The Future of Asia: Forces of Change and Potential Surprises – Supplementary Report

Policy Horizons | Horizons de politiques May 1, 2014

Image of yellow arrows going from left to right against a white background for The Future of Asia Forces of Change and Potential Surprises Supplementary Report blog post

Chimerica – The Beginnings of a New Regional Reserve

What is it?

Chinese concerns over the ability of the U.S. to manage its debt have led to recent calls by China to “de-Americanize” the world economy and seek an alternative to the U.S. dollar as the international reserve currency.¹ As far back as 2008, China proposed the need for a new international currency reserve which would limit the importance of any one national currency.²

In recent times, the U.S. economy has avoided a debt crisis by raising the debt ceiling level. Any adjustment has the potential to impact the Chinese economy, given the level of exposure to U.S. securities. The People’s Bank of China (PBOC) has amassed US$3.5 trillion in foreign reserves – largely U.S. Treasury securities. The fact that a single institution wields so much influence over global macroeconomic stability has caused considerable anxiety, with doomsayers predicting that doubts about U.S. debt sustainability will force China to sell off its holdings of U.S. debt. This would drive up interest rates in the U.S. and ultimately could trigger the dollar’s downfall.

However, selling off U.S. Treasury securities may not be in China’s interest, as it would drive up the renminbi’s (RMB) exchange rate against the U.S. dollar, diminishing the domestic value of China’s reserves and undermining the export sector’s competitiveness. Indeed, a U.S. Defense Department report last year on the national security implications of China’s holdings of U.S. debt concluded that “attempting to use U.S. Treasury securities as a coercive tool would have limited effect and likely would do more harm to China than to the [U.S.].”³

U.S. debt is only one side of the coin. Economist Robert Shiller believes that the real estate bubble is a serious problem in China.⁴ According to Shiller, people are buying apartments in the expectation that house prices will continue to rise. This gambling mentality is leading them to make completely irrational buying decisions. Slowing economic growth and exports has the potential to expose a serious financial bubble in the Chinese housing sector. The banking sector in China would need to be recapitalized should the Chinese housing bubble burst.

Why is it important?

The symbiotic relationship between Chinese export-led growth and U.S. consumption is such that should one economy falter the other will follow. Both of these disruptors exist against a backdrop of rising bilateral trade using national currencies and a call by the International Monetary Fund for a new global currency to replace the U.S. dollar.⁵

Research by AMRO-Asia, the chief economists of ASEAN+3, finds that while the U.S. remains the anchor currency in the Asian region, the U.S. dollar has “seemingly lost its dominating status.”⁶ At the same time, the weight of the RMB in regional currency baskets has been increasing since 2005.⁷ ⁸ The rise of the RMB as the Asian regional reserve has implications for regional trade and global growth. In the long run, the success of the U.S. economic pivot to Asia is likely to be slowed by the rise of the RMB and the corresponding decline in U.S. economic power. Over the last decade, U.S. growth has been facilitated by Chinese holdings of U.S. securities. Questions remain as to whether a decoupling in the long run will have a positive outcome for China and the U.S. as well as global growth.