China editorializes

Over the weekend, Xinhua, the official Chinese news agency, wrote an editorial, sparked by Beijing’s worry about possible US debt default, but also addressing its general concerns about the military, political and economic dominance of the US in the world.

Xinhua says:

” instead of honoring its duties as a responsible leading power, a self-serving Washington has abused its superpower status and introduced even more chaos into the world by shifting financial risks overseas, instigating regional tensions amid territorial disputes, and fighting unwarranted wars under the cover of outright lies”

Therefore, fundamental change is needed.  Along with renewed respect for international law and increasing reliance on the UN, 

“What may also be included as a key part of an effective reform is the introduction of a new international reserve currency that is to be created to replace the dominant U.S. dollar, so that the international community could permanently stay away from the spillover of the intensifying domestic political turmoil in the United States.”

my take

These sentiments aren’t exactly new.

Internally, the faction of the Chinese Communist Party that controls the investment of the country’s gigantic accumulated current account surpluses has got to be very worried that it will take the political fall for any loss on China’s Treasury bond holdings if the US defaults.  That’s what political infighting is all about.  And loss could come either through rising interest rates or a decline in the value of the dollar.  Important, then, to get the story out that the real villain is, as usual, the US.

At the same time, the editorial underlines the immense power that the US wields because the dollar is the world’s  de facto reserve currency.  For the US, it’s like owning the bank and being able to write/cash a check to yourself whenever you please.  You also get to defuse internal economic pressures by exporting them to the rest of the world through the currency.  

The US won’t lose this central role in world commerce any time soon.  However, an unintended consequence of the current Washington rhetoric of embracing default as a political tool–and the prospect of more of the same to come–may be a serious China-led effort to decouple from the dollar.  

Potentially very damaging to the US   …but a long time away.  

The imponderable here is the discounting mechanism in the financial markets.  Were large international banks and foreign government managers of their countries’ financial reserves to sense the possibility that a move away from the dollar might actually happen, their defensive measures (selling the dollar) could come very far in advance of the facts.  In other words, a move away from the dollar could snowball.

As investors, I think we have to be concerned that the role of the dollar as world reserve currency may not be as secure as the consensus thinks.  Personally, I’m a long way from acting on this possibility.  But it’s a lot higher up on my list of worries today than it was a month or two ago.