China Thinks Beyond the Dollar

Central banker Zhou wants a new global currency to supplant the greenback Illustration by Sean McCabe; Photograph of Zhou by Zhang Peng/Imaginechina/ZUMA Press

Beijing's quest to dethrone the dollar as the world's dominant currency is a natural strategy for hard-line Chinese leaders bent on undercutting U.S. influence in the world. Yet here's a twist: A key figure behind this policy drive, Chinese central banker Zhou Xiaochuan, is actually an economic reformer and internationally respected economist. And Zhou's criticism of America's runaway public finances and the dollar's postwar reign in global trade and finance isn't so easily dismissed.

Beijing is nudging trading partners to use its currency, the yuan, in trade transactions. Meanwhile Zhou, who has served as governor of the People's Bank of China since 2002, backs the creation of a "super-sovereign reserve currency" managed by the International Monetary Fund that would challenge the dollar's power. True, the greenback's exalted status isn't in immediate danger. However, an international campaign led by China to move away from a dollar-centric global economy is gathering momentum.

In recent days, worries about America's fraying public finances and dollar weakness have unnerved Treasury bond investors the world over, not to mention Zhou and Chinese Premier Wen Jiabao. Much of China's national wealth, about 70% of its $2 trillion in foreign reserves, is denominated in dollars.

Zhou earned his doctorate in economics from Beijing's prestigious Tsinghua University and knows that a bigger international role for the yuan is a fantasy unless China lets its currency trade freely and lifts capital controls on money going in and out of the mainland.

Instead, the Chinese economy is now somewhat hostage to economic policies set in Washington. The U.S. budget deficit has exploded, and the Federal Reserve is effectively printing money to buy Treasury bonds. That's a recipe for a weak dollar, a bond glut—and a nasty financial hit to Chinese holdings of U.S. Treasuries.

Well-informed Chinese now realize Beijing's strategy of keeping the yuan artificially low vs. the dollar to stoke exports—and then recycling export earnings back into the U.S. Treasury market—has backfired. Chinese blogs rant about "irresponsible investment policies of the Chinese government, which also happen to be subsidizing the U.S. economy," says Wenran Jiang, an associate political science professor at the University of Alberta.

LATIN CONNECTION

To reduce its exposure to U.S. economic policy, Beijing is forging currency swaps with Asian and Latin American nations, contracts that provide their central banks with yuan to use in trade with China. More ambitiously, Zhou thinks the IMF should create a new international currency that would be valued against a basket of existing currencies, such as the dollar, euro, and yuan. Instead of recycling unwanted dollars into U.S. Treasuries, a central bank would deposit them in an IMF account offering an interest rate. In theory, the new reserve currency would be more stable than the dollar because it would be "disconnected from economic conditions and sovereign interests of any single country," Zhou wrote in an essay published on China's central bank Web site in March.

Such a grand scheme, now backed by Russia and Brazil, is a long shot. Yet Zhou has tapped into resentment about the huge—and unique—funding advantages America enjoys. The U.S. can borrow and trade in its own currency, while other economies with dollar assets must worry about currency swings or U.S. policy shifts. That's why China's currency crusade may carry on long after the global recession subsides.

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