The Chinese Lecture on Capitalism

The Head of the People's Bank of China has just spoken about the creation of a new currency akin to what Keynes had proposed at Bretton Woods. Zhou Xiaochuan who heads the Bank, and curiously is a PhD Chemical Engineer and NOT an economist, a rather insightful observation in itself, has thrown down this challenge to the US a week ahead of the G20.

Some of what he has said is of note and a warning to the Administration:

"The outbreak of the current crisis and its spillover in the world have confronted us with a long-existing but still unanswered question, i.e., what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF? There were various institutional arrangements in an attempt to find a solution, including the Silver Standard, the Gold Standard, the Gold Exchange Standard and the Bretton Woods system. The above question, however, as the ongoing financial crisis demonstrates, is far from being solved, and has become even more severe due to the inherent weaknesses of the current international monetary system....

I. The outbreak of the crisis and its spillover to the entire world reflect the inherent vulnerabilities and systemic risks in the existing international monetary system.... Issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries' demand for reserve currencies. On the one hand, the monetary authorities cannot simply focus on domestic goals without carrying out their international responsibilities and on the other hand, they cannot pursue different domestic and international objectives at the same time....

II. The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies...

III. The reform should be guided by a grand vision and begin with specific deliverables. It should be a gradual process that yields win-win results for all ...

Special consideration should be given to giving the SDR a greater role. The SDR has the features and potential to act as a super-sovereign reserve currency. Moreover, an increase in SDR allocation would help the Fund address its resources problem and the difficulties in the voice and representation reform. Therefore, efforts should be made to push forward a SDR allocation.... Create financial assets denominated in the SDR to increase its appeal. The introduction of SDR-denominated securities, which is being studied by the IMF, will be a good start. Further improve the valuation and allocation of the SDR. The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies, and the GDP may also be included as a weight...

IV. Entrusting part of the member countries' reserve to the centralized management of the IMF will not only enhance the international community's ability to address the crisis and maintain the stability of the international monetary and financial system, but also significantly strengthen the role of the SDR...."

Hopefully the Administration is prepared for the G20 next week. The Europeans are preparing for world regulation of all financial markets and the Chinese are planning for a new world currency. The Geithner-Obama bailout looks a lot like a Paulson-CDS II type plan. It really creates a great deal of long term credit uncertainty. he Chinese are warning the US not to over reach on the US internal spending, namely excessive domestic programs, all at once. It is amazing to be lectured by the Chinese on Capitalism! This may be more telling than anything else.