign policy aims. The fungability [glossary] of financial power in the international arena is, in this respect, limited.

What’s more, while the Chinese government has expressed a desire to move away from the dollar as the de facto international reserve currency, the feasibility of most alternatives remains limited. China could push harder, but such a strategy would entail considerable costs for the Chinese government and economy, not the least of which includes a devaluation of its $3 trillion in dollar-denominated assets. As a result, it appears the U.S. and China remain in an uneasy situation of mutual dependency, each expressing dissatisfaction with the current political and economic arrangements, but each equally unable to move away from them.

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Is the Euro the New Dollar?

The turn of the new year always seems to bring about attempts to prognosticate about what the future will hold.  I’ll return to that tomorrow, but for today, a very interesting story about the future of global currencies.

On Monday, the Financial Times carried a short story about continental Europeans support for the euro.  According to the FT, a large majority of continental Europeans believe the euro will overtake the dollar in global importance within the next five years.  There’s certainly good reason to be optimistic; relative to eh U.S. dollar, the euro’s value has spiked in recent years.  And over the past couple of weeks, the euro has reached parity with the British pound.  There are already more euros in global circulation that there are dollars, and the currency’s role in foreign reserves and capital markets has grown markedly since its introduction in 1999.

Fair enough, but why should we care about global currency markets and foreign reserves in the first place?

Since the end of World War II, the U.S. dollar has been the de facto global currency.  Most international transactions took place in dollars, oil was priced in dollars—as were all other major traded commodities.  International lending generally took place in dollars as well.  Countries even held dollars in their coffers rather than gold.  The use of the dollar as the basis for international exchange established high levels of demand for the U.S. dollar and placed the United States in a privileged position in the international political economy.  So long as the dollar was the reserve currency of choice, the U.S. government could always find buyers for treasury bills and a relatively easy (and painless) way to finance the national debt.  But as demand for U.S. dollars declines—and an increase in the use of the euro as the international currency of choice would certainly facilitate this decline—the U.S. government could find financing its growing national debt increasingly difficult.

We could also see a dramatic decline in the value of the U.S. dollar were such a shift to the euro occur.  While this may make U.S. exports more competitive on global markets, it would also make imports more expensive.  More importantly, however, as the events in the summer and fall of 2008 demonstrated, a declining U.S. dollar tends to result in increasing commodity prices, particularly oil, as investors hedge against wild swings in currency markets.

While it may be too early to know whether (or perhaps when) the euro will replace the dollar as the global reserve currency of choice, the potential impact of such a shift could be dramatic, and the implications of such a shift are well worth consideration.

Five Stories You Might Have Missed

The opening of the Olympic Games this week pushed many stories to the sidelines.  Here are some of the important stories from last week that you might have missed.

1.  On Friday, fighting between Russian and Georgian forces broke out, marking the worst fighting in nearly twenty years.  Georgia claims that the two countries are now officially at war, and accusses Russia of choosing this moment hoping that the Olympic Games will divert attention away from their action.  Russia claims they had to intervene to prevent ethnic cleansing on the part of the Georgian government; Georgia claims Russia is involved in ethnic cleansing of its own.  The UN Security Council has since taken up the matter.

2. Pakistan’s President Pervez Musharraf canceled his planned trip to the opening of the Olympic Games after the country’s ruling coalition announced plans for impeachment. Musharraf, a former general who came to power through a military coup, has been widely touted as one of the United States’ closest allies in the war on terror, despite the inability of the Pakistani government to effectively address the presence of al Qaeda-linked groups in the northwestern part of the country.  The planned impeachment raises concerns about the stability of Pakistan. 

3. Salim Hamdan, former driver for Osama bin Laden, was sentenced on Thursday to 66 months in prison for supporting terrorism.  After being found not guilty on a number of other charges, Hamdan could be free in less than 6 months after being granted credit for the five years he has already served as a detainee at Guantanamo Bay.  The verdict was the first issued by the military tribunal system established to try prisoners captured by the US government in the war on terror.  The Pentagon has already announced that Hamdan may be held as an enemy combatant even after he completes the sentence issued by the military tribunal. 

4. An economic slowdown in Germany has raised concerns about the economic stability of the European Union.  The Euro declined to $1.5378 to US $1, marking a seven-week low.  A sharp increase in bankruptcies and the fact that Japan is close to declaring it is in a recession confirm the fact that the economic downturn in the United States is having a global impact.

5. Violence in the Xinjiang region in northwestern China broke out late last week, as Muslim separatists hoped to use the media focus on the country to draw attention to their cause.  The attacks, which included both gun battles and the use of explosives, marked the largest outbreak of violence in the region since the 1990s.