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Dollar Debate

July 8, 2009

China may not yet be a member of the G-8 group of leading industrial nations. But it is expected to raise the most controversial issue of the current summit -- whether the world should get away from the US dollar.

A handful of dollars in front of US and Chinese flags
China thinks it's time to reconsider the supremacy of the dollarImage: AP Graphics/DW

Most of the leaders at the summit would probably be content with emphasizing the fragile signs that the world economy is stabilizing. But China may try to shift the focus to the dollar when it joins the proceedings as a guest.

China, which according to some estimates could be holding some 70 percent of its $1.95 trillion (1.4 trillion euros) reserves in US dollars, has repeatedly hinted in recent weeks the world should take a cold hard look at the greenback as a global reference currency.

It is unclear what has motivated the remarks form Beijing, but they could be an attempt to pressure Washington into preventing inflation - which could benefit the US economy but damage China's reserves.

Another possibility, suggests Friedrich Heinemann, a financial expert at Germany's Center for Economic Research, could be national vanity.

Chinese Premier Wen Jiabao
Chinese Premier Wen Jiabao will be attending the summit in ItalyImage: AP

"Currency issues are always questions of prestige," Heinemann told DW-WORLD.DE. "China may think that the financial crisis, which started in the US, means that America should no longer be the world's unchallenged economic leader. They may also feel their own currency is undervalued and that exchange rates don't reflect recent global changes."

But given China's emphasis on dollars in its own reserves, Beijing may be pursuing a risky strategy.

"It's is a bit difficult to understand entirely," Heinemann said. "China missed the opportunity to transfer resources into euros. It's baffling, especially as most people expect the US to recover."

Few open ears

cartoon dollar bank note
George Washington can't believe his eyes in this cartoon bank noteImage: AP

Belief and expectations have played a huge role in the current economic crisis, and much of the politicians' rhetoric about recovery is about restoring faith. So the experts think it's unlikely that Western leaders will get behind the Chinese initiative.

"It's improbable," said Heinemann. "The leaders have entirely different problems, and it would be impossible for them to send Obama back home with the news that the dollar is going to be replaced as the world currency."

In a statement last week, Canada's Finance Minister Jim Flaherty flatly dismissed the idea.

"In the midst of what is still a significant global recession, it's important that we aim for stability, and stability has been based on the US dollar as the global currency," Flaherty told reporters.

China could use its influence to get the issue mentioned in the official statement coming out of the G-8. But Reuters news agency quoted an unnamed official close to the G-8 as saying the wording of such a statement would be so watered down as to be "meaningless."

And the G-8, of course, has no official authority in this area.

"Politicians can't decide to change the world currency," Heinemann said. "Investors do that when they decide which currency to conclude contracts and transactions in."

Pressure on the dollar

Barack Obama
The G8 will almost certainly back Barack Obama over BeijingImage: AP

Still, the mere idea of such a debate taking place is likely to affect global currency markets in the short term.

"There is caution that talks on the dollar as an international reserve currency would trigger dollar selling," Masato Otsubo, a currency analyst at Resona Bank, told AFP news agency.

Other experts concur.

"The fact alone that heads of government could comment on the role of the dollar is putting pressure on the greenback," said Commerzbank analyst Ulrich Leuchtmann to AFP, adding, though, that the pressure would likely disappear after the summit.

Indeed, after China broached the topic last week, the dollar suffered slight falls against other major world currencies.

Such fluctuations underscored the fact that the dollar has not been investors' currency of choice in this economic slowdown, as it has been in past ones.

"The safe-haven appeal of the dollar has been undermined recently by increased concerns over accelerated reserve diversification, leaving it vulnerable in the week ahead to further comments around the sidelines at this week's G-8 meeting questioning its role as a store of value," Bank of Tokyo-Mitsubishi UFJ economist Lee Hardman told AFP.

There is little to no chance that the dollar will lose its status as the world's premier currency. But if currency matters are always questions of prestige, it's clear that America's prestige has taken a dent.

Author: Jefferson Chase
Editor: Michael Knigge