My friend Professor Steve Hanke warns in his article of the Cato Institute that the schizophrenic monetary polices of the Fed - "When it comes to the big elephant in the room — bank money — she (Yellen) is very tight. But, when it comes to state money, she is loose" - causes huge hot money flows to emerging economies and greatly destabilizes the world's monetary system.
His analysis serves to underpin the fact that the United States continues to use its ""exorbitant privilege" as the world's unchallenged arbiter of fiat money, treating the world's monetary system as a greenback-centric "closed" universe, thereby acting as a global destabilizer.
Professor Hanke refers to Prof. Ronald McKinnon's argument in "The Unloved Dollar Standard: From Bretton Woods to the Rise of China"- (Oxford University Press, 2012) that "China has been a major stabilizing force. China has injected stability into the international sphere by smartly, and ironically, linking the Chinese yuan (more or less tightly) to the U.S. dollar since 1995".
To maintain global stability, Professor Hanke suggests that the greenback should now form a closer union with the Euro, trading with each other in a narrow range and committing to defend each other, while the Asian dollar block should strengthen its ties to the greenback. Other emerging economies could choose either to tie to the greenback or the euro. Professor Hanke's formula is designed to avert the disruptive effects of a global "currency war"".
While such a formula has many merits to commend itself, it ignores certain new, game-changing, global realities.
First, the Chinese yuan (the RMB) has eclipsed the greenback as the world's ipso facto "reference currency", according to Professor Subramanian of the Petesen Institute for International Economics ("Eclipse - Living in the Shadow of China's Economic Dominance, September 2011). Click here This is supported by the fact that China has already displaced the US as the largest trading nation. There are now 126 countries which have China as the largest trading partner, compared to only 76 in the case of the United States. Admittedly the vast majority of world trade is still being conducted using the greenback. But the RMB is gaining traction as an international currency. It has already displaced the euro as the world's most used trading currency. This momentum is being driven by China promoting RMB internationalization through currency swaps and issue of more RMB-denominated investment products. All indications point to the RMB becoming a fully-convertible currency within about five to ten years. Click here The days of an Asian dollar block are therefore numbered.
Second, likewise, the European Union has displaced the United States as China's largest trading partner. There is no reason why the EU should choose to defend the greenback unless it coincides with her main economic interests. This is not to mention the growing divergence in views between the EU and the US about their respective roles in a changing world.
What should help in stabilizing the world's economic and monetary systems is for the United States to re-balance its economy towards more savings and less consumption while China is actively doing the opposite. That way, the United States could export more to China while retaining more savings to re-build its crumbling infrastructure. Additionally, the United States must also re-sharpen its economic competitiveness through improving the educational level of its workforce.
Moreover, as the two countries are at very stages of advancement, America can no longer afford to compete at the lower levels of products that a country like China still manages to do best. America, however, is miles ahead of China in high technological and scientific innovations, which are being wooed by China with open arms. What stands in the way is continued suspicions of a Rising China, which translate into many US restrictions on high-tech exports to the Middle Kingdom.
If America can sell more to China (as in the case of Germany) as China consumes more , this could help reduce the need to rely on America's "exorbitant privilege", which in any case is destabilizing to the world's economic and monetary systems as it is past its sell-by date as a panacea for America's fortunes.