Thursday, May 14, 2009

Roubini is light-years off on China as a reserve currency country

A repy to the Roubini letter to the editor in the NYTimes

'The Almighty Renminbi' A rejoinder 

 Mr Roubini: As you warn of the potential ascent of the renminbi why not also warn of the end of the world? It’s about as pressing an issue.

Nouriel Roubini’s article on why the renminbi could become the next super currency, or reserve currency, misses any number of crucial points.


In terms of nuts and bolts: China is a capital account deficit country. It runs a trade and current account surplus meaning it has a capital account deficit, exporting capital to the world. What that means is that China is a net placer of funds in international markets and does not attract funds on net basis. It is hard to become a reserve currency these days in that situation. The reserve unit is something for others to acquire. China would be asking the international investor to do the equivalent of swimming upstream while it would increase the flow downstream to remain a net investor itself. Not likely.


Addressing the lessons of history: The world is no longer on a gold standard. The old metrics of history on the characteristics of reserve units should been read with caution and re-written for these times.  Countries today, need to acquire currency reserves in a floating exchange rate environment. Conversely, on a gold standard they needed to acquire gold (you do that by running a current account surplus, by the way). So forget history and the notion that reserve unit countries are surplus countries. That worm has turned: been there, done that.


Dollar fragility: There are certainly issues that the US needs to address, mostly in terms of making US assets safe for acquisition by overseas investors and protecting the value of the dollar by keeping inflation low (a Fed task). Protecting the policy of free trade would also help to assure the place of the dollar.  


Beyond nuts and bolts: Even more fundamentally, China cannot issue the world’s reserve unit because it is not trusted. A true reserve unit needs a strong legal framework and property right protections. The lack of those elements are a far greater impediment to China being a reserve unit country, given China’s current standing. There is the need for freedom of capital movements, too. How about an even more basic issue: free speech; an internet that is not censored?


China’s day in the sun: When China solves these ‘other’ problems and develops its own financial sector we may be able to consider the nuts and bolts economic issues. The problem is not just mechanics. I don’t think Professor Roubini has any idea how far away China really is; it far more than the decade he casually refers to at his article’s end. It is generations away. A reserve currency is more than mechanics; it needs a certain socio-economic framework, culture and mindset. Not only is China not there, it is not clear that China is headed there.     


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