The Dollar Trap

At Bloomberg, William Pesek writes on Eswar Prasad’s new book, “The Dollar Trap.” This part caught my attention:

Prasad’s argument is that for all the worries about U.S. policies and debt, and the many efforts to build up an alternative, the dollar’s linchpin role is only strengthening. What struck me most, though, is that China still can’t see that it’s the dupe in this giant pyramid scheme.

China’s $3.8 trillion of currency reserves are the largest stockpile ever amassed. Economists have long seen that money as a strength — the ultimate rainy-day fund should China’s shadow-banking system blow up. Trouble is, the value of those holdings depends on China’s $1.3 trillion of U.S. Treasuries. If they plunge in value, all hell breaks loose and officials from Beijing to Brasilia will scramble to exit the American bird cage.

(…)

As Prasad writes, “China now has a strong incentive to support the dollar’s value, limiting its losses for the time being but at the cost of getting even more entangled in the dollar’s sticky web.”

The Chinese central bank is stuck in a dangerous cycle. Every time it clamps down on credit to curb excessive lending, markets panic, interbank borrowing rates skyrocket and policy makers back off. At the same time, a minicrisis in emerging markets this year will greatly complicate President Xi Jinping’s efforts to restructure the economy away from exports and hyperinvestment.

The irony is that that means even more dollar purchases. This dynamic runs counter to Beijing’s aspirations for a greater global role for the yuan, and to the desire of Russians and others to get the dollar out of their lives. Indeed, one no longer hears much about the regional bank Xi proposed in October, to invest in infrastructure across the region. The Chinese leader had pledged to provide funding from what essentially would be a local International Monetary Fund free from those pesky Americans. The only problem is that the $7 trillion-plus Asia would tap for such an enterprise is largely beyond its reach.

“So the choice the U.S. offers the rest of the world is simple: you get to choose when to take a loss on your holdings of our debt — now or later,” Prasad says. “Faced with this stark choice between two evils, many emerging markets end up being boxed into maintaining export growth by accepting the unpleasant trade-off of a loss on their reserve holdings in the future. The choices they have made — intervening in foreign exchange markets and accumulating reserves as a self-insurance mechanism — have only fueled U.S. fiscal profligacy and strengthened the dollar’s role in the global monetary system.”

Posted by on February 18th, 2014 at 11:01 am


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