“We have been talking about the risk of the dollar and dollar devaluation for a long time,”

TO BE NOTED: From Real Time Economics:

"Fan Gang on the China-Dollar Conundrum

From the WSJ’s China Journal blog:

Associated Press

General Manager of the Bank for International Settlements Malcolm Knight and Fan Gang, director of the National Economics Research Institute, in 2006.

The pan-Pacific debate over the dollar’s standing as a global currency continues. On Tuesday, U.S. President Barack Obama dismissed suggestions raised by China’s central bank governor that the world needs a new international currency that can take the place of the dollar in international reserves. Fan Gang, a prominent economist and advisor to China’s central bank, watched Obama on CNN in his Hong Kong hotel room, but says he was hardly convinced.

“Of course” an alternative is necessary “in the long run, if we want to avoid the cyclical problems associated with the dollar standard,” Fan says in an interview with the Journal on Wednesday. Besides being director of China’s National Economic Research Institute, a nongovernment think tank, Fan sits on the monetary policy committee of the People’s Bank of China, which means his views carry some weight in Beijing.

Fan describes the dollar as a kind of transmission mechanism for risk. The current crisis, he says, may have begun in the U.S. and Europe, but because of the dollar standard, “the risk of highly leveraged institutions has spread to other countries.”

The onus therefore is now on the U.S. in particular to better regulate its banks and hedge funds for the sake of the global economy, he believes. Next, Fan says, “we should monitor capital flows, and monitor leverage, and this information should be reported to the countries where (institutions) are investing.”

International trade in goods is heavily monitored and regulated, says Fan. It therefore makes no sense that “you have a regulated real market and an unregulated financial market.”

Of course, China is pretty good at keeping a close eye on capital flows. It allows only limited convertibility of its currency, the yuan, and tightly restricts foreign investment in the country’s capital markets. Fan, who asserts that “Chinese prudence has paid off,” says capital controls are “better for developing markets.”

(Later, speaking at a Credit Suisse investment conference here over lunch, Fan reiterated his line about prudence paying off. Privately, one critic in the audience quietly scoffed. China happily financed the U.S. trade deficit by buying low-yielding Treasurys for years, he said. How prudent was it to offer cheap vendor financing to a big customer with a lot of debt?)

Fan says while China is eager to keep its currency stable, there is pressure to let the yuan fall — “not just domestic pressure, but regional pressure,” as other Asian currencies weaken, making them more competitive. Rather than let the yuan fall against the dollar, he suggests that China should make reference more to the other currencies in the basket it uses to set the yuan’s exchange rate. “Eventually, China’s currency should be related to other currencies, not just the dollar,” he says.

Fan worries that the Fed’s quantitative easing is raising the risk of dollar inflation and devaluation, which “is a concern not just for China but for everyone.” He also believes monetary problems will fuel more “China bashing” in the U.S. from members of Congress that have previously railed against China’s currency policies. “In the future, you will see, when the dollar devalues, these senators will come back,” says Fan. Interestingly, Fan’s excitement level seems to peak when he’s asked why China is choosing to speak up now about the dollar.

“We have been talking about the risk of the dollar and dollar devaluation for a long time,” he says. “We have been talking about U.S. causes behind the imbalances in the trade deficit. No one listened. This is a time to get noticed.”