Tuesday, March 31, 2015

Opinion: The New Silk Route to World Bank of China

Old route or a grand plan?


The New Silk Route is not just another road or route for trade with China. And the new Asian Infrastructure Investment Bank is not another cooperative global bank. They both are set to accomplish much more than business. Both are promoted by China to make it economic superpower and their currency a reserve currency, an alternate to Dollar and Euro. Here is how.

Interest free loans

The US dollar as a reserve currency, dominates international transactions now (even when US is not involved in transactions). For example, when India buys Gold from Switzerland or Gulf buys clothing from Asian countries, they are likely to carry out the transactions in dollars. Companies in both countries must possess dollars to carry out the trade, which leads to greater demand for the dollars. So the Central Banks around the world hold majority of their foreign exchange reserves in dollars. That is like interest free loan to US Govt. which gets capital at no cost to spend on the welfare of its own country. Who would not want interest free loan? China is on its way now.

Higher reserves for a weaker currency

For many years, China had pegged its currency to dollar. That helped China to mop up trillions of dollars reserves and print its currency to fund domestic growth. Once you have enough money, you do not wish to be a daily wage labor; instead you want money to work for you. As the wages in China went up, its advantages of low cost manufacturing hub started losing out, and China is planning to avoid dependency on exports for its economic growth by devaluing its currency. It has to find ways to slowly disengage itself from US and dollar reserves. But that will hurt growth and converting dollar into yuan may cause inflation.

Grand plan

What if those forex reserves are used to fund someone else, let us consider, you help neighboring countries to build roads to China and finance it? Nice, you found a way to lend your money and also upgrade your infrastructure at the borders. Those roads help boost bilateral trade, avoiding the use of dollar as China will insist it that way. That means China can reduce its dollar reserves and convert it into its own currency and lend it through Asian Infrastructure Investment Bank for building the silk route. As many partners begin to accept Yuan/RMB for trade, it becomes a reserve currency for Asia and some parts of Europe. China can go on printing which will end up as reserves in many countries replacing dollar at least partially. That lets China do what US does now, make others fund your growth.

Roadblocks

Everyone has a plan 'till they get punched in the mouth, so said Mike Tyson. Resisting China’s moves, the US and Japan have refused to join the Asian Infrastructure Investment Bank. That means Russia is in. India happily joined the Bank as it is set to get second biggest share there. One needs to see how China’s ambitions will take shape when its neighbors want to see the end of dollars dominance but are also wary of China’s arrogance and intriguing strategies.

Times ahead


‘The New Silk Route’ will not be built in a hurry and dollar’s dominance would continue for some more time. But most of the world’s growth is coming from Asian countries and they are free to choose the currency they want to use. The new Bank would come in handy to limit the use of dollars over a period of time. If and when that happens (I guess it is at least a decade away), dollar would not command the same value, wages in Asian countries would rise quickly from here, and the gap in GDP valuation (at current prices) would narrow between US, China and India.