G-20 is over but the acrimony is not. Bloomberg reports China Assails Monetary Easing, Citing Inflation, Bubble Risks

China renewed an attack on quantitative easing, citing the risk of increased prices in emerging economies, a day after the Group of 20 nations said the markets can adopt regulatory steps to cope.

China “doesn’t support” the monetary easing that causes “imported” inflation in developing countries, Commerce Minister Chen Deming told a forum today in Macau, a Chinese special autonomous region. The capital inflows increase the risk of “asset bubbles,” Jin Zhongxia, deputy director general of the international department at the People’s Bank of China, said at the same forum.

“Major reserve-currency issuing countries excessively print money to get out of their own economic difficulties, posing a policy dilemma for emerging economies,” Jin said in Macau today, without naming any countries. “That will impose greater pressure on capital inflows, bigger bubbles in asset markets and inflationary pressure.”

Capital flows into emerging markets are running at $575 billion a year, 20 percent higher than before the world financial crisis, Goldman Sachs Group Inc. said in September. The U.S. dollar has weakened over the past three months against all 16 major market currencies tracked by Bloomberg.

Steps to impose restrictions on capital have increased as emerging-market currencies strengthened, with Brazil’s real climbing 21 percent against the dollar in the past 18 months, Chile’s peso up 18 percent, Thailand’s baht rising 16 percent and South Korea’s won appreciating 10 percent.

China plans to boost cross-border yuan-denominated trade with other countries 10-fold to 20 percent of total trade, or more than 2.5 trillion yuan, to reduce reliance on a few reserve currencies, Jin said, without specifying a target date.

More Regional Yuan Trading Proposed

Echoing the sentiment of Jin Zhongxia, Thailand calls on Asia to use yuan in trade.

Prime Minister Abhisit Vejjajiva, fearful of the effects of the soaring baht due to massive capital inflows, has proposed the use of the Chinese yuan as a major regional trading currency.

“The G20 did not make any progress on the matter and it is difficult to get the United States and China to express their clear stances on the issue. But what we can do is try to cooperate in the region and reduce the impact from currency volatility,” Mr Abhisit said before leaving for the Asian Games in China and an Asia-Pacific Economic Cooperation (Apec) leaders’ meeting in Yokohama, Japan, this weekend.

Only vague “indicative guidelines” were set for measuring imbalances between their multi-speed economies. Leaders called a timeout to let tempers cool and left details to be discussed in the first half of next year.

Mr Abhisit echoed a call made by the Asian Development Bank (ADB) to use China’s yuan as a major trading currency in the region to reduce the impact of currency volatility, especially linked to the weakening of the US dollar. He said he was the one who proposed the idea to the ADB.

Donald Tsang, chief executive of the Hong Kong Special Administrative Region, said the regional private sector should brace for high volatility in the currency and securities markets as economies were increasingly linked.

The most pronounced problem to result from capital inflows, stemming from US funds seeking returns in Asia, would be an unsustainable rise in asset prices, Mr Tsang said.

“The imbalance is unique. I have never seen it in my working life,” he said.

An Attack on US$ Hegemony?

Is this the start of a the Yuan as a reserve currency? China may want that, but it hard to take China serious unless and until it is willing to float the Yuan.

The irony in the proposal by Jin and Abhisit is they are proposing a reserve currency that is still tied to the dollar.

Moreover, there are other several constraints, but first consider this UN proposal.

UN Proposes to Scrap Dollar as Sole Reserve Currency

A UN Report says Scrap dollar as sole reserve currency.

A new United Nations report released on Tuesday calls for abandoning the U.S. dollar as the main global reserve currency, saying it has been unable to safeguard value.

But several European officials attending a high-level meeting of the U.N. Economic and Social Council countered by saying that the market, not politicians, would determine what currencies countries would keep on hand for reserves.

“The dollar has proved not to be a stable store of value, which is a requisite for a stable reserve currency,” the U.N. World Economic and Social Survey 2010 said.

The report says that developing countries have been hit by the U.S. dollar’s loss of value in recent years.

“Motivated in part by needs for self-insurance against volatility in commodity markets and capital flows, many developing countries accumulated vast amounts of such (U.S. dollar) reserves during the 2000s,” it said.

The report supports replacing the dollar with the International Monetary Fund’s special drawing rights (SDRs), an international reserve asset that is used as a unit of payment on IMF loans and is made up of a basket of currencies.

“A new global reserve system could be created, one that no longer relies on the United States dollar as the single major reserve currency,” the U.N. report said.

Russia and China have also supported the idea.

But Paavo Vayrynen, Finland’s Foreign Trade and Development Minister, told reporters that he doubted it was possible “to make any political or administrative decisions how to formulate the currency system in the world.”

The Market Dictates Reserve Currencies

Short of reestablishing gold as a mechanism for forcing trade balances to be kept in sync, the whole idea of establishing new reserve currencies by decree or agreement is potty.

How can you dictate what currencies a country should hold, or if they hold any at all? Does one size fit all? Look at the acrimony out of G-20. Think there is going to be an agreement on using SDRs?

Reserve currencies cannot be set by decree or even by agreement. There are market constraints and mathematical constraints.

Function of Math

Some maintain that commodities are priced in dollars so dollars must be held.

Nonsense. To the extent that countries trade with each other and not the US, there is no need to hold dollars at all. The Yen is freely convertible to dollars so is the Euro. One does not need dollars to buy oil or copper. Currencies are fungible.

With a couple mathematical caveats, any country is free to hold whatever it wants.

One mathematical constraint is there are not enough New Zealand dollars (or Australian dollars or Canadian dollars, etc) to go around for everyone to expect to buy oil in any of those currencies.

However, there are enough New Zealand dollars to go around to support all existing trade with New Zealand.

Why Are Countries Piling Up US$?

The second mathematical constraint relates to trade imbalances. The US runs a trade deficit as well as a budget deficit partially financed by foreigners. Our dollars go overseas, month after month, year after year. The reserves pile up over time as a function of basic math.

To the extent Asian countries trade with China, then sure, a buildup of Yuan reserves is possible. However, given the US trade deficit dwarfs the trade deficit of every other country, it will be tough mathematically to make a dent in the buildup of US dollar reserves relative to other reserves.

Sure there will be periods of fluctuations in reserves are there are now, but the trend towards higher reserve levels is essentially mathematically forced by trade imbalances.

In addition to trade imbalances, one must also factor in hot money inflows of US$ into China, Brazil, and other places. Those countries hold reserves to accommodate an eventual exodus of hot dollar inflows. That is the third constraint.

Note that Bernanke’s QE has had such an impact that countries are resorting to capital constraints to stop the inflight of dollars.

Mathematically, whoever has the biggest trade deficit and hot money outflows on a sustained basis will see the biggest amount of reserves pile up elsewhere. It’s as simple as that. Thus, all this talk about SDRs and using the Yuan or the Yen as major reserve currencies is complete silliness.

As it stands now, any reserve currency changes will be dictated by math, not decree.

Want to cure global trade imbalances? It’s quite easy. Go back to the gold standard and have the political will to balance the budget. Nothing else will work.

Mike “Mish” Shedlock
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