China's currency unlikely to be major global player soon (NEWS ANALYSIS)

Honolulu -- There is continued concern in Washington that China's economic rise, and its relatively weak currency, could threaten the dominance of the US dollar over the next five to 10 years. However, this may not happen.

According to Paul Bowles, a University of Northern British Columbia professor, and a recent visiting lecturer at the East-West Center, "China's re-emergence as an economic power is unlikely to point to an end of the dominance of the dollar." He notes that even if some predictions that China may overtake the US as the world's largest economy by mid-century prove true, the dollar "would likely continue for decades after that as the world's leading currency".

He points out that historical experience is on his side of the argument. "The pound sterling continued to play a significant role in the international monetary system long after Britain's economic pre-eminence was lost."

Bowles says there is little chance that China's currency, the renminbi, will become a significant international currency any time soon, "given that many of the factors required for an international currency are not present". As for talk of an "Asia dollar" with the Chinese currency at its core, he is pessimistic about that too.

"An Asian currency is also a long run possibility at best and, even then, only if long standing regional rivalries between Japan and China can be resolved."

But, that does not mean the dollar is home free, he cautions. "The threat to US dollar dominance does not come from China's re-emergence or from a possible Asian Currency Unit, but rather from the current imbalances (in foreign exchange rate regime, trade surpluses, and official reserve holdings) and the policy history which lie behind them."

Bowles says the current situation is "one marked by China having a large bilateral trade surplus with the US, a rapid build-up of official reserves to over $1 trillion and a very slowly appreciating renminbi against the US dollar".

What to do about those factors lies at the heart of policy matters that must be dealt with in both Beijing and Washington. But, he adds: "The scope for mismanagement is considerable."

The US continues to pressure China into letting the renminbi appreciate, as Bowles puts it, "in an effort to reduce the bilateral trade deficit." Meanwhile, he points out, "China's policymakers have continued with their public declarations that they are moving to a more flexible exchange rate system but have provided no details of when or to what degree." To be fair, he adds, China has switched from a fixed rate against the dollar to a tightly managed float against a basket of currencies, and the renminbi has appreciated a percentage point or two against the dollar.

On the trade front, Bowles sees the possibility of China gradually shifting over the next five to 10 years to a more domestic-oriented economy from today's export-led industrialisation strategy. And, the shift has nothing to do with pressure from Washington. Bowles points out, "From a policy perspective (the export-led economy) is seen within China as being responsible to a considerable degree for the widening regional income inequalities, inequalities which the new leadership view as threatening social stability." That shift, if and when it comes about, could lower the trade surplus to a certain degree.

China's hoards of foreign reserves are another issue. Approximately 80 percent of Beijing's reserves are held in US-dollar denominated assets, and not all are due to the trade surplus. Of the approximately $220 billion increase in reserves in the period from June 2005 to June 2006, roughly $132 billion (61 percent) was the result of trade surplus and $85 billion (39 percent) was the result of foreign direct investment and/or "hot money" inflows.

Bowles says there is a growing argument within China that the current level of reserves is harmful because a build-up of reserves "is associated with the loss of real output, higher risks as a result of a potential US dollar depreciation, higher political risks associated with more conflict with the US, increased difficulty of domestic monetary management as a result of the need to sterilise the inflows, and a reduced ability to borrow from the World Bank."

In response to these arguments, he says "it is not surprising to find Chinese leaders indicating that they do not wish to see a further build up of reserves".

But, as of now, the comprehensive measures Chinese leaders have talked about have led to nothing specific being tabled. Bowles says, "Barring a major political upheaval and/or a rapid relaxation of outward capital flows, we might expect the current level of official reserves - the world's largest - to continue." And until a major policy retooling is put in place, he adds, over the short term "it is not in the interests of Chinese leadership to spark a fall in the value of the dollar."