Is there a clandestine understanding between the world’s two most powerful central banks, the Federal Reserve and the People’s Bank of China?
Naturally, no one can talk about it, let alone confirm or deny anything. But it’s not too difficult to make out the broad outlines of how Chinese-American monetary cooperation may be working.
People’s Bank governor Zhou Xiaochuan and other figures in the Chinese leadership seem to use every opportunity to broadcast finely calibrated skepticism over the dollar’s future. Such Jeremiahs feed on and — in turn — feed doubts about potential American inflation caused by the Fed’s quantitative easing and exploding budget deficits.
But both Washington and Beijing appear to recognize — whatever the saber-rattling — that large-scale shifts in the currency composition of Chinese currency reserves are more or less impossible. Roughly two-thirds of Chinese reserves of more than $2 trillion are thought to be held in the greenback.
Heavy Chinese sales, or even a deliberate policy of diverting export proceeds into Euro or yen by re-dominating sales contracts, would depress the U.S. currency and lower the value of Chinese reserves. It’s the well-known Beijing dollar trap. And it has to be said: the Chinese have maneuvered themselves into it of their own volition, and in full knowledge of the potential problem.
So Governor Zhou’s strictures are, to a certain extent, shadow boxing. However, in return for a tacit standstill agreement on the currency composition of reserves, the Americans have to acknowledge that the renminbi’s value will rise only moderately.
If the Chinese continue taking in dollars, logic tells us the Chinese currency can hardly revalue strongly. A signal of the U.S. authorities’ acceptance of this state of affairs is that the word “manipulation” for Chinese currency management now clearly is banned.
There is another, still more intriguing, side to Chinese currency pronouncements. The doubts voiced from Beijing on the dollar’s stability, far from unsettling the U.S. monetary authorities, are actually manna from heaven for the Federal Reserve. The Obama administration hardly can go in for years of reckless deficit spending when the country’s largest creditor is emitting so many warning signals.
More importantly, the Fed is getting a certain amount of cover from Beijing for its eventual “exit strategy” — a reversal of quantitative easing and a rise in interest rates as soon as economic recovery gets under way.
The Chinese even are giving a strong tailwind to Fed Chairman Ben Bernanke’s bid for re-nomination after his initial four-year term ends in January. The reason? With the Chinese appearing to turn the knife through gloom-laden dollar prognostications, President Obama knows that appointing a heavily political successor to Bernanke would be fraught with great risks.
Any Fed chairman who looks less than squeaky-clean on currency stability is likely to send dollar holders heading for the exits — and could spark the full-scale currency collapse that Wall Street bears have been growling about for months.
So, if Obama wishes to replace Bernanke, he can do so only by bringing in a full-scale monetary hawk — a step that he must rule out on domestic political grounds. The conclusion is that the Chinese maneuverings leave Obama with no choice but to re-appoint Bernanke, whatever the doubts about his stewardship that have arisen in recent months.
When Bernanke a little later this year eventually is confirmed in a second term of office, what’s the betting that a laconic red-rimmed telegram from Governor Zhou will turn up in his in-tray?
The missive and its contents, of course, will remain secret. We can only guess at the possibility that the two men, just for a moment, will share the opportunity for a modicum of discreet self-congratulation.
David Marsh is chairman of London and Oxford Capital Markets. The Marsh on Monday column appears in German in the newspaper Handelsblatt.
A Deal Between the Fed and Bank of China? – David Marsh, MarketWatch
