China Advocates Fundamental Reform of the Global Monetary System, and Works to Ease Dependence on U.S. Dollar

Sources: Businessweek.com: China Ratchets Up Pressure on the Dollar; Reuters.com: China Officials Call for Displacing Dollar, In Time

As the G8 summit in Italy approaches—the summit begins on Wednesday—China has heightened its call for the fundamental reform of the international financial system. In its push for the replacement of the U.S. dollar as a reserve currency, China acknowledges that it will take time to overhaul to current system. Chinese officials maintain that the IMF unit of special drawing rights (SDRs) may provide a viable alternative to the dollar.

The dollar comprises an estimated 70 % of the $1.95 trillion China holds in official foreign exchange reserves. Accordingly, China remains cautious not to make statements which may hurt its investments.

To reduce its dependence on the dollar, China stated last week that it would permit its exporters and importers to settle international trade agreements with the renminbi. Prior to this action, companies have had to exchange renminbi for U.S. dollars or alternative currencies when settling cross-border transactions. Starting July 2, the People’s Bank of China (PBoC) would invite banks to offer settlement services tied to the renminbi.

The renminbi’s projected regular appreciation next to the dollar provides the incentive for Hong Kong companies to use it in settling trade agreements. Even though China has limited the renminbi’s appreciation since July 2008 to assist exports, the mainland currency has risen 21% since 2005 when a dollar peg was cast aside. Investors are betting it will strengthen less than 1% to 6.77 per dollar in the next year. Since July 1, 2008, the central bank has maintained a range of 0.08%.

Other initiatives also aim to promote the renminbi’s regional usage. For instance, China said in May that it would endorse the issuance of renminbi bonds by locally incorporated foreign lenders.

Still, in spite of the disfavor with the dollar-centric global financial system, the IMF announced on June 30 that the portion of dollars in international foreign exchange reserves reached 65% during the first three month of 2009, rising to its highest level since 2007.

Discussion Questions:
1) What short and/or long-term effects might China's promotion of the renmindi as a regional currency have on the dollar as well as other currencies?
2) How might China's efforts fuel discussion concerning the reserve currency at the G8 summit in Italy on Wednesday?