Benn Steil

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Dr. Strangelove or: How China Learned to Stop Worrying and Love the Dollar

by Benn Steil and Dinah Walker
February 21, 2013

currency wars

China has since 1994 operated some form of currency peg, harder or softer, between its yuan and the U.S. dollar. While China’s state-run Xinhua news agency has in recent years railed against U.S. management of the dollar, and has called for “a new, stable, and secured global reserve currency,” this week’s Geo-Graphic illustrates why China has little incentive to press for such a thing.

During the 1956 Suez crisis the Eisenhower administration threatened to create a sterling crisis in order to force Britain out of Egypt. A collapse in sterling would have caused minimal collateral financial damage in the United States owing to trivial U.S. government holdings of British securities – amounting to just $1 per U.S. resident. In contrast, China’s holdings of U.S. securities today amount to over $1,000 per Chinese resident. Any major fall in demand for dollar-denominated assets would cause a collapse in the global purchasing power of China’s massive dollar hoard.

For its part, the United States finds congenial a world in which a dollar sent to China for cheap goods comes back overnight in the form of a near-zero interest loan, which can then be recycled through the U.S. financial system to create yet more cheap credit.

Neither partner in this monetary marriage is, therefore, likely to file for divorce any time soon.

Steil: Red White
Steil: The Battle of Bretton Woods
Eichengreen: Exorbitant Privilege
Treasury: Report on Foreign Portfolio Holdings of U.S. Securities
Xinhua: U.S. Must Address Its Chronic Debt Problems

Post a Comment 2 Comments

  • Posted by Woland

    Has the author considered the possibility that China, (or for that
    matter other large dollar holders) might hold an asset which acted
    as the “reciprocal” to the dollar, such that any loss suffered as the
    dollar declined was made up for by the rise in that “other asset”?
    Imagine an asset which could make good all the losses suffered in
    the event of a dollar collapse, as all dollar holders bid it up as they
    sought to escape, just as, for example, funds flowing out of a former
    darling stock (Apple) as it declines, flow into Google. I presume
    you know what asset I have in mind. Cheers!

  • Posted by DTGUSA

    Dear All,

    Good day.

    Very interesting factoids, my initial thoughts leave me with two questions I hope other readers will comment upon.

    1) Is there any information on the Peoples Republic of China (PRC) following through on shifting to the Euro? They refused assistance to the EU but exchanging holdings in their currency basket away from USD may still be an option. The idea was bandied about in the international press some time ago.
    2) As the Eisenhower administration did to the UK so to could the PRC do to the current or some future US administration. I’d appreciate others thoughts as to why or why not this is or is not a viable political tool?

    Dear Woland,

    No I am not sure to which asset you allude? I can think of three starting with hard assets like rare earths, which the PRC holds and has manipulated a significant percentage of the worlds readily resources in this commodity.

    One 1956 USD converts to about 8.4 USD in 2012. Granted macroeconomic conditions were a tad different then. None-the-less, the amount of leverage represented by the PRC’s holdings in USD is significantly higher.

    Thank you all in advance for sharing you thoughts.

    Cheers,

    DTGUSA

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