May 15, 2009 Friday

'American gold' losing its lustre

By Victor Zhikai Gao

IN CHINA, many people refer to the dollar as mei jin, or 'American gold'. So if a Chinese person tells you that he owes you 100 American gold, don't expect a big fortune, because he's planning to pay you US$100 (S$150).

Chinese impressions of the American dollar as the gold standard were so deeply entrenched that they survived President Richard Nixon's 1971 delinking of gold and the greenback. Around 30 years ago, China's foreign exchange reserves were as little as US$167 million. At one important meeting in the late 1970s, Deng Xiaoping prophesied to an audience of top government officials: 'Comrades, just imagine! One day we may have a foreign reserve as big as US$10 billion!' Silence fell on the audience, because that figure seemed so improbable. After a long pause, Deng went on to tell the unconvinced crowd: 'Comrades, just imagine! With 10 billion American gold, how much China can do!'

Deng's view of the dollar reflected his admiration for many elements of American capitalism. In November 1986, I served as his interpreter when he met Mr John Phelan, then chairman of the New York Stock Exchange, who was visiting Beijing. During the meeting, Deng told him: 'You are the rich capitalists with great wealth, and China is still very poor with little wealth. You know finance and capital markets very well. You need to teach China a lot about finance and capital markets. One day in the future, China will also have its own stock exchange.'

That was the prelude to China's rapid economic growth. China's foreign reserves are now close to US$2 trillion, with US$1.5 trillion invested in dollar assets. The attention of the world often focuses on this huge pile of US dollars in Chinese hands.

What many don't remember is that for years, there was either a shortage or a feared shortage of American dollars. In the 1980s, for example, the government required everyone to convert dollars into the Chinese currency, the yuan or renminbi, which literally means 'people's money'. As a result, 'American gold' became a status symbol. Despite the mandatory conversion, many people held onto their dollars, or bought them at inflated exchange rates, if they could find a seller at all.

No one knows for sure when the tide started to turn, or the exact moment when American gold started its slow but seemingly irreversible loss of lustre. But now, many shops in China no longer accept dollar-based credit cards issued by foreign banks (the customer pays in dollars, but the shopkeeper is paid in yuan) and foreigners cannot convert US dollars into yuan beyond a given quota.

In the past, people held dollars for no immediate purpose. Today, they are more likely to keep them only if they need them to send their children abroad for school, travel or to do business. Overall, the government is becoming more worried about the safety of its investments in the US, which are largely in Treasury bonds and quasi-sovereign securities issued by Fannie Mae and Freddie Mac.

Beijing recently called for a greater role in international trade for the International Monetary Fund's (IMF) special drawing rights currency. But China is also fully aware that the US can veto an IMF decision. China's call was more meant to sound an alarm to the US.

Many Chinese people increasingly fear the rapid erosion of the American dollar. The US may want to consider offering inflation-protection measures for China's existing investments in America, and offer additional security or collateral for its continued investments. America should also provide its largest creditor with greater transparency and information.

The Chinese still call the dollar American gold. But the US should not assume that this will never change.

The writer is an executive director of the Beijing Private Equity Association and a director of the China National Association of International Studies.