Council of Councils Inaugural MeetingThe Dollar's Future as a Reserve Currency

May 14, 2012


The following is the full text of Genron NPO Representative Yasushi Kudo's speech text prepared for, and delivered at, the session on "The Dollar's Future as a Reserve Currency" during the Inaugural Meeting of the Council of Councils of the Council on Foreign Relations, held in Washington D.C. on March 12. Kudo served as one of the four panelists at the session.

Hello, I'm YASUSHI KUDO, Representative of The Genron NPO, Japan.

First of all, I'd like to say our grateful we are for being given this opportunity to express our views at this session.

I am not a currency expert, but I organized a team of experts to conduct serious discussions on the given agenda "the future of the U.S. dollar." I served as moderator for the debate. The team was headed by a former deputy governor of the Bank of Japan, and included people close to the Japanese central bank and the Finance Ministry in a private capacity. Today, I will do my best to tell you about the results of the discussions and contribute to the debate at this session.

Well, let me begin.

Our basic thought on this agenda is that it is hard to justify altering the dollar's present international status and the role of the U.S. currency is most unlikely to undergo a marked change for the time being. The reasons for our view are as follows.

First, the share of the U.S. dollar in the total holdings of reserve currencies by central banks amounted to more than 60 (sixty) percent, and the dollar remains the most utilized reserve currency.

Due to the rapid growth of China and some other emerging economies, the relative share of the United States in the world economy has been diminishing. However, its share still accounts for a large 23 percent. Nothing has happened to alter the fact that the U.S. dollar is the most convenient currency for international trade and financial transactions. It is also a reality that the dollar is winning the confidence of the giant international financial markets as a safe asset.

This is especially true these days, given the fact that the flight of funds from the euro to other safer assets has become obvious due to the European sovereign debt crisis, leading to the shift toward the U.S. dollar, along with the Japanese yen and the Swiss franc.

Moreover, it is an undeniable fact that there is no alternative to the dollar as the key international reserve currency despite persistent calls by many countries about the weakening confidence in the dollar and the fragility of the unipolar structure of the international currency system centered on the U.S. currency.

From time to time, France and China have called for a review of the dollar's dominance of the international currency system. Today, however, the pressing task for eurozone countries is to prevent the breakup of the euro bloc and an argument of this kind is no longer on G-20 agendas. The Japanese side also think that the often-repeated argument about the adoption of the renminbi (or the Chinese yuan) as an international key currency is yet irrelevant, as I will explain later.

Realistically, the key international currency system centering on the U.S. dollar will prevail for some time, despite diverse uncertain factors, because in practical terms there is no alternative to it.

That said, we do not intend to shut the door to debate on any serious study on the desired shape of a future international currency system. Looking to the future, it is predicted that in spite of its high growth potential among advanced economies, the relative weight of the United States in the world economy will most likely continue to decline, given the economic development of emerging economies with huge populations. Therefore, we had better always keep in mind a long-term perspective of exploring a more stable international currency system.

In this context, I would like to explain the basic stance of the Japanese team as regards the moves toward the internationalization of the renminbi (the Chinese yuan) in our neighboring country and the possibility of introducing a common currency in Asia.

When it comes to the subject of introducing a unified currency in Asia, our conclusion is that it will be an extremely formidable task.

More than 10 years ago, at international conferences, the Japanese government twice proposed studying the desirability of a multipolar international currency system and an Asian common currency setup. Of late, the Japanese government has refrained from officially developing such an argument. I believe that probably there is no such official study being conducted.

However, I must admit that it remains one of Japan's future challenges to conceive a currency system that could facilitate Japan's closer economic ties with the rest of Asia in tandem with Asia's economic growth and enlargement of the economy. In this case, one of the agendas to be examined in the long term is whether we, the Asian countries, should continue to use the dollar as a key currency for transactions in the Asian region. However, our recognition is that it is extremely difficult for Asia to adopt a uniform currency like the euro in Europe.

The biggest challenge for the adoption of a uniform currency in any region is the creation of a single central bank and fiscal policy consolidation, as well. Given the large difference in stages of economic development and historical backgrounds, the introduction of a uniform currency for Asian countries is hardly within reach at this stage, although we do not rule out its possibility, at least in theory.

Next, let me refer to the internationalization of the renminbi.

Recently, the People's Bank of China has unveiled a capital liberalization road map while China's State Council's think tank (the Development Research Center) and the World Bank have issued a joint research report ("China 2030: Building a Modern, Harmonious, and Creative High-Income Society"), which calls for the structural reform of the Chinese economy.


The Japanese team is closely and carefully observing these moves in China. Admittedly, there were diverse opinions in our discussions. But our conclusion was simple. That is, moves are gathering momentum in China toward the internationalization of the yuan, but it is too early to measure that these moves are aiming to make the Chinese yuan an international key currency.

However, it is only natural to see the Chinese yuan assuming a larger international role to some extent in the future, given the size and growth potential of the Chinese economy. In fact, China is stepping up moves toward the internationalization of the yuan, as seen by its increased use for settlement of trade transactions.

Nonetheless, there are many hurdles for the Chinese currency to overcome before it becomes a new international key currency and is used extensively as a reserve currency.

For the Chinese yuan to be internationalized, China must satisfy such requirements as flexibility of foreign exchange transactions and liberalization of capital markets, and more important, independence of the central bank -- a political challenge.

We understand that the Chinese government maintains a policy of advancing internationalization of the yuan but on a phased basis, and the moves are going on very slowly. It remains to be seen whether the Chinese central bank's road map for capital liberalization and other related plans will be implemented by China's upcoming new leadership. The Japanese experts are very skeptical about this and it is hard to foresee the future of the Chinese yuan.

If these plans were to materialize, the Chinese yuan would appreciate substantially and probably sweeping reform of China's political system would have to be put on the agenda. Such being the case, we don't think that China is proactively moving to make the yuan an international key currency because of the political risks.

In the same token, we doubt the seriousness of China's argument that the Chinese yuan should be included in the International Monetary Fund's Special Drawing Rights (SDR) as its constituent currency. No doubt, China welcomes growing international appraisal of its economic power and future growth, but we think that China is more than cautious about any moves that might lead to the rapid internationalization of its currency.

Under such circumstances, the dollar regime will survive for the foreseeable future. If such is the case, an important point of argument is that this structure relies on an unstable equilibrium: the sizable deficit-financing of the United States hinges structurally on massive financing by other countries and this structure is sustained by confidence in the American currency.

China, for instance, is overtly conducting foreign exchange intervention in order to avert a rapid surge in the value of the yuan and continues to boost its foreign currency reserves in dollar-denominated assets by supplying the Chinese currency to purchase the dollar. By investing its massive dollar reserves mostly in U.S. government bonds, China is financing the U.S. deficits. This structure is the same with the other emerging economies, and Japan.

This structure would collapse overnight should the parties involved openly express doubts about its fragile foundation. Yet, the financiers of the U.S. deficit have to sustain the structure so as to avoid losses to their dollar-denominated assets. The problem is that this contradiction has been a chronic cause of "currency wars" between the United States and newly emerging countries. In the case of China, repeated exchange intervention is raising the cost of such operations while inflationary pressures persist.

The sovereign debt crisis of the eurozone is causing a temporary reversal of capital flows, but the fundamental contradiction remains intact as a source of instability, which is inherent in the dollar-centered international currency system.

In early August last year, international tension mounted in currency markets when Standard & Poor's cut the long-term U.S. credit rating to AA-plus on concerns over growing budget deficits triggered by the confrontation between the Democrats and the Republicans over the much-disputed rise in the U.S. public debt limit. In order to contain such concerns, the United States must avoid any fiscal and monetary policy measures that might result in a loss of confidence in the dollar.

In the same token, Japan is being held increasingly responsible for maintaining the stability of the dollar-led international currency system.

As you know, however, Japan faces serious fiscal problems and the population of elderly people continues to grow at a rapid pace. As is the case with the United States, Japan must address in earnest the difficult task of fiscal reconstruction, together with economic reforms to expedite growth.

Finally, I would like to add a few words about what Japan should do to contribute to the solution of Europe's sovereign debt crisis in relation to the issue of the U.S. dollar.

It is important for us to see the ongoing European crisis as a global financial problem, not just as the debt problem of some troubled European countries.

The European sovereign debt problem is having a negative impact on Japan's exports to Europe and Asia. European financial institutions face the task of increasing capital adequacy ratios. The problem is that they are massively lending to Asia. Therefore, any shrinkage of their credit lending to Asia would have major effects on the Asian economy in both trade and financial terms.

Needless to say, the EU countries themselves should respond to the crisis more responsibly. But given the fact that the European crisis is spreading to Asia, we consider it necessary for Japan and China to involve themselves in addressing the European problem.

The Japanese government has purchased bonds issued by the European Financial Stability Fund (EFSF). But this is not enough. In 2009, Japan provided the IMF with an additional $100 billion to increase the IMF's lendable resource. Why don't Japan and China provide additional and larger funding to the IMF so that it would be fully equipped with sufficient funds to deal with the European crisis? Based on the experience of the Asian currency crisis, Japan should have a bigger say in the international bailout efforts.

When it comes to the question of Asia's financial stability, the Multilateralization Agreement of the Chiang Mai Initiative (CMI), a multilateral currency swap arrangement among all the members of the Association of Southeast Asian Nations (ASEAN), Japan, China and South Korea, took effect in March 2010. The size of the currency swap is now close to $120 billion.

We recommend that a joint action be considered by Japan, together with the United States, China, South Korea and ASEAN, to address the issue in order to expand the size of the IMF pool further and to implement other prospective preventive measures before another global financial crisis rears its ugly head in Asia.

Thank you for listening.

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