China Pushes Hard

On his China visit, Secretary Geithner is immediately on the defensive.  The language he is using on the Chinese policy of exchange rate undervaluation-through-intervention is the mildest available.  And the commitment he is making, in terms of bringing down the US deficit - which we all favor - is an extraordinary thing to put numbers on in a foreign capital.  Such commitments are of course unenforceable, but still the wording indicates - and is understood by China - great US weakness.

Not surprisingly, China seems likely to push for more.  Their main idea is that some part of their US dollar holdings be transfered to a claim on the International Monetary Fund, which would shift it from being in dollars to being in Special Drawing Rights - and therefore a claim against (a) the IMF's whole membership, and (b) presumably, the IMF's gold reserves. (My bold)

This is a bad idea.

No one asked China to build up a huge level of reserves.  If one country wants to run a current account surplus that is big relative to the international economy, then someone else has to run a deficit - it's a zero sum game because "reserves" are a claim on another country (preferably a strong one, with a convertible currency).  No one has ever offered a guarantee on the real value of reserves, i.e., what China now wants.

People in Hell want ice water.  But we are about to see if the reserve banks of the other countries comprising the IMF are as easily duped as the average US citizen.  I have my doubts, but why should Giethner care if other peoples currencies are put at risk to guarantee the value of US financial instruments.  Gresham's Law would tend to indicate that the totality of the IMF holdings would quickly become US dollars or currencies equally weak, should the Chinese get their wish.


As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."