Euro-yuan-dollar diplomacy

Europe to China: Please do not buy any more euros.

EU economic and monetary affairs commissioner Joaquin Almunia said China should not take any steps to increase its euro reserves at the moment.  Asked what message the euro zone's high-level delegation gave China late last month on its purchases on foreign exchange markets, he said: 'We told the Chinese: it's not the moment to take decisions, it's the moment to stay as you are and take decisions in other areas.'

China to the US: The renminbi isn't the problem, the dollar is.  Richard McGregor writes:

"Beijing turned the tables on the US yesterday ... warning of the serious global implications of the weak dollar, recent US interest rate cuts and the subprime crisis." 

Chen Deming, China's future Commerce Minister, was quite direct (Hat tip, Michael Pettis):

"What I am worrying about now is the weakening dollar and its potential impact on global growth. The dollar is the major currency for trade, and its continuous depreciation will push up prices of oil and gold and reduce the wealth of dollar-holding nations. So I want to see a strong dollar.” 

It doesn't take much leg work to get a strong sense that there is more than a bit of friction among what might be termed the G-3.

Europe isn't happy with the RMB's depreciation against the euro.  China isn't happy with the dollar's depreciation -- and the United States unwillingness to do much to change the dollar's depreciation.    The US isn't happy with the pace of RMB appreciation against the dollar.

And perhaps US policy makers are starting to get nervous about the implications of a global financial system whose stability hinges on China's willingness to add $500b of reserves that it doesn't need to its already large stock, adding to its already large likely financial losses.

Particularly now.  

SWFs are hot.  CDOs are not.   In an eloquent and important column, Martin Wolf argues -- I think correctly -- that the current credit crisis is "a huge blow to the credibility of the Anglo-Saxon model of transactions-orientated financial capitalism."  That isn't good for the United States.  It has made the US even more dependent than usual on central bank financing.

I don't have much sympathy for China's argument.   The Unites States' dollar policy has long been to ignore the dollar's external value and direct policy toward stabilizing economic conditions in the US.  If that means a strong dollar, so be it.  If that means a weak dollar, so be it.    

And, more importantly, China didn't have to let its currency follow the dollar down.   And if China had actually started to loosen the RMB's link to the dollar a few years back, it wouldn't have to import US rate cuts either.  US policy isn't making Chinese policy easy right now, but China cannot really blame the United States for China's own policy choices.

It has been reasonably clear for some time that the dollar would need to depreciate over time to help reduce the US trade deficit (See Dr. Chinn).   And some warned three years ago that a global monetary system that tied the currencies of the world's largest surplus economies to the currency of the world's largest deficit economy was bound to cause trouble.    China and the Gulf need to appreciate not depreciate.  

And it never made much financial sense for China to spend so much money buying a huge stock of depreciating assets.  But now that China owns so many dollars, my guess is that - over time -- the US and China are starting to interact more as debtor and creditor.   China is in effect complaining that the US isn't paying enough attention to the concerns of its creditors in setting its policy.  

The US, on the other hand, can rightly say that it has only accepted the new Bretton Woods system because up it didn't impose any constraints on US macroeconomic policy.

Call it an additional source of friction in an already acrimonious relationship.