Greece is wooing China to buy up to €25bn of government bonds, a move that underlines Beijing’s increasing financial power, as Athens struggles to fund soaring public debt. Goldman Sachs, the US investment bank, had been promoting a Greek bond sale to Beijing and the State Administration of Foreign Exchange (Safe), which manages China’s $2,400bn foreign exchange reserves, said people familiar with the issue.

That’s what the FT reported yesterday, and the news immediately set pulses racing in Brussels and Frankfurt.  As Unicredit’s chief economist put it to the FT a day later,

For the eurozone, “a member country implicitly rescued by China would be an even worse signal than an IMF programme”.

But even worse, China then signalled they probably didn’t want Greece’s ropey debt anyway. Yu Yongding – who’s not only a senior member of the Chinese Academy of Social Sciences but was also a member of the Canadian-run L20 project back in the day (and hence a sort of Chinese government-licensed public intellectual on global affairs) – commented yesterday that,

It is unreasonable for an economist to support a diversification away from an unsafe asset class to a much more unsafe asset class. Let European governments and the European Central Bank rescue Greece.

Cue predictable carnage as the markets digested this news: stocks immediately fell 4%, according to the WSJ, and bond investors demanded a record spread of 3.70% between Greek 10 year bonds and the benchmark 10 year German bonds. But the events of the past couple of days are also an interesting little microcosm of larger issues, some of which are these.

- First, of course, it’s the latest example of a case where Beijing gets cast as potential saviour of the world, but proves unwilling to step onto the stage (c.f. Chinese reluctance to get stuck in on curtailing Iranian or North Korean nuclear ambitions; lead developing world emission reductions; keep buying US Treasuries but reduce its export surplus; etc.) But, as David Pilling notes in a useful overview, China just doesn’t see it that way.

- Secondly, this week’s events flag up – again – the euro’s enduring contradiction of having monetary policy centralised at the ECB while fiscal policy is left up to individual countries. Before the credit crunch, there was the problem of countries like Spain and Ireland overheating (shortly prior to crashing back to earth, as it turned out), even as other eurozone members huffed and puffed to scrape a few growth points together. Now, with Greece’s lack of transparency and credibility in public accounts, the immediate problem is different, but the underlying contradiction remains the same.  See Larry Elliott in yesterday’s Guardian for more on this.

- And finally, on a related point, note the underying battle underway here between the dollar and the euro. The US economy doesn’t look great: since 2000, the dollar’s lost 41% against the euro, what with near-zero rates, huge deficits, quantitative easing, and ongoing weak housing and employment data.  But as Greece underlines and the WSJ’s Liam Denning observes, “Europe is no beauty either”.

PS. fellow Brits – now that our quantitative easing party’s over and the lights have come up, we might be wise to go easy on the sneering at Greece until we see how our next couple of bond auctions go…

Just three of the observations that Gordon Brown has made in the past about the Tobin Tax. All the more surprising, then, that the Prime Minister should have come out in favour of it in a surprise speech at this weekend’s G20 Finance Ministers – at least until fierce opposition from Tim Geithner forced the UK to back off. (No mention of the idea in Gordon Brown’s FT op-ed on financial institutions this morning, you’ll notice.)

Now that the dust is settling, two questions stand out. First, why the Damascene conversion? And second, how – if at all – does this alter prospects for implementation of the tax?

Start with the reasons why.  Of course, some argue that Brown’s endorsement of the idea is no more than ‘tough on banks’ political positioning. Fraser Nelson, for instance, sees it as “the desperate vote-seeking move of a Prime Minister who knows he’s going down”. Beating up on the banks may be part of the story, but it doesn’t sound convincing enough on its own: you have to wonder whether anything as nerdy as an international currency transaction tax is really going to resonate with the public at large.

John Hilary, the Executive Director of War on Want – the UK NGO that, more than any other, has led the charge on the Tobin Tax – argues that to understand the move, you have to look further back than FSA head Adair Turner’s advocacy of the idea in August: back, in fact, over the last two years, during which several European governments (in particular Norway and latterly France) have been analysing the Tobin tax in detail.

Two weeks ago, John told me this morning, French Foreign Minister Bernard Kouchner hosted the first meeting of a new Task Force on international financial transactions (terms of reference here), which Financial Secretary to the Treasury Stephen Timms attended for the UK. When John met Stephen Timms after that meeting,  Timms told him that the UK’s previous resistance to the tax had been misplaced – and the UK was now on board.

Now, you might think that Timms’s reversal of long-standing HM Treasury policy was probably the result of prodding from Downing Street, and you’d probably be right.  But that’s not at odds with the proposition that Brown’s reversal is primarily because he’s become persuaded of the idea’s merits and feasibility. After all, Brown has more form on global Marshall Plan ideas than most: whatever reservations people have about his International Finance Facility (and I have a few), you can’t doubt the seriousness of his personal commitment to the idea.

As to the style of the announcement (of which Chris Giles justly observes, “just imagine if Tony Blair had arrived uninvited when Gordon Brown was chairing a G7 finance ministers’ meeting and upstaged the agenda by talking about things that had been kicked into the long grass. Brown would have exploded”): well, since when did Gordon Brown ever unveil radical new global proposals in a consultative way?

So what happens now? Brown’s starting point in his G20 speech was that financial regulation of this kind “cannot be successfully achieved other than at a global level” – which doesn’t seem to augur too well for further progress, given Geithner’s adamant opposition.

But if War on Want are any indicator (and they probably are), the NGOs aren’t giving up just yet. John Hilary insists that the idea of a currency transaction tax is entirely feasible on a unilateral basis. The unilateralism would apply not to all currencies in some jurisdictions, he continues, but to some currencies in all jurisdictions – as, he says, the implementation of the tax would simply be administered through the two main settlement systems, SWIFT and CLS.

Applying a Tobin tax just to Sterling and the Euro could still have a significant revenue-raising capacity, according to a United Nations University report commissioned by War on Want, which found that a 5 basis point tax could raise US $5bn a year on Sterling and US $12bn a year on the Euro (see page 13 of the report).

Of course, as the FT’s Lex column observes, James Tobin never intended his tax to be a revenue-raising measure: he wanted it to “throw sand in the wheels” of short-term speculation.  But with appalling public sector finances in most OECD countries spelling t-r-o-u-b-l-e for future aid flows – not to mention climate finance - there’s a good deal to be said for looking for ways of raising revenue internationally, rather than relying on national governments to live up to pledges that are by their nature unenforceable.

Admittedly, with the US absent, you’d probably be unwise to hold your breath for Europe to push ahead on its own. And a lot more analytical work is needed to explore the effects that a unilateral tax would have on global financial markets (if it resulted in financial centres departing Europe en masse in favour of the US and Asia – or offshore centres, for that matter - is that a good outcome?)

But these are questions for another day.  For now, I’ll just doff my hat to the NGOs – and particularly War on Want – for an impressive and unexpected policy win.  It just goes to show: there’s absolutely nothing to say that NGOs have to sheer away from complex policy areas in favour of motherhood and apple pie bromides.

- In the London Review of Books, David Bromwich explores President Obama’s tendency toward the conciliatory gesture and major pronouncement, assessing the consequences for delivering meaningful outcomes. “[H]is pattern has been the grand exordium delivered at centre stage”, Bromwich argues, “followed by months of silence”.  Writing in the WSJ, meanwhile, Bret Stephens offers a critical perspective on the President’s commitment to human rights.

- Elsewhere, Dani Rodrik rails against those raising the spectre of protectionism, suggesting that “the world economy remains as open as it was before the crisis struck” and that the “international trade regime has passed its greatest test since the Great Depression with flying colours”. The Economist, meanwhile, provides an analysis of the falling dollar, while Jean Pisani-Ferry and Adam Posen assess the limitations of the Euro as an alternate global currency.

- Finally, behind the scenes of the financial crisis, and based on in-depth interviews throughout, Todd Purdum chronicles Hank Paulson’s time in office. Reuters has an extract from Andrew Ross Sorkin’s new book offering another take on the former US Treasury Secretary’s actions during the crisis. Daniel Yergin, meanwhile, examines the importance of finding a narrative for the crisis – crucial, he suggests, not only in understanding what happened but also offering a “framework for organising thinking for the future”.

We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies’ exchange rates and promote a diversified and rational international reserve currency system.

This is the latest in a series of such statements from China, building on Wen Jiabao saying he was “worried” about China’s stash of US T-bills in March, central bank governor Zhou Xiaochuan‘s essay on reform of the international monetary system a couple of weeks later, and then China’s $120bn contribution to an Asian emergency currency pool in May – potentially an important step towards an “Asian IMF”.

So if / when the dollar does lose its perch as the world’s reserve currency – something that isn’t likely to happen in the short term, admittedly – then what are the candidates to replace it?

One possibility is the Euro. Europe’s monetary policy has been much more conservative than America’s since the credit crunch kicked off, with the result that budget deficits are under tighter control. But on the other hand, China worries that Europe’s future is hallmarked by low-growth sclerosis and inability to compete.  Another problem: markets for Euros are comparitively illiquid.

A second scenario is the Yuan. As Business Week noted back in May, China has already been quietly doing currency swaps (providing yuan to other central banks for trade with China) with economies including Argentina, Hong Kong, Indonesia, Malaysia, South Korea and others – in the process taking the dollar out of the equation, theoretically at least. Agreements like this were worth $95 billion in 2008 (not counting another mega-swap with Brazil, the amount of which wasn’t disclosed); that’s nearly a third of the value of trade between the US and China.

Although the yuan faces a hurdle in the absence of a serious market for yuan-denominated bonds, this looks potentially set to drop. While yuan-denominated bonds are so far only sold by Chinese banks and multilateral institutions like the Asian Development Bank, HSBC has now announced that it will start to sell these bonds in China too. 

The really big question, though, revolves around the fact that the yuan is not fully convertible with other currencies – which makes other central banks hesitant to hold it in large amounts. But moves in the last few months have started to convince observers that this change could be on the way: the Petersen Institute’s Nicholas Lardy is quoted as saying that  the yuan could become convertible within “two or three years”.

That said, it’s important to remember that such a change would represent a major break with China’s current policy of managing its exchange rate to keep its exports competitive (and disallowing its citizens from taking yuan out of the country) – and force China to let go of a big plank of its current protectionist posture. Historically, of course, that’s just what economies tend to do when they become ‘top nation’ – but that’s a way off yet for China.

A third possibility: a super-sovereign reserve currency, i.e. one that isn’t just issued by one country.  As I noted in a post in March, that was of course exactly what John Maynard Kenyes proposed (and the US vetoed) at Bretton Woods when he mooted the idea of the ‘bancor’ – an international currency for clearing trade balances, that would at the same time work in such a way as to prevent up dangerous trade imbalances (like the one that exists now between the US and China). While that precise idea hasn’t been remooted by China, it’s not a million miles from the proposal on Special Drawing Rights made by Zhou Xiaochuan in March, in that both are valued according to baskets of currencies and/or goods.

Another idea for a super-sovereign currency is to make carbon part of the basket (or just to use carbon permits as currency in themselves). While emissions trading markets are as yet in their infancy, the long term prospect is for a singe, global cap-and-trade market and a global system of binding targets for all countries. In such a set-up, carbon permits would become one of the key scarce resources in the world – and on the basis that it makes sense for economic systems to focus on the scarce resource whose use they seek to minimise (see e.g. Richard Douthwaite on this), the long-term role of carbon permits in the global economy is a big unexplored area.

Finally, of course, there’s gold. Until the US came off the gold standard in 1971, gold was effectively the world’s reserve currency – and it remains the most obvious alternative to fiat currencies (money which is money simply because a government says it is, and people believe them).  Today, of course, it’s gold that’s priced in dollars ($913 for a troy ounce, since you ask), rather than vice versa, and it’s hard to find many politicians around the world who would argue for a return to the gold standard (although Mahathir Mohamad used to call for a gold-based currency for Muslim countries).

Still, if fears about the US’s yawning budget deficit and / or the risk of a protracted global slump intensify, then gold may be the most obvious switch.  Gold dealers are certainly benefiting from that perception, at any rate: today, as has been the case on and off for some weeks now, the front page of my Financial Times has a large advert for a company called Ascent Gold. Their strapline: “the new global payment unit”.

Back in March, I flagged up the significance of a proposal from Zhou Xiaochuan, China’s central bank governor, for the dollar to be replaced as the world’s reserve currency with a new, more multilateral system based on Special Drawing Rights – and noted that his proposal harked back explicitly to discussions at the Bretton Woods summit in 1944.

As Ngaire Woods points out over at the GEG blog, this is just one component of a Chinese strategy for pursuing power shift in the international monetary order.  Another is the increasingly emphatic Chinese tone on the need for IMF reform – with Wen Jiabao making clear back in March that much-needed additional Chinese contributions to the IMF would be contingent on more voice for developing countries.

Now, another important plank of their reform drive has been unveiled: a new $120 billion emergency currency pool based on the existing Chiang Mai initiative.  Details according to the WSJ:

The initiative aims to create a network of bilateral currency-swap arrangements among Asean and the three East Asian countries. Asean includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam.

Japan, South Korea and China will provide 80% of the $120 billion currency pool and Asean members the remaining 20%. Japan will contribute $38.4 billion, while China, including Hong Kong, will also offer $38.4 billion. South Korea will provide $19.2 billion. Under terms of the program, smaller Asian economies will be able to borrow larger amounts in proportion to their contributions than the more-developed economies.

As Ngaire observes, proposals in the late 1990s for a new Asian Monetary Fund were publicly torpedoed by the US, but it’s the bilateral swap arrangements that Asian nations started to agree then that have grown into the initiative announced yesterday.  And, she stresses,

It is worth highlighting that while China is politely offering something to the IMF (it announced a contribution of $40 billion), it has just announced an almost equivalent contribution ($38.4 billion) to the Asian pool.

All this creates useful independence from the IMF, she continues:

…the ASEAN+3 countries have created for themselves an alternative to borrowing from the IMF. Their arrangements actually use the IMF as a monitor, but crucially guard control (within the region) over their shared reserves. It has emerged in no small part because countries in the region see the IMF as a useful but American instrument of economic coordination.

Like Zhou, Yu is explicit on Chinese worries about the potential erosion of the value of their rather large stash of US dollars – $1,200 billion of T-bills alone.  “Most of Mr Obama’s stimulus spending is devoted to social programmes rather than growth promotion,” he notes, “which may exacerbate America’s over-consumption problem and delay sustainable recovery”.

What’s more, he continues, that could in turn end up doing exactly what Tim Geither was worried about in the wake of Zhou’s essay: an erosion of the dollar’s role as reserve currency.  Here, interestingly, there’s what looks like a signal of preparedness to moderate the position set out in Zhou’s essay. Yu says explicitly that,

No other international monetary system offers a viable alternative. However, we can make the main reserve currency power more accountable by creating an instrument to help manage the global crisis.

Admittedly, Yu is an academic and not a member of the government.  But it’s very hard to imagine that a senior Chinese professor would directly contradict his government’s position, on such an acutely political issue, in a time of such severe risks, in the FT, the day before the G20 summit, without clearance.  At the same time, using this approach avoids losing face for Zhou – and may signal a willingness to talk, rather than a definite climbdown.

So what does Yu propose as an alternative way of safeguarding China’s assets, if not reform of the dollar’s reserve currency role?

The basic idea is to turn Asian savings, China’s in particular, into real business investments rather than let them be used to support US over-consumption are vulnerable to any fall in the value of the dollar, equity claims on sound corporations and infrastructure projects are at less risk from a currency default.

See the article for full details on how this would work – significantly, Yu says that the US government would need to act as guarantor, “providing a sovereign guarantee scheme to assure the investment principal of the crisis relief facility against possible default of targeted companies or projects”. His conclusion:

The crisis relief facility would lessen Asians’ concern about implicit default of sovereign debts caused by a collapsing dollar. It would cost little and help the US by channelling funds to business investment. Conventional Keynesian policies – fiscal and monetary expansion on a national basis – cannot solve the problem but will make it worse.

Martin Wolf shares some of the concern set out in the last sentence, albeit from a slightly different standpoint.  His big concern about the current tenor of discussion on fiscal stimuli is that

…next to no adjustment in underlying structural imbalances is occurring. In particular, the non-fiscal sectors of the three big surplus countries [China, Japan and Germany] are expected to continue to run huge surpluses. The change – temporary, the surplus countries surely hope – is that domestic fiscal expansion is modestly offsetting the decline in demand coming from deficit countries with over-leveraged private sectors. But that decline in private demand is also offset by massive fiscal boosts in deficit countries.

This is not a path towards a durable exit from the crisis. It is a path on which the fiscal deficits needed to offset persistent current account deficits, and collapsing private spending in external deficit countries, continue indefinitely. Unless and until surplus countries recognise that this cannot continue, no durable escape from the crisis will be achieved. Understandably, but foolishly, they are unwilling to do so.

Wolf concludes that while part of the answer is about changing the policies of surplus countries, it’s also at least as much about “rethinking the international monetary system”; in this light, he sees Zhou’s paper as “fascinating”.

As David noted in his excellent speech on international reform at the start of the year, the issue of current global economic imbalances is right at the core of the current turmoil.  Why Zhou’s paper is so significant, I think, is that in referencing Keynes’s idea of the ‘bancor’ as a new reserve currency, he’s nodding towards a system with built-in homeostasis: global imbalances would automatically be prevented from building up, through incentives inherent to the system.  This is exactly the kind of comprehensive shared operating system we ought to be thinking about – yet there are real questions about whether the current multilateral summit system has the bandwidth to handle such far-reaching proposals, even if the political will were there.

Yu’s proposed approach would probably be more acceptable to the US in the short term.  But on the other hand, it’s not yet clear to me that it would be as effective as a way of preventing global imbalances from building up again in the future.  Whatever happens tomorrow, it’s important that policymakers don’t lose track of where we need to be headed in the longer term – and think seriously about equipping their decision-making processes with the capacity to think further ahead.

Now, though, things are getting more interesting.  Two days ago, Zhou Xiaochuan – the governor of China’s central bank – quietly published a paper on the People’s Bank of China website, entitled Reform the International Monetary System.  It opened like this:

The outbreak of the current crisis and its spillover in the world have confronted us with a long-existing but still unanswered question, i.e., what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF?

Later, Zhou continues that:

The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.

Now this line of thinking really does take us straight back to Bretton Woods – and in particular to Keynes’s proposal for a new global currency called the bancor, and a new global institution called the International Clearing Union (ICU).

What Keynes proposed was for the ICU to be a kind of global bank, designed to regulate trade between nations, and in particular to prevent the build-up of dangerous trade imbalances in the global economy (sound familiar?).  Under his plan, all international trade would be denominated using bancors as the currency – the value of which would be fixed against a range of other commodities, including gold. Exports would add bancors to a country’s account at the ICU, while imports would do the opposite.

Crucially, incentives would then be applied to encourage countries to keep their ICU balance as close to zero as possible: run too high a surplus, and the ICU would take a cut of your money and put it into a reserve fund – giving you an incentive to spend your surplus on other countries’ exports, bringing the system back towards balance.  As author Michael Rowbotham observes,

The efforts of debtor nations to promote exports was intended to coincide with the efforts of creditor nations to expend their otherwise worthless Bancor surplus. These charges were intended not so much as a deterrent or punishment, but as a benign ‘feedback’ mechanism, ensuring that, over time, trade remained in balance.

In the event, Keynes’s proposal was overruled by Harry Dexter White, the head of the US delegation at Bretton Woods – one of the key moments in the global power-shift from the UK to the US. Instead of an ICU, the world got an IMF; and it was the dollar, not the bancor, that became the de facto reserve currency.  Many countries fixed their exchange rates to the US dollar; and the US, for its part, fixed the dollar to gold at $35 an ounce – a system that remained in place until 1971, when Nixon removed the dollar from the gold standard.

Zhou Xiaochuan’s essay is well aware of all this, and indeed explicitly regrets that Keynes’s approach did not carry the day at Bretton Woods:

Though the super-sovereign reserve currency has long since been proposed, yet no substantive progress has been achieved to date. Back in the 1940s, Keynes had already proposed to introduce an international currency unit named “Bancor”, based on the value of 30 representative commodities. Unfortunately, the proposal was not accepted. The collapse of the Bretton Woods system, which was based on the White approach, indicates that the Keynesian approach may have been more farsighted.

Most media coverage of Zhou’s essay starts from the perception that China is worried about the safety of its enormous stash of dollar holdings, particularly given the risk that US recovery plans may lead to significant inflation – and hence erosion in the value of its dollars.  As the Wall Street Journal put it,

Chinese officials are frustrated at their financial dependence on the U.S., with Premier Wen Jiabao this month publicly expressing “worries” over China’s significant holdings of U.S. government bonds. The size of those holdings means the value of the national rainy-day fund is mainly driven by factors China has little control over, such as fluctuations in the value of the dollar and changes in U.S. economic policies.

But in the background, there’s also the issue that the by issuing the world’s reserve currency, the US occupies a highly advantageous position – being, in effect, subsidised by everyone else.  With fundamental commodities like oil denominated in dollars, other nations must export products to the US in order to gather the dollars they need to buy oil: a windfall for the US economy, which can cheerfully issue debt and manage ever larger trade and fiscal imbalances, while simultaneously maintaining the dollar’s purchasing power. 

Source: WSJ

If, on the other hand, the world moved over to a multilateral reserve currency – based, perhaps, around a reformed version of Special Drawing Rights (as Zhou suggests) – then the US would forfeit this privilege.  So if Bretton Woods 1 was in some ways a negotiation on the transfer of power from UK to US, then an end to the dollar’s status as global reserve currency would certainly represent a transfer of power away from the US and towards the multilateral level.  (Time magazine’s Justin Fox argues that this ending the current set-up would be in the US’s long term interests anyway: as he observes, “running big deficits and spending more than you earn aren’t really great long-term economic strategies”.)

In practice, as Zhou recognises, this is a very long term agenda – certainly much further off than the London Summit.  Nonetheless, it does mark a significant evolution in the debate.  Until now, China has been notably reluctant to talk turkey about what it really wants from multilateralism, preferring instead to stick to the comfortable but largely content-free language of its a ‘peaceful rise’.  Zhou’s essay, on the other hand, moves a significant step closer to talking turkey on new rules for the global economy.