China's $2.4 Trillion Global Grip
China disclosed the other day that its foreign exchange reserves had increased to about $2.4 trillion in 2009, up $453 billion for the year. These stupendous figures -- and the likelihood that the country's reserves will rise by a comparable amount this year -- have become a financial, economic and geopolitical reality of surpassing significance. The significance is not, as many imagine, that China might suddenly "dump" the dollar and dethrone it as the world's major international currency, undermining American economic power and prestige. Two-thirds or more of China's reserves are estimated to be held in dollars. As an economic strategy, dumping the dollar would boomerang. It would amount to a declaration of economic war in which everyone -- Chinese, Americans and many others -- would lose.
Consider what would happen, hypothetically. China would first sell securities in which its dollars are invested. That would include an estimated $800 billion in U.S. Treasury bonds and securities, plus billions in American stocks and corporate bonds. After unloading the securities and collecting dollars, it would sell the dollars on foreign exchange markets for other currencies: the euro, the yen and who knows what else.
The massive disgorging of dollars could trigger another global economic collapse. As China's selling became known, other foreign and American investors might jump on the bandwagon, abandoning dollar securities and shifting currencies. If panic ensued, markets would fall sharply. Banks' and investors' capital and wealth would erode. The resumption of the global recession, even depression, would shrink foreign markets for China's exports (in 2009, its exports fell 16 percent). To protect jobs, other countries might impose quotas or tariffs on Chinese imports.
Why would China do this to itself? The answer: It wouldn't.
Look elsewhere for the significance of the huge foreign exchange reserves. For starters, they confirm China's mercantilist trade policies. A country that practices mercantilism strives to increase exports at the expense of its trading partners. China has done this by keeping its currency, the renminbi (RMB), at an artificially low rate that gives its exports a competitive advantage on world markets. The resulting trade surpluses are huge -- even last year's, which were somewhat shrunken by the global slump.
It's often said that the United States "borrows" from China, because the Chinese hold so many Treasury bonds. This inaccurately describes reality.
When China receives dollars, it could use those dollars to buy imports. Or it could limit the dollar inflow by allowing the renminbi to appreciate, making its exports more expensive and its imports cheaper. In 2005, China began a modest appreciation of the RMB against the dollar; in mid-2008, it stopped. Since then, the RMB has depreciated against many currencies, reports economist Nicholas Lardy of the Peterson Institute. In 2010, Lardy expects the trade surplus to grow. So China accumulates dollars, which must be invested. The large surpluses cause China to "lend" to us and other countries, regardless of whether we want the "loans."
Even if China had no trade surplus, its foreign exchange reserves would probably grow because it receives earnings on its existing reserves. These reserves serve China's other strategic purposes. They're used to invest in raw materials (oil, food, minerals) and important technologies around the world; or they buy political influence with foreign aid or favorable loans. In effect, China has a $2.4 trillion stash to use as it pleases. The irony: Despite complaints about big Treasury holdings, these holdings advance China's economic aims of job creation through exports and protection against scarcities of vital commodities. The underlying purpose is to bolster the government's grip on power by ensuring rapid economic growth. Granted, China is trying to generate more growth from domestic spending; still, it is promoting strong exports until that happens.
But what's good for China may not be good for the rest of the world, including the United States. It's not simply a redirection of economic power but a question of how that power will be used, consciously or unconsciously, to shape the global economic order.
Lopsided economic expansion poses many dangers. Already, China's huge reserves -- invested in U.S. bonds -- are cited as one reason for the low interest rates that brought on the financial crisis. The artificially depressed RMB hurts exports from developing countries and not just the United States, Europe and Japan. China grows at others' expense. The manipulation of trade subverts support elsewhere for open trading policies. For now, China has no desire to substitute the RMB for the dollar as the primary global currency. Its ambition is more sweeping: to create a world economy that serves China's interests and, only as an afterthought, anyone else's.