[Beats me that why the author only talked about China's reserve but not Japan's, which has 3 times more of US$ reserve than China. And BTW, many sources said that only 60-65% of China's reserve are US$ now]--"Commentary: China and the U.S. should spare the world a cliffhanger"
By Andy Mukherjee Bloomberg News
Monday, December 27, 2004
With the United States and China expected to clash over the fate of the dollar in 2005, it's only appropriate that the year should mark the 50th anniversary of the "chickie run," a fatal game that holds a mirror up to the trouble brewing between the world's largest economy and its biggest rival.
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The chickie run, or the "game of chicken" as it is known in academic research, was virtually invented by the 1955 Hollywood classic "Rebel Without a Cause," in which James Dean's character, Jim, and his adversary, a school hoodlum called Buzz, race each other to the edge of a cliff in stolen cars.
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The goal of chickie run, as the game is depicted in the film, is to avoid being the first to bail out - give up too late, and you die by falling off the cliff, a fate that befell Buzz; back out too early, and everyone calls you a "chicken."
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This game of adolescent dare tells us why, if both the United States and China refuse to budge from their current positions, there may not be an optimal rebalancing of a global economy in which Americans currently spend too much on Asian-made goods thanks to cheap money lent by Asian central banks.
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President George W. Bush's administration appears to be wedded to its strategy of a competitive devaluation in the dollar, mostly against undervalued Asian currencies and primarily against the Chinese yuan, in order to reduce the record-high current account deficit of about 6 percent of U.S. gross domestic product.
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China argues that a stronger yuan could make its exports uncompetitive, cause its rickety banking system to crumble under fresh bankruptcies and hurt the world by beggaring the Chinese producer just as a weaker dollar hurts the U.S. consumer.
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So much for disagreement. Now, comes the chickie run. If the United States is willing to race the world to the edge of a global recession only to nudge speculators to send a tidal wave of "hot money" to China, then Beijing also can retaliate by selling U.S. Treasuries from its $515 billion of foreign reserves, forcing American interest rates to rise quickly and prompting hot money to flow back to the United States. The net result: China avoids raising its currency from its pegged value of about 8.3 to the dollar.
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Both parties are pursuing high-risk strategies. The United States is betting that a weaker dollar alone would lead to less domestic consumption and more exports. The first may happen easily, the second may take time, presenting the world economy with a U.S. recession that no one wants.
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On the other hand, if People's Bank of China starts dumping Treasuries, other Asian central banks will rush to mimic it as no central banker would want to be caught holding a lot of debt denominated in a weak currency.
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As Asia switches to euro-denominated debt, the dollar could slip into a deep funk even with higher U.S. interest rates. Instead of being rerouted to the United States, speculative capital could come pouring into Asia, mainly China, at an even faster pace than at present, creating a deluge of money supply.
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In such a scenario, the only way to repel capital and control inflation may be a large, one-time appreciation in the yuan.
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Assuming that four-fifths of China's reserves are held in dollars, the Economist Intelligence Unit estimates that a 25 percent fall in the U.S. currency could result in a capital loss amounting to 6.5 percent of China's gross domestic product.
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The Chinese central bank would not be able to stomach the loss without the government picking up the tab by deficit financing, a move that would push up interest rates and that could cause a recession in China.
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What's the best way to play the chickie run? William Poundstone gives the answer in his 1992 book, "Prisoner's Dilemma." After considering the two equilibrium solutions suggested by John Nash, the Nobel Prize-winning Princeton University mathematician who was portrayed in "A Beautiful Mind," Poundstone concludes: "With an opponent you can't second-guess, you might be inclined to play it safe."
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In other words, it's better to be chicken than dead. From a social perspective, however, there's a better solution: Get an adult to break up the game.
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There's no world government. So the next best option is what the Oxford University economist Brad Setser calls an "Asian Plaza" accord, similar to the 1985 agreement drawn up at the Plaza Hotel in New York, whereby Japan, Germany, France and Britain agreed to let an overvalued dollar decline.
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Even the Morgan Stanley economist Andy Xie, who advocates the "Asia must fight back" strategy, is calling for a negotiated settlement with the United States, though he does not favor an appreciation in the yuan. According to Setser, substantial appreciation in Asian currencies would be the cornerstone of a new Plaza-style agreement.
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There is a scene in "Rebel" just before the start of the ill-fated race, when Jim and Buzz are sharing a cigarette, hiding their nervousness. Jim asks, "Why do we do this?" Buzz replies, "You got to do something, now don't you?"
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Buzz blew it. The United States and China can still walk away from the edge of the cliff, and no one will say "chicken."
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