Dollar dominance is sowing the seeds of financial turmoil, and the solution is to promote new reserve currencies, a Chinese government economist said in a paper published on the eve of a G20 meeting about how to reform the global monetary system.
Although not an official policy statement, the paper by Xu Hongcai, a department deputy director at the China Center for International Economic Exchanges, offered a window onto the domestic pressures bearing on Beijing to move away from a dollar-centric global economy.
The China Center, a top government think tank, has represented the Chinese government in organizing a forum on Thursday in Nanjing that will bring together finance ministers, central bankers and academics from the Group of 20 wealthy and developing economies.
Xu's paper, Reform of the international monetary system under the G20 framework, was published in Chinese on the center's website this week (www.cciee.org.cn).
Nations around the world have no way of restricting dollar issuance by the Federal Reserve. The current international monetary system lacks both stability and fairness, Xu wrote.
He said the global monetary system had fallen into a dollar trap. While it would be sensible to reduce dollar holdings in official currency reserves, nations cannot easily cut back, because doing so would only lead the dollar to weaken and so hit the value of their assets, he said.
China's dollar dilemma is particularly acute, though Xu did not say as much. China had $2.85 trillion in foreign exchange reserves at the end of last year, more than any other country. About two-thirds are estimated to be invested in dollars.
Beijing has repeatedly warned that loose U.S. monetary policy threatens the dollar, but it has continued to accumulate dollar assets at the same time, adding about $260 billion of Treasury securities last year, according to U.S. data.
With the Chinese government determined to limit yuan appreciation, it must buy a large amount of the dollars streaming into the country from its trade surplus and recycle those into U.S. investments.
Xu was not shy about proposing ways to remake the global monetary system.
For a start, he said diversification was needed, with several reserve currencies. Other countries could reinforce these currencies' status by buying or selling them to keep their exchange rates stable, Xu said.
He said the International Monetary Fund should also play a policing role.
If any international reserve currency depreciates, the IMF would be responsible for issuing a timely alert, increasing international pressure to force the country in question to take measures to stabilize its currency, he said.
Xu's call for regular intervention to keep key currencies steady is unlikely to find much support among developed economies, which have come to view a system of floating, largely market-determined exchange rates as the most stable underpinning of the global economy.
When the G7 rich countries banded together to weaken the yen earlier this month, it was their first joint intervention since 2000 and came against the extraordinary background of speculator-driven yen appreciation after Japan's devastating earthquake, tsunami and nuclear crisis.
Xu also suggested that the Special Drawing Right, the IMF's unit of account, should gradually be built into a global reserve currency, although he noted this would still be a long time off.
Chinese central bank governor Zhou Xiaochuan said two years ago that the SDR would be better than the dollar as a supra-national reserve currency, disconnected from the interests of any single country.
With France at the helm of the G20 this year, French President Nicolas Sarkozy has seized on the SDR idea, promoting it as a possible alternative to the dollar-led global monetary order. But China itself appears to have cooled on the SDR, instead describing it as a largely symbolic issue.
For all the defects in the global monetary system identified by Xu, foreign officials, especially from the United States, have said that China has a much easier solution within its grasp.
By allowing the yuan to float freely, the Chinese central bank would no longer need to buy dollars flowing into the country and so could drastically slow its accumulation of foreign exchange reserves.
(Reporting by Simon Rabinovitch; Editing by Ken Wills)