Dollar crisis looms, China ponders reform: Mundell

Tue Jun 3, 2008 8:23am EDT

A vendor counts yuan notes at a market in Beijing November 23, 2007. REUTERS/Claro Cortes IV

A vendor counts yuan notes at a market in Beijing November 23, 2007.

Credit: Reuters/Claro Cortes IV

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VALENCIA, Spain (Reuters) - A major dollar crisis could come within five years and China is discussing reforms to the global monetary system to protect its $1.6 trillion reserves pile, says Nobel Prize-winning economist Robert Mundell.

Mundell, who has regular contacts with Beijing officials, said they are considering proposing ways to to fix major currencies including the dollar and the euro, in a system similar to the one which operated under the Bretton Woods agreement from the end of World War Two until the 1970s.

"There's no doubt about it that inside the Chinese government there's a lot of discussion going on. I'm not sure how they're doing it but I know they're going to get an input from me," Mundell told Reuters in an interview.

Without reform, the global monetary system is headed for a dollar crisis within years, Mundell believes.

However, he thinks the United States will avoid a technical recession during the current downturn and that the weak dollar will help it to make a recovery around autumn of this year.

But its growing liabilities accumulated by its current account deficit means that it will eventually pay a high price if the current monetary set-up continues, he said.

"I see the problem coming maybe in the next recession," he said.

"There could be a real dollar crisis in five years."

CHINESE CONCERNS

China is worried about its pile of about $1.6 trillion in foreign reserves, built up during years of U.S. trade deficits, which loses value as the greenback depreciates.

"What you need to have is an International Monetary Fund that's going to take some of these excess dollars, put them into a substitution account inside the IMF or some other institution and then use that and create what is a new international currency," said Mundell.

"This kind of proposal would be very acceptable inside China. The Chinese are thinking in terms of this," he said.

Mundell, awarded the Nobel Prize for Economics in 1999 for his work on exchange rates and optimum currency areas, travels regularly to China, where he has advised senior government officials.

For years, China has come under pressure from U.S. and European authorities to allow its currency, the yuan, to appreciate, in order to make Western goods more competitive. But Beijing has resisted.

"They don't have many pre-conceptions. They don't have a belief obviously that floating is a good idea, whereas the European Central Bank and the Americans think that floating is the best of all possible worlds," Mundell said.

Fixing exchange rates would favor the euro zone, which is now battling with a euro at around record highs against the dollar, said Mundell, who has often been referred to as one of the intellectual fathers of the single European currency.

"I think the risk now is that the high euro is going to build in pressure which is going to involve deflationary pressure in the asset markets, housing and so on, and that's going to cause a problem, a nagging problem, that's going to go on for a long time as long as the euro is as high as this," he said.

"The swings in the dollar-euro exchange rate are big problems, and the problem is exacerbated by the fact that the Americans get the benefit of these swings and Europe gets the wrong end of the stick."

But Western policy makers, particularly in the United States which receives an economic stimulus from a weak dollar, would be reluctant to accept monetary change, Mundell said.

"The U.S. Bush administration isn't much interested in it, they're quite happy with the dollar the way it's working, and the Europeans are really behind the zone on this. Nobody in Europe is thinking about international monetary reform and Europe would be a major beneficiary of it."

"Bernanke and Trichet are very much behind the curve on this," he said, referring to Federal Reserve chief Ben Bernanke and ECB head Jean-Claude Trichet.

(Reporting by Jason Webb; editing by Keith Weir)

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