Today’s song of the day is “Great DJ,” by the Ting Tings.

it makes me happy. i hope it does the same for you.

enjoy

U.S. Dollar, Yuan and the New Reserve Currency

By Vadim Pokhlebkin

There has been a lot of talk lately about replacing the U.S. dollar as the world’s reserve currency. Read these thoughts on this and another hot subject — China’s dependence on the dollar — by Chris Carolan, the editor of Elliott Wave International’s Sunday-Tuesday-Thursday Asian-Pacific Short Term Update. (Excerpted from the recent APSTU issues.)

…the Chinese have announced that they would like the world to establish a reserve currency alternative to the dollar, perhaps under the auspices of the IMF. The U.S. has responded (through Paul Volcker) that the Chinese have created their own predicament by not allowing the yuan to float higher. But we believe that the larger trends to watch are the inevitable leadership role that the Asian-Pacific markets will play in the next bull market as they have access to cheaper capital than the debt-stressed West.

We think that people who focus on the alleged Chinese problem of holding too many dollars miss the point. In the long run, they can reduce their new dollar positions, while the U.S. government is, through their recent actions especially, committing themselves to issuing greater and greater amounts of dollar debt. The Chinese can (and may) push themselves away from the table, but the U.S. does not have the luxury of that freedom.

The yuan, whose exchange rate is controlled, seems to be pushing higher within the boundaries of its restricted trading. [This] chart shows the dollar falling relative to the yuan.

How will the Chinese cut their exposure to the dollar over time? News accounts tend to focus on one big event, such as the possibility of a new reserve currency to replace the dollar. But in all likelihood, the Chinese will be making a series of moves, each one gaining them a little bit of insulation from the dollar. If they can protect one hundred billion (US$) here and another one hundred billion there, pretty soon they will have cut their dollar exposure significantly.

We highlighted one such action in our recent discussion of China’s move into owning more resources as a way of diversifying out of the dollar. Now comes news of China executing more currency swaps, where they trade yuan for a local currency, thereby allowing that trading partner to use the yuan in future trade with China. These swaps then remove the need for dollars as an intermediary exchange between trading partners. The Chinese have signed six such swap agreements since November totaling $95 billion. The latest swap agreement is with Argentina.

Step by incremental step, the Chinese are solving their dollar problem, or at least ameliorating it. Those looking for that one big news event to signal the dollar’s irrelevance may be missing the trend, though such an event may still occur further out in time.

There was also an interesting article in the Shanghai Daily last week:

Of gold reserves, US dollars, yuan and a new global currency
Created: 2009-5-8
Author:Sean Maguire

GOLD prices leapt with the recent announcement by the Chinese government of an increase in its gold reserves to 1,054 tons.

The disclosure - an IMF requirement - caused a general reappraisal of gold’s relevance as a reserve asset by central bankers.

The Chinese government is not in the habit of releasing figures detailing its gold reserves - the last time such figures were disclosed was in 2003 when holdings stood at 600 tons.

The rise in gold holdings is substantial. Though this figure represents a 76 percent increase and places China fifth in the list of gold holding nations, it is worth noting that this rise has been spread out over a period of six years.

Moreover, gold holdings represent only 1.5 percent of China’s foreign exchange reserves in comparison with some European banks that hold 50 to 60 percent of their foreign exchange reserves as gold.

As a tidal wave of greenbacks looks set to come crashing into the US economy bringing searing inflation in its wake, Beijing has been steadily acquiring gold as a hedge against eventual dollar decline.

And the Chinese government is pushing hard to put the dollar out of its misery as the currency of international trade.

China has already negotiated currency swap deals for bilateral trade with Argentina, Malaysia, South Korea, Belarus and Indonesia as a way of unblocking trade finance and presenting the renminbi (yuan) as an acceptable alternative to the US dollar.

Putting further pressure on the US dollar was the decision at the end G20 summit to grant the IMF US$1 trillion in extra funding with a view to resurrecting the idea of its Special Drawing Rights (SDRs).

SDRs were launched in 1969 when the US dollar was attached to gold as a new international reserve asset class to assist liquidity. They are a supplement - or an alternative - to the US dollar for trade purposes. SDRs are, in effect, a de facto global currency outside the control of any sovereign nation.

Under the IMF constitution, the value of SDRs is fixed according to a basket of four currencies (The US dollar, the euro, the yen and the British pound).

The weighting is determined by the level of exports and the reserves of currency concerned held by IMF members.

The impact on the remnimbi of this new form of international liquidity will be determined largely by whether it is included in the basket of currencies and with what weighting.

The Russian government has proposed regional baskets of currencies so that the central SDR basket could be comprised of a number of regional baskets, each in turn including various local currencies.

However, the role of reserve currency puts upward pressure on the exchange rate by increasing demand for that currency.

For net importers, this is good news, but for net exporters it is a threat to growth as exports get priced out of foreign markets, as China and Japan have already experienced.

There are a number of problems, both political and economic, associated with SDRs but they may represent a temporary palliative to world trade anxieties.

The move away from the US dollar and towards a basket of currencies and perhaps gold as a new international reserve currency - not itself an entirely unproblematic scenario - is the likely outcome.