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China’s new policy strategy and the G20

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In Brief

People’s Bank of China Governor Zhou Xiaochuan’s article on the international currency system last week signaled an important departure in Chinese policy thinking. Since the outbreak of the U.S. financial crisis, Chinese leaders had maintained that promoting a stable domestic economy was China’s best contribution stabilizing the world economy.

Just before the G20 Washington Summit, the State Council hastily announced a stimulus package of CNY4 trillion, about 16 per cent of GDP in 2007, to boost domestic demand. But China was much more reserved on international policy issues. This strategy was consistent with the strategy enunciated by Deng Xiaoping: focus on developing the economy but keep a low profile in international affairs.

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There was a harbinger of change early this year, when Premier Wen Jiaobao criticized U.S. policies for causing global financial crisis during his tour to Europe. Zhou’s proposal, coming out right before the G20 London Summit, confirms China’s new interest in participating in, and even leading, the debates about changes in the international economic system.

The last six months have seen significant effects from the global crisis on China, contrary to earlier expectations that its impact would be limited. China’s economic interactions with the rest of the world are already deep and comprehensive, evidenced by its large export sector, which accounts for 37 per cent of China’s GDP or 8 per cent of total world exports, and huge foreign exchange reserves, which now amount to almost US$2 trillion.

The stakes are too high for China to simply stay out of the global economic policy game.

Zhou’s idea for establishing a new world reserve currency, building on the IMF’s SDRs, is not a completely new idea. But it does reveal is China’s strong underlying dissatisfaction with the state of U.S. economic policy. The position of the U.S. dollar as a world currency depends critically on the policy credibility of the Federal Reserve.

The Fed’s performance has been disappointing. Its unusually loose monetary policy and ineffective financial supervision were important factors contributing to the current crisis. On March 18, the Fed decided to purchase US$300 billion long-term treasury debt and an additional US$750 billion of mortgage backed securities. These purchases would expand the central bank’s balance sheet, probably via printing money, and would therefore be dollar-negative.

A near-term objective of the Zhou proposal is probably to add pressure on the U.S. policymakers to maintain a stable U.S. dollar, which is the key not only to maintaining stability of the international financial system but also to preserving the value of China’s massive dollar asset holding, of which China holds an abundance. But it certainly is not the Chinese government’s intention to dismantle the U.S. dollar now. Establishing a new world reserve currency arrangement will take decades to accomplish. But by announcing the new international currency idea now, Zhou and the Chinese leadership sent an important message to the world: China will play an active role in shaping future international economic arrangements.

The G20 Summit is the best available platform for China to achieve that goal. Some prominent scholars have proposed a new ‘G-2’ mechanism for the United States and China to pursue coordinated approach toward global issues. But a ‘G-2’ mechanism now would elevate China into a global leadership position that it is still ill-prepared to occupy and put it into a position of direct conflict with the U.S. Prematurely going it alone with the United States is more likely to reduce, not to elevate, China’s role in international economic policymaking. The ‘G-2’ would not be able to resolve the sticky international economic issues about exchange rates, the international currency system or climate change between the U.S. and China without third country participation.

This is not to say that cooperation between the largest developed economy and the largest developing economy is not a critical element in managing the international economic system already. Already there is an active dialogue and bilateral partnership that must address all these problems. But the G20 is likely to remain a much more effective platform through which China can pursue reform of the international economic system than any of the smaller groups (the G7 or G8 or G13) that already exist or have been recently proposed.

3 responses to “China’s new policy strategy and the G20”

  1. PBC Governor Zhou’s article about a better international monetary system can only be seen as a political statement with an obscure motive. The world economy is in crisis. Policy actions that bite in the short-term are required to halt the contraction of economic activity everywhere and restore a sense of confidence in the future. Reforming the international monetary system cannot be accomplished in the short term. The questions the Chinese authorities have not yet answered are how they will retreat from their unsustainable balance of payments surpluses and how they will “mobilize” their excessive foreign exchange reserves in a way that strengthens the international financial system. Until they answer these questions, Chinese citizens and the rest of the world will have a valid reason to believe that next year may be worse than this year.

  2. I agree completely with Lex, except that the likely political motive behind PCB Gov Zhou’s call for changing the international monetary system away from the dollar and Premier Wen’s putting the U.S. on notice about its huge fiscal deficit and monetary policies is not that obscure. China’s leaders presumably know that worse is coming and want to put the onus on the US, not their own economic and financial management. By ‘worse’ I mean that China likely will not come close to stimulating its way to the politically sensitive minimum of 8 per cent growth because it will take years to rebalance China’s economy away excessive dependence on export surpluses, the neglect of agriculture, and lack of adequate credit to private enterprises.

  3. Present crisis , that started from the developed Western Industrial democracies , is due to ballooning of expectations of all sections of the society, without a realistic economic base. Interdependance of economies means that some producers ( say China, East Asian ecnomies and Japan, -India may join them latter if its economists copy blindly) are overproducing and accumaulating surpluses and keeping currency in treasury bills, bonds). This has led to greedy consumption and kept the wolves away in Western countries because of cheap goodies from the east. Unless all the important World leaders meet ( G 20 for the present) and take a realistic view of the present causes and future course of action , the world economy is doomed for the next 10-15 years. Now is the time for aa realistic and humane world view to save ourselves ( and the planet in due course).

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