Currency Warts and All

As the struggle for dominance in the 21st century global marketplace intensifies the battle over which currency that economy will be denominated in is becoming more explicit. Can we see Osborne's appeals to China to use London as its banker to Europe and the world as the final betrayal of the dollar empire?

This blog has been following the currency wars and I have long been calling for a globally agreed trading currency. This is also the preference of the Chinese, who understand the risks that come with being the banker to the world and are apparently not seeking to take over from the US the role of global hegemon and global policeman that so often accompany the role of banker to the world.

More importantly, the renbinmi is not a convertible currency but is still controlled by the Chinese government. Although this value of external trade balances settled in the currency has increased rapidly in the past couple of years, this is a fraction of the global trade in dollars. Since the currency is tightly controlled it is also not held in reserves – the other key feature of any candidate for status of global currency.

China has long been calling on the IMF to extend the role of SDRs (special drawing rights) so that they can become a de facto global currency. In this context perhaps we should interpret today's intervention by Osborne as not only an attempt to tout for banking business but also an attempt to pressurise China to take on more of this role itself. Such a decision deeply affects the peace and stability of the world and should be taken, rather than via press release and bilateral discussions, in a full-scale global conference to remake the world economy and to focus on the need for stability, sustainability and equality.
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Financial Chincanery Threatens Our Future

While our policy-makers have been striding around their Cotswold estates burning off an excess of Christmas pudding, elsewhere in the world events are occurring that provide further signals that the economic game we have played so effectively for the past two centuries is being superseded.

Do not let your festive white-out blind you from the important decision taken a historic decision to avoid the dollar in their trade relationship. As reported on this blog, for some time China has been arguing for a change in the global terms of trade, a system that has hugely benefited the USA since it was negotiated at Bretton Woods in 1945. The US has refused to negotiate and so China is now taking bilateral action, and Japan appears to be following a similar strategy.

Japan and China have agreed to make direct currency exchanges to settle their external trade balances, rather than negotiate via the dollar. In addition, Japan will buy Chinese government bonds. This shifts the Chinese renminbi towards the status of a reserve currency that China's economic power suggests, although the currency is still controlled entirely by the government, rather than being available for free exchange as the other reserve currencies have been until recently.

The extraordinary fact that the dollar is still the global medium-of-exchange, giving the US completely undeserved and misused global economic advantages, is omitted from discussion of our economic woes. And yet the way that the City operates as the 52nd state leaves us increasingly vulnerable in a world where the powerful economies are those who produce and gain access to resources, rather than those who control currencies.

Another sign of the UK's vulnerability emerges from a report showing that we have been overtaken by Brazil in terms of the global economy league table. As the UK economy shrinks and those of the resource-rich and industrious economies outside the West expand, this is more a shock than a surprise. These economies face another significant advantage over those of Europe: they are able to create their infrastructures in a way not dependent on fossil fuels and hence face significant advantages in terms of a green economic future.
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Currency War Lurches Towards Trade War

The growing power of China over the US resulting from its ownership of US treasuries, not to mention its superior productive capacity, is the driver of the currency wars that have been the subject of a series of posts of this blog. Earlier this week this power struggle took a dangerous new turn, with a bill that was accepted onto the floor of the US Senate by a big majority.

According to the Guardian website, 'The Senate bill, which does not specifically mention China, sets in motion a process for imposing punitive tariffs against a country with misaligned currencies. The bill also makes it easier for specific industries to seek higher tariffs on foreign competitors when undervalued currencies become a means to subsidize exports.'

The US it attempting to fight back against China's decision to keep control of its currency. This is of course a root cause of the under-valuation of the Yuan, but what would be the appropriate value. In a global trading system dominated by the US, its allies and the international organisations such as the WTO that they control, why would China feel any inclination to fight fair?

This is a high-risk strategy. Given that China is the US's largest creditor by far, it is only its decision to continue to hold and buy US government debt that keeps the country afloat. In a fair market the US looks almost as unsaleable as Greece, given its vast national debt and low levels of productivity.

The only safe way out of this situation is via international negotiations in which countries and their interests are fairly represented. The removal of the dollar as the global trading and reserve currency would be a necessary first step if China is going to accept an invitation to such a negotiation.
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Chinese Check Us

For a while now it has been obvious that China is the dominant global power, and that it has accumulated, by a combination of skilful strategem and sheer hard work, the power to pull the plug on the US economy at any moment. It is almost exactly a year since Hilary Clinton's humiliating visit to Washington, when she almost begged the Chinese not to do this. When we hear that China is now offering to also buy the Greek debt – for which we might read by the Greek economy, given the way things stand in that country just now – it raises intriguing questions about why China became a 'state capitalist' country in the first place.

The use of that phrase implies that China is following the rules of the same economic game, perhaps with different motives. It is clear that China has understood the money-work nexus that lies at the heart of the capitalist game but there seems no reason to assume that they have any respect for the game itself. They have responded to its rules by keeping a rigid control over their own currency (a fact much bemoaned in Washington and the pages of The Economist alike), and working extraordinarily hard to displace the need for most of the other labour in the global marketplace.

Meanwhile the the shift in the designation of the Chinese currency away from the yuan (as it was traditionally called) to the renminbi (or people's currency) implies a shift from a domestic to a global currency. In much the same way that China accumulated pieces of eight that the Spanish had minted in their new world colonies, it is now accumulating hoards of US paper. Although the renminbi is surely the most powerful currency in the world today, it is not held as reserves by foreign governments. So long as China is prepared to buy US debt and use it as a trading currency then the dollar is secure. Once it decides its economy can grow on the basis of domestic consumption alone it could easily just walk away, leaving the dollar to crash.

In conclusion we can see that China is winning the work game and is also winning the money game. So far China has used this power to gain access to the world's rapidly diminishing resources, especially by striking deals in Africa that are far more favourable than those that Western nations have offered. Compared to our primitive and short-term economic thinking, the Chinese appear to be demonstrating a master play: as they have adopted our industrial methods and excelled us in their use, so they are playing the economic game we invented better than we are.

On a more conspiratorial note, what are we to make of the inscrutable Mr Li who, according to John Lanchester's book Whoops! was instrumental in creating the algorithm that lies behind explosion of collateralised debt obligations that led US traders to destroy the global financial system:

'Li had been sent to North America on a government scholarship in the late 1990s to learn about capitalism. . . In 2000, while working at J.P.Morgan, Li managed to apply a piece of mathematics called a Gaussian copula function to the creation of CDOs' (p. 97) His paper, published in the Journal of Fixed Income, was attractively titled 'On Default Correlation: A Copula Function Approach'. It offered a way to model how different types of stocks move up or down in value together. This enabled the financiers to reduce the risks associated with mortgage-backed CDOs to a single number and the trade took off.

To imagine Mr Li on a mission for the Chinese government is too appealing to be true, but one way or the other it seems that the 'state capitalist' power has out-manoeuvred the 'market capitalist' power and we are all just waiting to see when they will assert their authority. Tweet

Chinese whispers a siren song

Some surprise has been expressed by the discovery that the wealth that has been generated by Chinese workers making goods to sell to wealthy Westerners has become concentrated in a few hands. Even in an avowedly communist country, 'development' has led inevitably to inequality.

Or perhaps the surprise is rather that the government in China is concerned about this and is devising policies to deal with it. Because, aside from economists who create an increasingly unconvincing litany of metaphors involving water trickling down or raising boats, the reality is that inequality is an inherent part of capitalism.

Without the inspiration of the super-rich and the fear of joining the lumpenproles why would any of us reluctantly climb back onto the treadmill of work - so especially grim at this time of year and following the extended break most of us took with such alacrity (including this blogger!).

Unfortunately, it would appear that the Chinese are under pressure from the UN to follow entirely the wrong route. The problem is being framed in terms of inequality between the urban and rural areas. Urban incomes are three times as high as rural incomes, leading to suggestions from economists that farmers should become more efficient and China should abandon its policy of self-sufficiency in food.

The comparative figures are, of course, utterly misleading. Like all output figures they only measure what is bought and sold and innumerated in cash. Rural peasants in China do not need much income because they mainly rely on self-provisioning and mutual aid. Just as peasants in our own country did until a hundred years ago or so. The benefit or marketisation will not accrue to them and is more likely to increase real inequality.

More on a couple of programmes from the BBC documenting growing inequality here. Tweet