Sophie Leung, “China Sees Faster Production Gains in Fourth Quarter”

China Sees Faster Production Gains in Fourth Quarter, Bloomberg

By Sophie Leung

Oct. 27 (Bloomberg) — China predicted an acceleration in industrial production and reported a 190 percent jump in overseas investment for the third quarter, underscoring the nation’s role in driving a global economic recovery.

Investment by Chinese firms abroad rose to $20.5 billion in July through September, almost triple a year earlier, the Ministry of Commerce said in a statement. Industrial output may rise 16 percent in the fourth quarter, Ministry of Industry and Information Technology official Zhu Hongren said in a briefing, compared with a 13.9 percent pace of gains in September.

Policy makers may be encouraging Chinese companies to invest abroad in part to help counter pressure for the nation’s currency to appreciate, analysts said. Investors are betting on the yuan to gain in the coming year as China’s growth accelerates from its weakest pace in a year.

“China’s growth is certain and stable,” said Zhu Jianfang, an economist at Citic Securities Co. in Beijing. “Chinese policy makers see pressure for yuan to appreciate, so they encourage companies to invest abroad to strike the balance.”

Today’s figures came after the government last week reported that China, the world’s third-biggest economy, expanded 8.9 percent in the third quarter, the fastest pace in a year.

The economy is showing more signs of stabilizing, the National Development and Reform Commission said in a statement on its Web site today, adding that the government’s stimulus measures have been effective.

Yuan Bets

Yuan forwards, which rose to a 14-month high last week, suggest the currency will gain 2.3 percent against the dollar in the coming year. The 12-month offshore contracts were down 0.2 percent today to 6.6730. The yuan climbed 21 percent over three years after the government scrapped a fixed exchange rate in July 2005.

China’s policy on yuan will remain stable until the nation’s exports recover and improve, Jiang Jianjun, an official in the foreign trade department of the Ministry of Commerce told an online forum today.

The projection for China’s production gains encouraged some investors to sell the dollar on confidence that the global recovery will diminish demand for the U.S. currency as a haven. The dollar rose as much as 0.2 percent and traded at $1.4894 per euro at 7:55 a.m. in London.

Stephen Roach, chairman of Morgan Stanley Asia, today said investors are wrong to bet that China will restrain its unprecedented stimulus after the economy accelerated in the third quarter.

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Ralph Atkins and Richard Milne, “Tensions brew as Euro disparities appear”

Tensions brew as Euro disparities appear

By Ralph Atkins in Frankfurt and Richard Milne in London

Published: October 25 2009 23:10 | Last updated: October 25 2009 23:10

A stronger euro is adding to the tensions in Europe’s 11-year-old monetary union, with the greater vulnerability of some countries and their industrial sectors complicating the job of policymakers.

The euro last week broke through the $1.50 level for the first time in more than a year. On a trade-weighted basis, Europe’s common currency has risen 3 per cent since early September and is fast approaching the all-time highs seen in 2008.

So far, the euro’s appreciation has had little apparent impact on the pace of economic expansion. Growth is thought to have resumed in the third quarter and purchasing managers’ indices last week showed the eurozone on course to expand robustly in the fourth quarter.

But with currency effects typically taking many months to feed through, the risk is that the euro’s strength, which stems largely from the dollar’s weakness will act as a brake on activity in 2010 and exacerbate divergences in performance between the eurozone’s main economies.

As the global economic storms abate, the currency’s rise is exposing countries’ failures to adapt policies that can ensure competitiveness when the option of currency devaluation is no longer available.

Aurelio Maccario, an economist at Unicredit, says: “Now the worst of the crisis is over, performance will depend crucially on how the eurozone countries cope individually with a new order that will probably see the euro remaining strong for a sustained period.”

Each eurozone country’s vulnerability will depend on their reliance on exports to countries that do not use the euro – and the scope companies have to squeeze profit margins. Mr Maccario says: “Ireland looks most exposed because exports to non-eurozone countries account for such a large share of GDP … and companies are also facing pressure because of rising unit labour costs.”

The flexibility of the Irish economy in cutting costs, however, may act as a significant counterforce.

On the same basis, Belgium, Finland and the Netherlands also appear exposed to the rising euro.

At the other extreme are Spain and Greece, where exports to non-eurozone countries are relatively unimportant. But the collapse of the housing market and high unemployment in Spain means it can no longer rely on domestic demand to power growth as it has in the past. The hit taken by Spanish exporters will be an additional blow.

Germany’s reliance on exports would also appear to make it vulnerable. But industrial leaders in Eur­ope’s largest economy argue that sales of their high-tech products are less price sensitive than elsewhere.

The country’s BGA exporters association said last week that although the currency’s strength was creating “certain problems”, it expected up to 10 per cent export growth in 2010, after an 18 per cent fall this year. Chinese demand was making up for lost trans-atlantic exports, it said.

Businesses, meanwhile, have become used to living with a strong currency. Across Europe, industrial companies such as Siemens and ABB might see an impact of 5-6 per cent on revenues from the strong euro.

But the impact on profitability would be marginal, according to analysts at Morgan Stanley, because the big industrial companies can switch between production sites round the world according to demand.

Hedging can also help preserve profitability, and carmakers such as BMW and Daimler, which have lost hundreds of millions of euros in recent years from currency movements, are expanding US factories to boost “natural hedging”.

Airbus, the European aircraft manufacturer, will probably be less sanguine: in the past it has estimated that a one cent shift in the dollar costs it $100m.

Fabrice Bregier, chief operating officer, said earlier this month: “At current levels, the situation is becoming very difficult for all industrial companies that have their costs in euros. We can only appeal to monetary authorities to ensure currency stability.”

http://www.ft.com/cms/s/0/29a48d2e-c18e-11de-b86b-00144feab49a.html

Kevin Brown and Tim Johnston, “Asia bank chief urges ‘serious’ talks on currencies”

Asia bank chief urges ‘serious’ talks on currencies, Financial Times

By Kevin Brown and Tim Johnston in Hua Hin, Thailand

Published: October 26 2009 02:00 | Last updated: October 26 2009 02:00

China, Japan and other east Asian countries must have “serious” talks on currency co-operation to prevent a recurrence of violent fluctuations that have raised trade tensions in the region, said the president of the Asian Development Bank yesterday.

Haruhiko Kuroda said currency movements threatened the growth of trade between Asian countries, widely regarded as a key way of reducing the region’s reliance on exports to the US and Europe.

“I think this is one area where east Asian countries are well advised to start a serious effort to co-operate,” Mr Kuroda said at the East Asia Summit between the 10-member Association of South East Asian Nations (Asean) and China, Japan, South Korea, India, Australia and New Zealand.

Yukio Hatoyama, the recently elected Japanese prime minister, is understood to have raised the issue informally with some leaders in the region, but there has been no comment from China, which has in effect pegged the renminbi to the declining US dollar.

Mr Kuroda said the east Asian countries, known as the Asean plus three grouping, had made substantial progress on regional financial stability through the $120bn Chiang Mai currency swap initiative, intended to combat short-term liquidity problems. But there had been no talks on a co-ordinated approach to currency movements. “I think the Asean plus three finance ministers could discuss this,” he said.

Traders say Thailand, Malaysia and Singapore are among east Asian countries that have intervened in currency markets recently to try to slow the appreciation of their currencies.

http://www.ft.com/cms/s/0/521d41e8-c1ce-11de-b86b-00144feab49a.html

Alex Frangos, “Yuan’s Fall Annoys the Neighbors”

HONG KONG — As the dollar continues to weaken, concerns are mounting in much of Asia over another descending currency: the Chinese yuan.

For more than a year, China has kept the yuan largely unchanged against the dollar. So, like the dollar, the yuan has been falling steadily against the currencies of China’s neighbors, including the Malaysian ringgit, the Indonesian rupiah and the South Korean won. That makes goods produced in those countries more expensive compared with China’s.

“If you have one large economy in Asia lock itself against the U.S. dollar, everyone feels pressure,” says Frederic Neumann, Asia economist for HSBC in Hong Kong. “Even 5% in this context feels painful.”

The countries that compete with China are at a critical juncture. To stem the rise of their currencies against the yuan (and the dollar), central banks around Asia have in recent months been purchasing gobs of greenbacks and building their foreign reserves. And now those reserves are back up to precrisis levels.

At the same time, Asian economies are under pressure eventually to allow their currencies to rise and reduce their emphasis on exports to fuel growth. Some economists and international policy makers fear continued intervention in currency markets would reflect an unwillingness to break old habits of export growth driven by policies that kept currencies undervalued. Intervention can also raise the risks of domestic inflation.

Federal Reserve Chairman Ben Bernanke echoed concerns about Asia’s role in rebalancing global trade in a speech last week. “We must avoid ever-increasing and unsustainable imbalances in trade and capital flows,” he said.

But for Asian countries shepherding fragile export recoveries, it is hard to take the world’s advice and allow their currencies to rise with the Chinese yuan falling along with the dollar.

“China has a fixed exchange rate that helps the Chinese companies a lot, and hurts us,” says Sung Jin Lee, president of the consumer-products arm of Bukang Sems Co., an Incheon, South Korea, manufacturer. Bukang makes everything from auto parts to antimicrobial mattress cleaners. Mr. Lee supports Korean intervention in currency markets, saying his profits will be squeezed if the won rises more than it already has.

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Dan DiMicco & Peter Navarro, “The road to prosperity”

The road to prosperity,

Dan DiMicco,Peter Navarro

Monday, October 19, 2009

For the second time, President Obama and his Treasury secretary, Timothy Geithner, have refused to brand China a currency manipulator. This is not just a shattered campaign promise. It is a critical missed opportunity to get the U.S. economy back on a growth track.

China’s undervalued currency, and more broadly its unfair trade practices, are gutting U.S. manufacturing.

Manufacturing jobs are critical for U.S. economic growth because manufacturing jobs pay more than service-sector jobs. Such jobs are essential to build the purchasing power needed to fuel the economy – with consumption accounting for fully two-thirds of the U.S. economy.

Also, a manufacturing job creates more jobs downstream than a new service-sector job. With the national unemployment rate forecast to remain high for months and perhaps years to come, only an infusion of new manufacturing jobs can reverse this Second Great Depression trend.

The loss of millions of American manufacturing jobs may be directly traced to China’s 2001 entry into the World Trade Organization, which gave China unprecedented access to U.S. markets. Since joining the WTO, China has undermined or destroyed many key U.S. industries – e.g., cookware, furniture, textiles, paper, tires and steel.

China’s primary “weapon of mass production” in its assault on U.S. manufacturing is not just cheap sweatshop labor. If that were so, the United States would be inundated with products from other dollar-a-day nations from Guatemala and Nicaragua to Bangladesh and Cambodia.

China’s major weapon has been its grossly undervalued currency. This is how the Chinese government manipulates its currency: China first sterilizes the dollars that flood into China and then recycles them by buying U.S. Treasury securities, thereby undervaluing its currency by 30 percent or more. This subsidizes its exports and taxes U.S. exports to China.

As a result, China accounts for more than half of the U.S. trade deficit after excluding oil imports.

Here’s what every American citizen must understand: Only after the U.S. brands China a currency manipulator can this country firmly address the root cause of its chronic trade imbalances. Such a branding would allow the Treasury Department to apply countervailing tariffs and duties that would offset China’s currency advantage and start America down the path of constructive trade reform with China.

The dirty little secret here is that the Obama administration refuses to make such a currency manipulation finding because it wants China – a.k.a., America’s mortgage banker – to keep financing its enormous budget deficits. Indeed, the economic recovery now fueled by federal stimulus and the Fed’s “ultra-cheap money” policies must necessarily be short-lived because once spent, America will lack the manufacturing base to generate the jobs and income necessary to propel our economy forward.

America will go from being up to its waist in debt to China to being up to its neck – and maybe even over its head. That heavy debt burden will mean a loss of both economic control and political sovereignty. This is not the world we want our children to be left with.

Dan DiMicco is the CEO of Nucor Steel. Peter Navarro is a professor at the Merage School of Business, UC Irvine and author of “The Coming China Wars.” www.peternavarro.com.

Paul Krugman, “The Chinese Disconnect”

Senior monetary officials usually talk in code. So when Ben Bernanke, the Federal Reserve chairman, spoke recently about Asia, international imbalances and the financial crisis, he didn’t specifically criticize China’s outrageous currency policy.

But he didn’t have to: everyone got the subtext. China’s bad behavior is posing a growing threat to the rest of the world economy. The only question now is what the world — and, in particular, the United States — will do about it.

Some background: The value of China’s currency, unlike, say, the value of the British pound, isn’t determined by supply and demand. Instead, Chinese authorities enforced that target by buying or selling their currency in the foreign exchange market — a policy made possible by restrictions on the ability of private investors to move their money either into or out of the country.

There’s nothing necessarily wrong with such a policy, especially in a still poor country whose financial system might all too easily be destabilized by volatile flows of hot money. In fact, the system served China well during the Asian financial crisis of the late 1990s. The crucial question, however, is whether the target value of the yuan is reasonable.

Until around 2001, you could argue that it was: China’s overall trade position wasn’t too far out of balance. From then onward, however, the policy of keeping the yuan-dollar rate fixed came to look increasingly bizarre. First of all, the dollar slid in value, especially against the euro, so that by keeping the yuan/dollar rate fixed, Chinese officials were, in effect, devaluing their currency against everyone else’s. Meanwhile, productivity in China’s export industries soared; combined with the de facto devaluation, this made Chinese goods extremely cheap on world markets.

The result was a huge Chinese trade surplus. If supply and demand had been allowed to prevail, the value of China’s currency would have risen sharply. But Chinese authorities didn’t let it rise. They kept it down by selling vast quantities of the currency, acquiring in return an enormous hoard of foreign assets, mostly in dollars, currently worth about $2.1 trillion.

Many economists, myself included, believe that China’s asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis. But China’s insistence on keeping the yuan/dollar rate fixed, even when the dollar declines, may be doing even more harm now.

Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable. America needs a weaker dollar to help reduce its trade deficit, and it’s getting that weaker dollar as nervous investors, who flocked into the presumed safety of U.S. debt at the peak of the crisis, have started putting their money to work elsewhere.

But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.

And that’s a particularly bad thing to do at a time when the world economy remains deeply depressed due to inadequate overall demand. By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere. The biggest victims, by the way, are probably workers in other poor countries. In normal times, I’d be among the first to reject claims that China is stealing other peoples’ jobs, but right now it’s the simple truth.

So what are we going to do?

U.S. officials have been extremely cautious about confronting the China problem, to such an extent that last week the Treasury Department, while expressing “concerns,” certified in a required report to Congress that China is not — repeat not — manipulating its currency. They’re kidding, right?

The thing is, right now this caution makes little sense. Suppose the Chinese were to do what Wall Street and Washington seem to fear and start selling some of their dollar hoard. Under current conditions, this would actually help the U.S. economy by making our exports more competitive.

In fact, some countries, most notably Switzerland, have been trying to support their economies by selling their own currencies on the foreign exchange market. The United States, mainly for diplomatic reasons, can’t do this; but if the Chinese decide to do it on our behalf, we should send them a thank-you note.

The point is that with the world economy still in a precarious state, beggar-thy-neighbor policies by major players can’t be tolerated. Something must be done about China’s currency.

Qin Xiao, “China must keep its eyes fixed on the exit”

China must keep its eyes fixed on the exit, Financial Times

By Qin Xiao

Published: October 21 2009 19:55 | Last updated: October 21 2009 19:55

Geoff Dyer, “Top China banker calls for urgent shift in Beijing’s monetary policy”

Top China banker calls for urgent shift in Beijing’s monetary policy, Financial Times

By Geoff Dyer in Beijing

Published: October 22 2009 03:00 | Last updated: October 22 2009 03:00

China needs an “urgent” tightening of monetary policy to prevent the huge stimulus measures introduced this year from inflating stock and property bubbles, one of the country’s leading bankers has warned.

Qin Xiao – chairman of China Merchants Bank, the country’s sixth-biggest – saysin today’s Financial Times that the government should not be afraid of a “moderate slowdown” in the economy.

“Monetary policy must not neglect asset-price movements,” he writes. “Therefore, it is urgent that China shifts from a loose monetary policy stance to a neutral one.”

Mr Qin’s unusually frank warning comes ahead of the publication today of third quarter gross domestic product figures that are expected to underline the rapid recovery in China’s economy, with analysts forecasting growth of nearly 9 per cent compared to last year.

According to calculations by the Financial Times and independent economists, China’s stimulus measures could amount to 15-17 per cent of GDP this year if government-induced bank lending is taken into account – by far the largest among major economies.

The Chinese government has used its control over the banks to engineer a massive increase in lending this year, with new loans in the first nine months of the year 149 per cent higher than last year at Rmb8,650bn ($1,260bn). Much of this investment has gone into infrastructure projects. The M2 measure of money supply is up 29.3 per cent, year-on-year.

The giant investment programme has polarised critics, with some predicting inflation, while others have argued the lending binge would exacerbate over-capacity and encourage deflation.

The State Council, China’s cabinet, gave its first clear hint yesterday evening that it was considering a tighter monetary policy when it said that policy should focus both on managing inflationary expectations as well as securing stable growth – the first time it has mentioned inflation since the global economic crisis hit China last year.

“This is the first thing you would expect the authorities to say before they begin to moderate policy,” said Stephen Green, economist at Standard Chartered in Shanghai. But any increases in interest rates or controls on lending were unlikely before Chinese New Year in February, he said.

Geoff Dyer, “Springing China’s forex trap”

Springing China’s forex trap, Financial Times

By Geoff Dyer in Beijing

Published: October 19 2009 17:04 | Last updated: October 19 2009 17:04

China’s foreign exchange reserves are so vast that the numbers barely register. Yet in just six months the reserve pile has jumped another $318bn (€213bn, £195bn), a sum nearly equal to the annual gross domestic product of Argentina.

With a grand total of $2,270bn, that is a lot of insurance against financial crises but, as China has discovered this year, such reserves are also a bit of a trap, especially when two-thirds are in vulnerable US dollar assets.

What to do with all these reserves has been the subject of intense domestic debate. When the crisis hit last year, there were plenty of calls to reduce Chinese exposure and punish US profligacy by dumping dollar assets. But the inevitable plunge in the dollar and Treasury bonds from such a move would make China a big loser too. The conversation was dominated for a while bycalls from Zhou Xiaochuan, the central bank chief for the dollar to be replaced as the global reserve currency. Yet this is a project for decades, not years.

In the background, another big idea has been gathering support, with much more potential to have an impact soon. A growing number in Beijing are calling for some of the reserves to be channelled to the Bric nations – Brazil, Russia, India and China – and other developing countries. This is not just about snapping up oilfields and copper mines on the cheap, as China has been doing all decade. The stated goal is much bigger: to use the reserves to help stimulate a new cycle of development and trade between China and with the developing world.

The discussion has largely come from China’s flourishing think-tank world. Over the summer Xu Shanda, the economist who used to run the federal tax bureau, called for the creation of a Chinese “Marshall plan” to lend money to Africa, Asia and Latin America to boost living standards in those regions and create demand for Chinese products to replace struggling US and European customers. But his proposal might politely be described as overambitious: he called for $500bn, or nearly a quarter of the reserves, to be handed over to the fund.

More recently, the same themes have found echoes in official comments. According to documents released last month, Hu Xiaolian, deputy governor of the central bank, proposed at a Group of 20 meeting the creation of a “supra-sovereign-wealth investment fund” that would invest foreign exchange reserves in developing countries to allow “these countries to serve as new engines in global recovery and growth”. Justin Yifu Lin, the Chinese academic who is now the World Bank’s chief economist, said in an interview last week with Caijing magazine that Chinese companies should step up investment in Africa and south-east Asia, including outsourcing some low-end manufacturing, to boost consumer demand. “This is a source for future global economic growth and a source of demand,” he said.

Plenty of holes can be picked in these proposals. China may need new export markets but consumer demand in the developing world will not surpass the US and Europe for generations to come. China’s reserves are so large that it cannot avoid the US’s deep, liquid capital markets. Diverting a huge slice of funds to parts of Africa could also be a recipe for corruption – which is perhaps why Ms Hu talks about handing over reserves to an international sovereign fund, rather than local middlemen.

Most of all, a lending binge in Africa and Latin America is an old film with an unhappy ending. China signed a $6bn loan deal with the Democratic Republic of Congo this month, just as western creditors were writing off nearly $11bn of debts.

Yet the idea is potentially powerful because it goes with the grain of big shifts in the global economic map that are already taking place. China is at the centre of powerful economic new links between developing countries. In the past Brazil’s economy would have been felled by a US crisis but Brazil could in fact grow this year. Fifteen years of sound economic policies have helped but it is no coincidence that China has this year become Brazil’s biggest trading partner. South Africa tells a similar story.

If China can channel even a modest portion of its vast liquidity to the developing world in a responsible way that boosts demand without creating a new, suffocating debt burden, it will be pushing on a door that is already opening.

http://www.ft.com/cms/s/0/b9383574-bcc2-11de-a7ec-00144feab49a.html

Martin Wolf, “The rumours of the dollar’s death are much exaggerated”

The rumours of the dollar’s death are much exaggerated, Financial Times

By Martin Wolf

Published: October 14 2009 03:00 | Last updated: October 14 2009 03:00

It is the season of dollar panic. These panic-mongers are varied: gold bugs, fiscal hawks and many others agree that the dollar, the dominant currency since the first world war, is on its death bed. Hyperinflationary collapse is in store. Does this make sense? No. All the same, the dollar-based global monetary system is defective. It would be good to start building alternative arrangements.

We should start with what is not happening. In the recent panic, the children ran to their mother even though her mistakes did so much to cause the crisis. The dollar’s value rose. As confidence has returned, this has reversed. The dollar jumped 20 per cent between July 2008 and March of this year. Since then it has lost much of its gains. Thus, the dollar’s fall is a symptom of success, not of failure.

Can we find deeper signs that the world is abandoning the US currency? One beloved indicator is the price of gold, which has risen four-fold since the early 2000s (see chart). But its price is a dubious indicator of inflation risks: its previous peak was in January 1980, just before inflation was crushed.

Higher prices of gold reflect fear, not fact. This fear is not widely shared. The US government can borrow at 4.2 per cent over 30 years and 3.4 per cent over 10. During the crisis, the inflation expectations implied by the gap in yields between conventional and inflation-protected securities collapsed. These have since recovered – yet another sign of policy success. But they are still below where they were before the crisis. The immediate danger, given excess capacity, in the US and the world, is deflation, not inflation.

The dollar’s correction is not just natural; it is helpful. It will lower the risk of deflation in the US and facilitate the correction of the global “imbalances” that helped cause the crisis. I agree with a forthcoming article by Fred Bergsten of the Peterson Institute for International Economics that “huge inflows of foreign capital to the US . . . facilitated . . . the over-leveraging and underpricing of risk”.* Even those who are sceptical of this agree that the US needs export-led growth.

Finally, what can replace the dollar? Unless and until China removes exchange controls and develops deep and liquid financial markets – probably a generation away – the euro is the dollar’s only serious competitor. At present, 65 per cent of the world’s reserves are in dollars and 25 per cent in euros. Yes, there could be some shift. But it is likely to be slow. The eurozone also has high fiscal deficits and debts. The dollar will exist 30 years from now; the euro’s fate is less certain.

This view may be too complacent. The danger of a collapse of the dollar is small and of its replacement by another currency still smaller. But a global monetary system that rests on the currency of a single country is problematic, for both issuer and users. The risks are also growing, particularly since the emergence of “Bretton Woods II” – the practice of managing exchange rates against the dollar.

In the 1960s, Robert Triffin, a Belgian-American economist, argued that a global monetary system based on the dollar had a flaw: the increased liquidity the world sought would require current account deficits in the US. But, sooner or later, the overhang of monetary liabilities would undermine confidence in the key currency. This view – known as the “Triffin dilemma” – proved prescient: the Bretton Woods system fell in 1971.

Strictly speaking, reserves could be created if the key-currency country merely borrowed short-term and lent long-term. But, in practice, the demand for reserves has generated current account deficits in the issuing country. In a floating exchange-rate regime reserve accumulations should also be unnecessary. But, after the financial crises of the 1990s, emerging countries decided they needed to pursue export-led growth and insure themselves against crises. As a direct result, three quarters of the world’s currency reserves have been accumulated just in this decade.

Yet this very search for stability risks creating long-run instability. Indeed, Chinese policymakers are worried about the risk to the value of their vast dollar holdings that, on Triffin’s logic, their own policy exacerbates. US policymakers may repeat the “strong dollar” mantra. But this is an aspiration without an instrument. Relevant policy is made by the Federal Reserve, which has no mandate to preserve the dollar’s external value. The only way China’s policymakers can preserve the domestic value of external holdings is to support the dollar without limit, which compromises China’s domestic monetary stability and will prove self-defeating in the end.

At this point, the widespread concerns about US monetary stability and the dollar’s external role converge. A standard recommendation on the former is to preserve both the independence of the Federal Reserve and ensure long-run fiscal solvency. If the fear grows that either – or, worse, both – is in danger, a self-fulfilling crisis might ensue. The dollar could tumble and long-term interest rates soar. In such a crisis, it might well be feared, a less-than-independent Federal Reserve would be compelled to buy public debt. That, in turn, would accelerate flight from the dollar.

The two key preconditions for long-run stability, then, are a credibly independent central bank and federal solvency, both of which seem to be within US control.

Yet this is too simple. Most analysts assume that the US fiscal position can be determined independently of decisions taken elsewhere. But if the US private sector were to deleverage over a long period (and so spend substantially less than its income), while the rest of the world wanted to accumulate dollar-denominated assets as reserves, the US government would naturally emerge as the borrower of last resort. A corollary of the Triffin dilemma is that the international role of the dollar could make it hard for the US to manage its fiscal affairs successfully, even if it wanted to do so.

I arrive, by a somewhat different route, at the same conclusion as Mr Bergsten: the global role of the dollar is not in the interests of the US. The case for moving to a different system is very strong. This is not because the dollar’s role is now endangered. It is rather because it impairs domestic and global stability. The time for alternatives is now.

* The Dollar and the Deficits, Foreign Affairs, November/December 2009.

http://www.ft.com/cms/s/0/f51cf304-b858-11de-8ca9-00144feab49a.html