The China Syndrome

Chinese financial authorities have carped about the dollar’s role as the sole world reserve currency, most recently at the G8 meeting of industrialized nations in L’Aguila, Italy. The world will rely on the greenback for international transactions for the foreseeable future. But China is already testing the waters in Latin America, where the country has started some yuan currency swaps with its key partners, Brazil and Argentina.
The implications are huge. The impact for now remains small.

“In May of 2009, they traded $22.6 million in local currencies,” said John Hernandez, managing director at the Bank of New York Mellon. “On trade of $1.6 billion, it is a small amount. But it is significant.”

China’s move into currency swap arrangements in Latin America and a few Asian countries is an effort “to hedge their dollar exposure,” said Henry Smyth, director of the Granville Cooper Gold Fund. China holds large amounts of its foreign reserves in U.S. government bonds and other financial instruments and is now trying to reduce the dependence on the shakier dollar.

China’s economic clout in Latin America continues to grow. China recently surpassed the United States as Brazil’s biggest trading partner; it is the second largest trade partner with Argentina, and Venezuela is now shipping 16 percent of its oil exports to China. Although it will take time to dislodge the dollar in trade, another sign of China’s growing influence are moves by Latin American banks to deal directly with Chinese financial institutions instead of handling currency transactions through U.S. banks.