Zhou Xiaochuan (People’s Bank of China) wants to replace US Dollar with new Global Currency

Zhou Xiaochuan Governor PBOC

Helicopter Ben, did China just FIRE you and your reserve currency?

The hand-wringing in China over the management of the global economic system continues.  This Monday 3/23, Zhou Xiaochuan, governor of the People’s Bank of China, made a case to ditch the U.S. Dollar, over the long-term of course, in favor of an global currency potentially managed by the IMF.

Every Action has an equal and opposite Reaction

I’m reminded of my high school physics.  Newton’s Third Law states, “for every action there is an equal and opposite reaction.”  In this case:

Action:

March 19 -  Fed announces plans to purchase $300 billion of long-term Treasuries and more than double mortgage-debt purchases to $1.45 trillion, aiming to lower home- loan and other interest rates (source: Bloomberg).  This takes the Fed balance-sheet from $1.9 trillion in September to $4.5 trillion in March.  Yves Smith at NakedCapitalism wryly noted that some called it a “shock and awe” tactic, which was a term used for the initial phases of the US invasion of Iraq, and “We know how well that theory worked…I suspect the unintended Iraq-Fed analogy is apt.”

Reaction:

March 23 – Zhou Xiaochuan (周小川), Governor of the People’s Bank of China, gives speech entitled “Reform the International Monetary System” (source: People’s Bank of China Website) and calls for the establishment of a new international reserve currency.

Zhou: reserve currencies based on a single issuing country just doesn’t work:

Issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries’ demand for reserve currencies. On the one hand–the monetary authorities can not simply focus on domestic goals without carrying out their international responsibilities.  On the other hand–they cannot pursue different domestic and international objectives at the same time. They may either fail to adequately meet the demand of a growing global economy for liquidity as they tries to ease inflation pressures at home, or create excess liquidity in the global markets by overly stimulating domestic demand.

In other words, the U.S. chose to stimulate domestic growth which resulted in exporting inflation to the rest of the developing world that was growing faster.  In other words, Greenspan, it was your fault!

So what happens next?

Well, according to Joanna Slater at the Wall St. Journal, the Chinese can whine all they want about the exorbitant privilege of our reserve currency status and our recent mismanagement of our currency.  But there isn’t anything they can do about it.  Here’s why:

First, the U.S. won’t want to give up this privilege and will fight against giving it up. (How though?)

Second, the U.S. dollar is already established as a medium of exchange.  From the article:

Large, deep, and highly traded markets involving a particular currency “don’t spring up spontaneously just because the Chinese central bank governor suggests this would be a good idea,” says Barry Eichengreen, an economist at the University of California at Berkeley.

Effectively, some government or groups of governments would need to create these markets in a different currency.

Third, a supra-national currency, such as one backed by the IMF, would have no natural “home-base” from which to expand.  Zhou proposes the use of “Special Drawing Rights”, backed by a basket of national currencies.

Whew.  So we’re ok, right?

Well, that depends on if Bernanke and the Fed can retain some degree of trust among central bankers around the world that they know what they are doing, and that they will somehow sop up all the excess liquidity they’ve created once there are some signs of economic growth.

All the same, it appears that the Chinese are going on a global commodities buying spree and, based on this policy speech by Zhou Xiaochuan, probably looking to back their own currency by a basket of other currencies and hard commodities, including a possible increase in gold reserves.

On an individual level, you could mimic commodities investor and American permabear Jim Rogers, who is buying agriculture, commodities, and even walks around with a few gold coins in his pocket (see Bloomberg.com Jim Rogers video with Bernard Lo) in case the whole system melts down before he can get to his safe.

In tumultuous times, stay in “cash.”  But what is “cash” these days? RMB? JPY? EUR? Oil? Gold? Commodities? Real estate? Agricultural land?  Ammo? Brass nails?

Some more links:

• Naked Capitalism – China Calls For New Reserve Currency
• Financial Times – China Calls for New Reserve Currency
• CCTV – China calls for new global currency
• Wall St. Journal – Beijing Faces Big Barriers in Effort to Supplant the Dollar
• Wall St. Journal – China Takes Aim at Dollar
• Washington Post (John Pomfret) – The End of Dollar Dominance?

Photo Credit: People’s Daily