USA & China – Debate Over Reserve Currency

Steven Spielberg

In the meeting of Group 20 in London in April, China impressed the summit by its viewpoint regarding the reform of the international monetary system, which includes supporting a “super-sovereign reserve currency” plan proposed by Russia. It is viewed as a challenge to the US Dollar’s reserve currency statue. As the world’s biggest Dollar-advocator, with US$ 1 trillion lying in its bank, why should China make such a proposal to against its own major currency reserve?

Debtor or Saver: Who Pays for the Crisis?

To repair the economy in crisis, US will have a $1.75 trillion-fiscal-deficit for 2009, which means Fed has already started printing money. Extra money supply may provide an abundance of liquidity and stimulate the economy in depression. Meanwhile, as the world’s largest debtor, the US may also reduce its pressure to pay foreign debts through the inflation brought by extra money supply. The US Dollar will depreciate in this course, and this makes other reserve currencies appreciate, such as Euro, Pound and Yen. In order to promote their own economy and export, these countries may also start to print money. Finally, this may hurt two types of people-creditors and savers. Creditors have to follow relatively low interest rate; and savers’ holding is devaluing day by day. As the biggest saver in the world and the biggest creditor of the US, China does have reasons to be worried.

China’s Dilemma in Dollar Domination

For year, China accumulated enormous Dollar reserve, almost equal to half size of its 2008 GDP, this expose the country a lot to America’s financial well being. But even in times of crisis, US Dollar is still China’s first choice in foreign exchange reserve, because it by no means has an option. As of 2008, 64% of the world’s currency reserve was in US Dollar; about half of international transactions today are dominated in US Dollar; many of the world’s currencies are pegged against the US Dollar. As the US Dollar maintains the reserve currency status, it is easy for the US to run higher trade deficits and over issue its currency. Under this situation, introducing a new global reserve currency to diversify the risk of foreign exchange reserve might be a way for China out of the adverse impact of Dollar domination.

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