China may willfully undermine dollar if trade tensions erupt: think tank

An escalation of trade spats between China and the U.S. would not only undermine the relationship between the two countries but disrupt commerce on a global scale, stated a paper from the Peterson Institute for International Studies.

In this scenario, the U.S. would enact protectionist measures against China and China would respond by building a trade bloc with exclusionary walls in Asia and by taking measures to undermine the role of the dollar as the world’s reserve currency.

Trade tensions between China and the U.S. are inevitable because of huge trade flow between the two countries, said the study. Nevertheless, some aspects of it are troubling.

The majority of trade complaints filed by China with the World Trade Organization (WTO) are against the U.S. and one-third of disputes filed by the U.S., since China joined the WTO, have been against China.

Since 2002, the U.S. has requested eight consultations with China, the most of any WTO member. Moreover, the U.S. has conducted 71 anti-dumping investigations against China, which is by far its most frequent target.

Recently, trade tensions have escalated on the macroeconomic front, with the U.S. stepping up rhetoric against China's undervalued currency and China firing back against the U.S. program of quantitative easing.

Whether these tensions are just growing pains or the foreshadowing of something far worse will depend on how the two countries behave down the road, stated the Peterson study.

On the macroeconomic front, adjustments -- in the form of U.S. consuming less and saving more, and China doing the opposite -- need to be cooperative and bold as both countries have only begun to take small and tentative steps.

For specific trade disputes, China and the U.S. need to accept WTO rulings that go against them and work within the WTO framework.

However, there are incipient signs that China-U.S. trade relations are growing increasingly hostile.

On the U.S. side, there have been talks among legislators of officially labeling China as a currency manipulator and slapping tariffs on its imports. Related to that is the current political focus on job creation and the government's plan of doubling exports in five years.

Furthermore, the U.S. continues to subsidize certain industries and has various Buy American provisions in place.

China has been forging more and more bilateral and regional trade agreements in Asia in recent years. Furthermore, it has promoted the use of the yuan for trade in Asia. At this point, though, it remains unclear if such moves are deliberate attempts to undermine the dollar.

In November, China agreed to allow the yuan to trade against the Russian ruble in order to promote the bilateral trade between China and Russia [and] facilitate the cross-border trade settlement of [the yuan].

Back in August, China struck a similar deal with Malaysia.

Furthermore, in 2009, China's central bank governor Zhou Xiaochuan suggested the creation of a new world currency based on the International Monetary Fund's (IMF) special drawing rights (SDRs) system.

Email Hao Li at hao.li@ibtimes.com