China Calling For New Reserve Currency

China today called for the replacement of the US Dollar as a reserve currency. The response is natural as the largest holder of US debt is facing the prospect of the United States spending its way out of recession, and using printing presses to do it. This proposal comes on the heels of another proposal put forward by Russia over the past few weeks calling for an alternative reserve currency.

Many in the US call into question the reliance of the Chinese as the largest foreign debt holder, but at this point, with China holding some $1T+ in US Dollar reserves I would question who exactly is the most vulnerable. Still though, the dropping of the US dollar as the main reserve currency would have ramifications for the USA that would be widespread and have the potential to really set off inflation, beyond what is already envisaged by many as a result of the rampant spending.

The article published on the PRC’s website is embedded below. In it, the call for a super-sovereign reserve currency (SDR), and in the process taking the following actions to promote it at the widely accepted medium in international trade and finance:

• Set up a settlement system between the SDR and other currencies. Therefore, the SDR, which is now only used between governments and international institutions, could become a widely accepted means of payment in international trade and financial transactions.
• Actively promote the use of the SDR in international trade, commodities pricing, investment and corporate book-keeping. This will help enhance the role of the SDR, and will effectively reduce the fluctuation of prices of assets denominated in national currencies and related risks.
• Create financial assets denominated in the SDR to increase its appeal. The introduction of SDR-denominated securities, which is being studied by the IMF, will be a good start.
• Further improve the valuation and allocation of the SDR. The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies, and the GDP may also be included as a weight. The allocation of the SDR can be shifted from a purely calculation-based system to one backed by real assets, such as a reserve pool, to further boost market confidence in its value.

If this proposal were to gain, particularly moving the pricing of commodities to this other reserve currency, it would have a huge impact on the US Dollar. Currently for instance, (most) oil dealings are transacted and priced in US Dollars, which creates demand for the Dollar since buyers need to purchase dollars to purchase oil.

Bottom line is that if an alternative would be introduced, and demand for US Dollars goes down, interest rates will have to rise to attract buyers, and with it asset prices (think Cap Rates also rising) would fall as well.

We’re far off from such an alternative being in place, but the Chinese are obviously very concerned by all the spending in Washington, and the vulnerability they’ve felt amidst the current downturn.

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