Dollar and yuan both hold the answer to global imbalances

There are currently two sharply contrasting arguments to explain the global imbalances between the US as the biggest trade deficit country and China as the biggest trade surplus country.

The first argument blames China as the major source of the imbalances, and the other seeks more fundamental reasons within the international monetary system (IMS) itself. This second argument goes that the world economy is based on the US dollar, and this gives rise to these global imbalances.

In fact, both arguments are two sides of the same coin. On one side, the US dollar has always been regarded as a ‘public bus’, providing a ‘free ride’ to other currencies.

The advantage of seigniorage

Apart from the network externality value to the US of widespread dollar usage, such a position by the issuer in the IMS has an obvious economic advantage, known as ‘seigniorage’. In return for injecting liquidity into world trade and investment, the US government has, in exchange, received goods and services from other countries. And this seigniorage can be realised under two conditions only: one is that the currency must be international; the other is that the issuer must be a sole or dominant importer.  

The past six-plus decades since the birth of the Bretton Woods international economic system have seen the US dollar playing a pivotal role as a catalyst for the post-war international trade and economy, which has enjoyed the greatest rate of development ever seen in history.

Shared trade deficit

As time has gone by, however, the US dollar has been constantly injecting excess liquidity into the world economic system. As a result, the US has accumulated a huge trade deficit, shared between 91 countries, among which China and Japan are the largest.

The US has fulfilled the two above-mentioned conditions for seignorage, despite the inbuilt risk of tension between its domestic and its international economic objectives – the so-called Triffin Dilemma, which was identified by Professor Robert Triffin in the late 1950s.

Then, in 2009, Governor Zhou Xiaochuan of the People’s Bank of China raised the question of whether the world would benefit from a supra-national currency – ideally the International Monetary Fund (IMF) Special Drawing Right, to get rid of the Triffin Dilemma.

International reserve currency

However, there is no certainty that this artificially created supra-national currency will ever come into being, so the practical issue confronting the world will be this: if the creator of an international reserve currency cannot eliminate the Triffin Dilemma on its own, could the burden be shared with other emerging currencies, such as the Chinese remnimbi, Brazilian real or Indian rupee, to make the global economy more balanced?

Such a second-best choice should be based mainly on the economic and demographic weights of major IMS participants. For instance, the US share in the world economy amounts to about 23%, but the US dollar is widely used in 70% of world trade and 67% of international reserves. The euro comprises 26% of the world’s foreign exchange reserves, while the EU’s voting power in the IMF surpasses that of the US.

China is now the world's second largest economy, and the top exporter, but its voting power in the IMF has barely climbed above the 4% level. The answer is apparent: the IMS needs readjustment.

Balancing act

On the other side of the coin, China also needs to readjust its economic development scheme from an export-led strategy to a more consumption-oriented economy, in spite of its huge accumulation of foreign reserves – which are largely in US dollars. In order to better manage its foreign reserves, China should import more, and find alternative ways to invest offshore, other than putting its trade surplus back to US treasury bills.

These methods certainly work well to reduce the imbalances that have been accumulated throughout the years, but this only tackles the existing stock of reserves, not the future flows. For the future, China’s national currency should sooner or later be playing an international role in trade settlement and central banks’ deposits, in line with its economy going global.

This sounds like a solution to the Triffin Dilemma: if it cannot be totally eliminated, it can, at least, be shared by many others so as to get the imbalanced global economy back to a more balanced track.

Meeting of minds

In March this year, G-20 central bankers, top academic thinkers and financial leaders assembled in China to seek solutions to this question. Former IMF managing director Michel Camdessus formed an elite 18-member economist group from around the world to tackle the Triffin Dilemma.

The Nobel prize-winning Canadian economics professor, Robert Mundell, proposed the idea to eventually set up a world central bank, with a fixed exchange rate system. Many others have provided their wisdom in dealing with this issue.

However, no consensus on the reform of the IMS is, so far, in sight. We are, and will be still, living for a long time to come in a predominantly US-dollar-denominated world economy that has generated imbalances in trade and the oversupply of liquidity.

Niu Tiehang is senior researcher at the China Center for International Economic Exchanges in Beijing.