November 24, 2010

China and Russia Abandon the Dollar

China and Russia are looking at avoiding the dollar.  In an interesting development the two countries announced an agreement regarding currencies used for bi-lateral trade. China Daily reports,
St. Petersburg, Russia - China and Russia have decided to renounce the US dollar and resort to using their own currencies for bilateral trade, Premier Wen Jiabao and his Russian counterpart Vladimir Putin announced late on Tuesday....

Pang Zhongying, who specializes in international politics at Renmin University of China, said the proposal is not challenging the dollar, but aimed at avoiding the risks the dollar represents.

Yuan exchange with Ruble 

This makes a lot of sense for China. Since the economic downturn the yuan has depreciated versus the rouble, making imports from Russia like oil cheaper.  Naturally since it continues to appreciate, at least modestly versus the US dollar it would mean buying the oil in US dollars would require first buying US dollars which have become more expensive.  

Yuan exchange with Dollar

So for China, getting the US dollar out of the equation would seem to make it easier to allow the yuan to appreciate against the dollar because the impact is limited to trade with the US, versus having it impact every transaction with every country.  Perhaps China has found a less painful way to allow the yuan to appreciate.  Ultimately this is a short term benefit, since as the yuan appreciates, it will not only do so against the US dollar.

That gives them some credibility internationally for not protecting their currency by pegging it to the US dollar and rather, allowing it to float freely.  China manages to get some respect on a global level for starting to play by the rules.  At the same time they protect their trade by minimizing the cost of purchasing goods.

What is less obvious is the benefit to Russia.  It could be as simple as being able to give the US a black eye in return for the drubbing it took to end the cold war.  Perhaps it is more about doing whatever it takes to make the sales to China it needs to make.  Winning over a growing international customer would certainly prove a boon to Russia's economy which has been less than robust since the fall of Soviet communism. Or there could be some intimidation from China.  Certainly China could be throwing around some of it's economic weight and pushing Russia into accepting the change which more supports China's goals than Russia's.

Notwithstanding, this is an interesting development in the sense that it isn't likely other countries will follow suit.  It seems more like a specific side deal suited to this situation.  However, if other countries start adopting similar side deals, it could create a ripple effect. Then as far as the US dollar as the world's reserve currency, all bets are off.

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