Pessimists say the Euro is finished, even though its value did not fall below $1.17 (its issue price) at any time during the recent troubles. It has remained robust in the face of challenges, most recently surviving the tempest around the island of Cyprus. Moreover, measured according to the goals set by Jean Monnet and other players of the Great Game who founded the EU, the deep purpose of the project—to keep the peace in Europe—has been realized.
The relative success of the eurozone at preserving peace illustrates that it is not fanciful or impractical to seek a closer monetary and financial partnership between China and the United States. The goals—economic progress and political stability—are the same.
Nations deeply in debt often seek to avoid true repayment by inflating and devaluing their currency, especially when the lenders are foreign. Were the United States to follow this shortsighted policy, it would injure not only its own interests, but also those of China’s and the rest of the world. Robert Mundell, a Nobel Prize-winning economist, recently said the U.S. Treasury Bill—a short-term financial document that is the physical entity by which America’s debt is made tangible—is the current form of the world’s money. Thus according to Mundell, there is already a joint financial instrument linking the fates of the United States and China.
When Chinese sovereign-wealth funds invest in oil-pipeline infrastructure in Canada, they sell U.S. treasuries for U.S. dollars, use the funds to buy Canadian dollars, and thus cover the costs of their Canadian investments. If the values of these treasury instruments fall, meaning the U.S. dollar no longer buys as many Canadian dollars as before, the investment projects may be stymied.
Such an outcome is in no one’s interest. There is only one true solution to current international distress: all the world is in serious need of new investment to bring about real growth in world income. The United States would be harmed if the bonds held in China were to lose purchasing power as a result of U.S. domestic inflation. In such a case, when China would cash in bonds in order to make U.S. investments, inflation would diminish the scale of a proposed project. This would in turn reduce the degree to which China’s entrepreneurs could help cure the slow growth rate in the United States.
Moreover, the special case of U.S. Treasury Bill money connecting China and the United State creates a kind of economic family, in which debt instruments are simple records of who owes what to whom. Angry chaos will result if the importer cheats by using devalued paper money to fraudulently pay off debt.
How might Treasury Bill money be stabilized? It needs a COLA (Cost of living adjustment clause)—a guarantee against inflation and devaluation. The COLA will be in the form of a promise that today’s purchasing power over some specific collection of internationally traded goods—a basket of standard commodities like wheat, corn, oil, gold and silver—be listed as always available in exchange for each $10,000 T-bill.
The standard T-bill also should be able to “buy” a specified basket of international currencies. The list of currencies would include a specific number of euros, pounds sterling and yen, for example.
Who would offer such a guarantee? Under present circumstances, a simple promise from the U.S. Treasury might be improved with a backup guarantee from the European Central Bank. Why would the ECB be willing to help? Because with the investment power provided by stable international money, Europe would benefit from future real investment projects undertaken by China. And China would be willing to spread its growth-boosting investment horizon more broadly in exchange for European guarantees of stability. Supporting U.S. Treasury obligations would be a wiser and safer use of the ECB’s lending power than giving more German money to Greece, Spain or Italy.
One technical objection may be put to rest: critics may say no entity is large enough to guarantee the entire $17 trillion dollar U.S. debt. But the entire debt need not be protected.
Each Treasury bond has its own serial number. Bills are short term, but holders “roll them over,” keeping money invested for the medium to long term by “trading in” mature bills for new. COLA guarantees must be designed to carry over into succeeding generations of new bills: but this is a trivial design issue. Financial “insurance policies” may be written by the ECB or even by individual private financial players on any basket of Treasury bonds, with the basket size ranging from one to any number of individual, serial-number-specified securities. The guarantee would apply to a stream of new bills, extending into the future to an agreed upon distant terminal date. Coverage would continue as long as protected investors continued to pay an ongoing “insurance premium.” Such a plan would not require U.S. Treasury cooperation, although it would benefit Americans by allowing devaluation or inflation, but with the costs of such maladministration absorbed by the insuring entities.
This “insure the debt” plan is not unprecedented. Credit-default swaps, whereby the buyer receives credit protection and the seller guarantees the creditworthiness, are a form of financial derivative already in use. Our plan is a close cousin. In any case, serious thought must be given to the strategies needed to protect the world’s investment cycle from the cataclysm that would follow from U.S. inflation and devaluation.
China’s surging national credit risk is worrisome, particularly in the context of rising global national credit risk and as a result of loose monetary policy and high debt levels in the West. Time is running out. If nations choose to adopt the idea of a monetary and financial partnership, in terms of a U.S. guarantee backed by the ECB, there may still be time. The idea will help China turn more paper into real investments, thus effectively triggering real growth in the West. This solution is a win-win: it allows the debt-ridden West to come out of recession more rapidly and China’s economy to grow more steadily.
Professor Tom Velk is director of North American Studies at McGill University. Olivia Gong is a research assistant at McGill University with experience in Chinese banking and finance.