LOSING CONTROL (25 page)

It may be that Mr Putin, never a man to mince his words, was just trying to antagonize American delegates who, in earlier years, had been more than happy to talk up their own successes.
In his Davos remarks, Mr Putin also offered the following pithy reminder:

In Russia, they call it
zloradstvo
.
In Germany, it’s
Schadenfreude
.
In the US or the UK, there is no precise word.
We know, however, what Mr Putin meant.

Russia’s concerns about the emerging world’s reliance on the dollar are well founded.
Because the US borrows from the rest of the world in its own currency, a decline in the dollar’s value reduces the amount the creditors receive from the US in their own currencies.
The US has, therefore, a strong incentive to carry on printing dollars so long as investors elsewhere are prepared to snap them up.
The merry-go-round suits America’s interests very well indeed.

One obvious way to deal with this problem is for emerging investors to buy assets priced in dollars over which the US authorities have no control.
Commodity producers, for example, could easily fall into Russian or Chinese hands.
Their products are priced in dollars but, in the event of a dollar decline, the price of their products in dollar terms would simply rise – this is one reason why China is so keen to build up relationships in Africa and the Middle East.
There are only so many commodity producers up for sale, however.
Another option would be for Russia and China to diversify away from US bonds into US equities and company acquisitions, but, as we saw in Chapter 7, this is easier said than done given the climate of mistrust in Washington.

Arguably, then, major emerging nations have no alternative other than to challenge the dollar’s pre-eminent reserve currency role.
It’s not just a case of switching out of dollars into, for example, euros.
That might bring diversification benefits but it would not deal with the underlying problem, namely that the emerging economies would still be dependent on foreign currencies to conduct their international business.
They need, instead, to create their own reserve currencies.
They need to create the financial equivalent of the Protestant Church.

In principle, it’s a simple process.
Imagine, for example, that China’s renminbi became a reserve currency, widely held around the world and used for trade and capital market transactions.
Imagine, also, that the use of the renminbi in this way led to a partial displacement of the dollar.
How would China fare in these circumstances?
The
likely appreciation of the renminbi against the dollar would leave China nursing losses on its foreign-exchange reserves.
However, the wider use of the renminbi around the world would lower transaction costs for Chinese individuals and businesses.
Ultimately, whether China gained or lost overall from this process would be an empirical question.
Nevertheless, China’s own dependency on a monetary system created in Washington would gradually fade.

In practice, of course, turning the renminbi into a reserve currency poses all sorts of difficulties.
Given China’s record on property rights and business undertakings more generally, would people elsewhere in the world willingly hold renminbi when they could, instead, choose to hold dollars or euros?
Could China easily dispose of the capital controls which, to date, have prevented Chinese citizens from directly owning foreign assets (and have limited foreign ownership of Chinese assets)?
How might this fit with the limited political freedoms in China compared with those in, for example, the US?
Given a lack of depth and development in China’s capital markets, together with continued heavy state involvement, is it realistic to believe that foreign investors will happily hold large amounts of Chinese assets when there are other, more liquid, alternatives available elsewhere in the world?

While these doubts are all perfectly valid, there are, nevertheless, six points that favour the development of the renminbi as a reserve currency.
First, China is now the second or third largest economy in the world and, by the middle of the twenty-first century, will probably be the largest.
That does not give China any right to impose the renminbi on anyone else, but it increasingly makes it difficult for governments, businesses and individuals in other countries to ignore China’s currency.
Second, as we saw in Chapter 3, China’s share of world trade has risen dramatically over the last thirty years.
China doesn’t just have a large economy, it also has one of the most successful trading nations on the planet.
Third, as China has become
economically more powerful, other countries have become increasingly dependent on China’s status as a key trading partner.
Now it is the world’s biggest consumer of metals and the second-biggest consumer of oil, other countries have a strong incentive to strike bilateral deals with this new economic behemoth, an economy that finds itself at the epicentre of expanding emerging-market-to-emerging-market trade.
Fourth, even if China did nothing to promote the renminbi as an alternative to the dollar as a reserve currency, the renminbi’s status could be elevated by default, merely as a result of growing disenchantment with the dollar.
Fifth, many countries that tried but failed with the so-called Washington Consensus might now be content to build economic relationships with a country that at least offers an alternative to US economic hegemony.
⁹

Sixth, and politically most interesting, China is now actively promoting the renminbi’s role as an alternative reserve currency to the dollar.
Admittedly, it’s still early days.
However, China has seen a blossoming of bilateral currency swap deals with, amongst others, Indonesia, Belarus and Argentina.
At the time of writing, these deals were worth a total of $650bn.
If similar deals proliferate around the world, China will increasingly be able to conduct trade with other nations – notably those in the emerging world – in its own currency and not in dollars.
State capitalism isn’t just a matter of the ownership of foreign assets; it can also be used to strike bilateral trade and financial deals between nations and avoid too much concern about market forces.
By so doing, it threatens the multilateral arrangements that have increasingly governed the global economic system since the 1950s.

There is a long way to go.
China conducts around $2.6trn of annual trade of which around 70 per cent is invoiced in US dollars.
China’s foreign-exchange reserves, by far the biggest in the world, now stand at over $2trn and cannot be easily diversified.
China’s
capital markets are still mostly shut.
They will have to open more fully before the renminbi can be treated as a serious contender for reserve currency status.
Importantly, though, these initial steps reflect a slow redrawing of the world financial landscape.
Emerging economies, previously in thrall to Washington, now want to stand on their own two feet.
They no longer want to be slaves to the dollar.

There is a tendency to believe that only one reserve currency can dominate the international financial system at any point in time.
Certainly, the dollar has dominated since the end of the Second World War, thereby supporting this notion.
Pre-war, however, it was a different story.
As Barry Eichengreen of the University of California at Berkeley notes, ‘At the end of 1913, sterling balances accounted for less than half of the total official foreign exchange holdings whose currency of denomination is known, while French francs accounted for about a third and German marks a sixth … In the 1920s and 1930s three currencies again shared [the reserve currency] role, although now the dollar supplanted the German mark.’
¹⁰
In other words, although the dollar has monopolized the reserve currency role in recent times, sterling wasn’t quite so dominant, at least not in the first half of the twentieth century.

Arguably, the existence of rivals to a sterling reserve currency reflected an empire already in decline.
Sterling may have accounted for less than half of known foreign-exchange holdings in 1913, but, at the end of the nineteenth century, sterling had accounted for around 64 per cent of holdings.
While, therefore, reserve currencies may co-exist, their co-existence may be an indication of a growing malaise with the prevailing
ancien régime
.
The dollar’s rise in the 1920s was, in part, a reflection of the economic costs of the First World War: the Treaty of Versailles and subsequent hyperinflation
put paid to the German mark’s reserve currency status, while economic upheavals in both France and the UK (with its General Strike in 1926) made the dollar a more attractive option.
These were not happy times for globalization.
Similarly, the dollar temporarily lost its way as a reserve currency in the 1970s alongside the collapse of the Bretton Woods exchange-rate system.
The Deutsche Mark was suddenly in high demand while globalization was in trouble.
Germany, unlike the US, wasn’t in the business of creating inflation.

Thus, while it’s perfectly possible to have more than one reserve currency circulating simultaneously, it has typically been a sign of weakness rather than strength.
Reserve currency rivalry generally reflects unease with the international financial system, whether for economic or political reasons.
Mr Putin’s comments and Beijing’s actions deserve to be taken seriously.

In both the interwar years and the 1970s, the loss of trust in the prevailing reserve currency contributed to huge economic dislocations.
This is hardly surprising.
A reserve currency acts as a beacon of stability in an otherwise uncertain world.
It lubricates the wheels of trade and allows capital more easily to move across borders.
Should a reserve currency lose its way, the wheels of international trade and finance are in danger of falling off.
The world needs an international means of exchange.
Should the prevailing currency be rejected, trade shrivels, cross-border capital flows dry up, exchange rates become increasingly volatile and periodic bouts of price instability become commonplace, as the world saw in both the 1930s (with excessive deflation) and the 1970s (with excessive inflation).

We face similar risks today.
In response to the 2007/8 credit crunch and the part-collapse of the Western banking system, the US authorities, alongside those in the UK, chose to adopt so-called unconventional
policies, designed to increase the supply of money by, in effect, turning on the printing press.
These policies were a response to a perceived shortfall of lending as banks came to terms with earlier losses linked to sub-prime loans.
By increasing the supply of dollars, however, the dollar’s value on the foreign exchanges dropped.
In effect, the pursuit of unconventional policies revealed a schism between the sovereign interests of the US as a nation and the global demands for a stable reserve currency.
With a higher world supply of dollars, existing holders of dollar assets – including reserve managers across the emerging economies – suddenly found themselves sitting on potential losses.
Moreover, because unconventional policies lower the cost of government borrowing – they operate partly through central-bank purchases of either government or quasi-government debt, thereby increasing the supply of money – there is no great pressure on the US government to put its fiscal house in order.
If the long-term costs of the credit crunch are persistently high budget deficits funded through resort to the printing press, holders of dollars elsewhere in the world have every right to be very worried indeed.

The US response to the credit crunch may be the last throw of the dice for a country that, for too long, has been able to live beyond its means.
To understand what’s at stake, it’s worth going all the way back to the sixteenth century when, for a while, Spain was, like the US today, an all-conquering nation.