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Currency war or wealth stealing?

11:20, October 09, 2010

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By Li Hong

At a time of painful economic re-starting, the world's powers, eager to get out of recession and high unemployment, have lost sangfroid and collaboration. Lately, they are waging a war of words over each other's currency policy. Some have even decided to preempt others by intervening in the market.

Economists and insiders warn of breakout of a global "currency war", which risks hijacking a nascent world recovery and sending many economies back to instability and contraction.

With the U.S. Federal Reserve almost certain to extend its "quantitative easing" monetary policy by printing and throwing more dollar bills into the broad economy, countries such as Japan, China, India and in the euro-zone will feel an increasing pinch of the weakening greenback. The counter-measures may include "learning experiences" by some central banks, including the Bank of Japan, to supply more yen papers and dilute its value at the market. The European central bank could decide to do the same, too.

But emerging economies, like China, whose currencies are not freely convertible on the market, face scant choices. All the more, these countries could do little but to see the genuine value of their hard-earned foreign reserve dwindle, in the face of inflated costs of resources including oil, ore and minerals, which are often priced by the dollar. With a flooding of dollar liquidity, the purchasing power of the greenback is seriously diminished.

Another negative effect of rising commodity prices on emerging economies is inflationary pressure. Trying to protect a normal economic operation, the developing countries will have to appreciate their currencies or raise interest rates to blunt the imported inflation.

The People's Bank of China, the central bank, has encouraged trial runs of currency swaps between the yuan and a few countries' currencies, including Russian ruble and Malaysian Ringgit, in an apparent effort to ward off the dollar's volatilities. However, bilateral business trading remains considerably constrained, because of the inconvertibility of the yuan.

There are reports that some central banks are storing the yuan bills as they pin hope on the rising value of the Chinese currency in the future. Residents and corporations in Hong Kong and Taiwan are also keen in keeping the yuan as part of their de-facto reserves. However, the PBC still keeps its lip tightly closed on whether it has meted out a plan to push the currency into the global market.

If the U.S. Federal Reserve decides to buy another US$750 billion, or, as some hyped, as much as US$2 trillion, long-term U.S. debts, it is expected to boost markedly the balance sheet of the Treasury Department, and might help the Obama administration draft out and enforce another mammoth stimulus plan, which the slumping U.S. economy needs urgently. Recently, many American economists have called Washington to rush investments to expand and modernize its careening public infrastructural projects.

Of course, the Treasury could also use the "printed money" to extend huge tax breaks to all American households so that they ratchet up domestic spending, assisting the largest economy to walk out of a cruelly long recession. By making use of the dollar's position as the world's NO 1 reserve currency, it seems to me that the U.S. could, at its convenience, reap the dividends of "jerking up the air".

Theoretically, this will lead to U.S. inflation, as the market greets rising liquidity. The trick is: after three long years of the financial crisis and serious economic slowdown since late 2007, the Federal Reserve and other U.S. research organizations have come to acknowledge the biggest challenge to their economy is repeating Japanese-style deflation – price declines across the board and growth stagnation. And, the move also helps U.S. maintain a low valuation of the greenback, a result embedding President Obama's drive to double American exports in three years.

Last year, some economists in the United States claimed that China has trekked to a "dollar trap" by building a US$2.5 trillion foreign reserve. For several times China's Premier Wen Jiabao has called on Washington to secure stability of its dollar, because it concerns the "safety" of China's huge reserve.

Isn't the Federal Reserve's push to buy U.S. government debt a direct danger of depreciating China's reserve? Where is PBC's response? Aren't we far too skittish of a market-regulated yuan? Isn't George Soros laughing at us in secret?

As China's economy has surpassed Japan to become the world's second largest economy, and, increasingly, it is motored by domestic spending and strong investment in infrastructure, it seems to me that PBC should seriously consider planning a roadmap of bring the yuan to the global market place, letting it become a world reserve currency at the earliest possible date. After all, a freely convertible hard currency will do China much favor.

The articles in this column represent the author's views only. They do not represent opinions of People's Daily or People's Daily Online.

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About this column

Li Hong has been a reporter and column writer, mainly on China's economy and politics.

He was graduated from Beijing Foreign Studies University, and once studied in University of Hawaii and the Poynter Institute in Florida.

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http://english.people.com.cn/90002/96743/7160702.pdf