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April 6, 2015

Washington in Panic as China Taking Steps to Overthrow Dollar

By Wolf Richter at Wolf Street

Now even Israel – joined at the hip to the US though the relationship has run into rough waters – has applied to become a founding member of the China-led Asian Infrastructure Investment Bank. Despite US gyrations to keep them from it, over 40 countries, including bosom buddies Australia, Britain, and Germany, have signed up to join. Japan is still wavering politely.

The US government sees the China-dominated AIIB as competition to the US-dominated World Bank and Asian Development Bank. But now that it is clear even to the White House that the US can’t stop the tide, Treasury Secretary Jack Lew backpedaled vigorously on Tuesday. The government would welcome the AIIB, he suddenly said, as long as certain conditions are met, such as adequate transparency.

So after this bruising setback, the US now has another opportunity to oppose China’s financial and monetary ambitions.

China is trying to get the IMF to bestow reserve currency status on the yuan, which would add the yuan to a glorious basket that includes the dollar and the euro – currently the dominant reserve currencies with a 63% and 22% share respectively. So it has been lobbying core members of the IMF behind the scenes for support, and they’re coming around despite US conniptions, the Wall Street Journal reported.

China also wants the yuan to become part of the IMF’s Special Drawing Rights “in the foreseeable future,” Yi Gang, Director of the State Administration of Foreign Exchange and Deputy Governor of the People’s Bank of China, pointed out a couple of weeks ago. With the yuan, SDRs – which currently include only the dollar, the euro, the yen, and the British pound – would “undoubtedly” be more “representative” of the global economic landscape, Yi said.

Numerous countries are already publicly supporting the yuan as a payment currency. Excluding transactions between China and Hong Kong, the yuan’s use as payment currency is still tiny and edged down last year, handicapped also by China’s restrictions on capital flows. But hey, those are minor details. By now, there are 15 yuan clearing centers around the world, including in London, Frankfurt, Paris, and Luxembourg.

And oops, the rebellious city of Los Angeles, in the rebellious state of California, has signed such a deal with the Industrial and Commercial Bank of China late last year, without apparently asking distant Washington for permission. So this is happening, whether the US government wants it or not.

And 20 central banks, once again including US allies Australia and the UK, have inked $430 billion in currency-swap agreements with China.

Baby steps, all of them, but part of a slow, methodical, relentless process of elevating the yuan and whittling away at the power of the dollar – and by extension, the power of the long arm of the US government.

More immediately, all these efforts contribute to making the yuan “freely useable,” which is what a currency must be in the eyes of the IMF in order to qualify as a reserve currency. And the IMF’s executive board will rule later this year on the yuan’s reserve currency status. Hence China’s intense lobbying.

The governments of Germany and Australia have already indicated that they would support the yuan as a reserve currency; other countries that support the yuan as a trading currency are expected to do the same.

It would be a huge win for China. Central banks around the globe would start buying the yuan, necessarily at the expense of other currencies, including the dollar. It would create demand for the yuan. It would raise China’s profile on the global stage. It would, in fact, bring China one step closer to being a full-fledged economic, financial, and political challenger to the US in a US-dominated system.

The US government has been, let’s say, lukewarm in its support for the idea. And it’s fighting back. To truly internationalize the yuan, China would need to first implement “a more market-determined exchange rate, interest-rate liberalization as well as strengthening of financial regulation and supervision,” Lew said.

These three items are where the Fed excels: It has manipulated the exchange rate of the dollar for decades; it has repressed interest rates to near zero for over six years; and it has abysmally failed “financial regulations and supervision,” as the Financial Crisis has amply demonstrated. So Lew’s concerns are baffling. Unless they’re a pretext, in which case they’re not baffling.

But US opposition at the IMF could still be difficult to overcome: the US has nearly 18% of the vote, as opposed to China, the second largest economy, which has a puny 3.8% of the vote. With the odds stacked against it, China would have to get the support of a lot of other countries.

The US is trying to leverage its power at the IMF to get China to reform its financial sector and liberalize its financial markets, though it remains unclear if the US’s manipulated financial markets and a financial sector gone haywire under the direct supervision and encouragement of the Fed make such a great model for China to follow.

Despite these US conniptions, the writing is on the wall, at least for the long term. IMF Managing Director Christine Lagarde summarized it last week while in China: The yuan as a reserve currency, she said, is more a matter of when, not if.

For China, it’s part of a long-term strategy, and not dependent on the next election cycle: reign in the power of the dollar – and the benefits it conveys to the US – by elevating the yuan and transferring some of those benefits to China. It won’t happen on a straight line. A “hard landing” or the outright implosion of the China bubble would be one of the zigzags along the way. But it will happen, and the US government is only able to slow down the process.

Courtesy Wolf Richter at WolfStreet.com (EconMatters archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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