China put the United States unexpectedly on the defensive shortly before the Group of 20 (G20) summit convenes next week in London by proposing that the dollar be replaced with a global currency reserve to settle international payments.
Chinas central bank chief, Zhou Xiaochuan, fired a broadside with his proposal against the United States and its dominance of the global financial system and began a battle over the structure of the new world financial order. The former currency system is obsolete and reform is necessary, Zhou said Tuesday.
"The outbreak of the crisis and its spillover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system," Zhou said in a speech posted on the Peoples Bank of Chinas website. The new currency system with a global currency reserve to be administered by the International Monetary Fund (IMF) should be independent from individual countries, Zhou said.
Chinas proposal could be based on the IMFs special drawing rights (SDRs), a currency created in 1969 by the international lending organisation for accounting purposes. Under Chinas proposal, the use of these SDRs could be expanded into international trade and the buying and selling of commodities.
The SDRs are now based on the value of the dollar, euro, pound and yen, but the basket of currencies would have to be expanded, Zhou said, saying that SDRs could then be used internationally for payments and capital layouts. The idea by Chinas top banker is not new. British economist John Maynard Keynes proposed a global currency in the 1940s. But the timing of Chinas proposal, coming little more than a week before Thursdays summit of the worlds 19 largest economies and the European Union showed that China intends to have a much bigger voice in the new makeup of the world financial order.
"It has to do with the new division of power," a bank expert said. In the US-dominated IMF - which, according to the wishes of the G20, would better supervise countries financial systems in the future - China is seeking a directors post. It wants a higher quota for Beijing, whose 3.67-per-cent contribution to the fund has long failed to equal the economic weight carried by the worlds third-largest economy. A reweighting of the quotas is on the G20s agenda in London.
As the worlds largest developing country, China has continuously demanded more say for poor countries, which are being especially hard hit by the global recession. China intends to expand its weight in international financial organisations not only for its benefit but also as these countries advocate. But the proposal for a "supercurrency" demonstrates a dilemma for China as well. It wants to get out from under the dollar, which has been the worlds reserve currency since the end of World War II, but it cannot do so.
Chinese Prime Minister Wen Jiabao said two weeks ago that he was "worried" about the value of Chinese-held US bonds. China is the largest creditor of the United States, holding 740 billion dollars in US government debt, as its huge trade surplus feeds the worlds largest foreign currency reserves.
As the United States prepares to take on large increases to its already enormous national deficit to fight the recession, it also risks inflation and endangers the value of its bonds. China, which has already seen losses on those investments, cannot divest itself of them because to do so would decimate their value. What it does want to do is to raise the pressure on the already weakened United States to give up some of its power on the financial front, experts said.
But a new supercurrency would be difficult to implement. Major commodities such as oil and gold are traded in dollars, and private enterprise would have to agree to use the new currency. There were also indications that Zhous proposal was motivated purely by politics. Zhou failed to inform his deputy, Hu Xiaolian, of the initiative. Hours before Zhous speech, Hu had rejected a similar Russian proposal as unrealistic because most trade is conducted in dollars. "At the moment, we should focus more on enhancing control over the existing international financial system," Hu said.
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