You are looking at the mighty U.S. Dollar, the global reserve currency which is helping the U.S. maintain the largest military in the world and gives it unmatched power to impose sanctions on its enemies.
But, now two of the world’s most prominent analysts in economics believe that this might all be about to change. The reason for these bold predictions is that during his recent visit to Saudi-Arabia, China’s president, Xi-Jinping, presented a bold new plan that threatens the U.S. Dollar as the world’s dominant reserve currency.
(clip of Xi)
But, no worries, you don’t actually have to listen to that speech because, in this video, I will bring you completely up to speed about
China’s bold new plan to end Dollar dominance and whether or not these worries about the end of the Dollar are overblown.
Alright, to understand China’s plan, let’s start with it’s motive. In other words,
1 why does China want to end Dollar dominance?
The simple answer is that China’s is unhappy with how dominant the Dollar is because it gives it’s rival, the United States, two great advantages in their global rivalry.
The first advantage is that, by issuing the world’s reserve currency, the United States can sustainably spend much more than it earns internationally than it otherwise could. Economists typically refer to this advantage as the United States’ exorbitant privilege, a term that was coined by the French in the 1960s, when the Dollar was already the world’s reserve currency.
The United State’s exorbitant privilege primarily refers to the fact that the United States is pretty much the last country in the world that needs to worry about a currency crisis, such as the one experience by Lebanon and Sri-Lanka. You see, in each of these cases, the country ran out of Dollars that were needed for crucial imports. But, since the U.S. issues these Dollars itself, it can literally never run out of them. Because the demand for Dollars is so great internationally, the U.S. can spend much more than it otherwise could on, for example, military aid and military bases, which is obviously quite a big advantage compared to China.
But, that is not all.
The second major advantage that the Dollar gives the United States is that it allows it to hurt it’s enemies greatly by excluding them from the Dollar based international financial system. This prevents them from buying crucial imports or getting new loans. The U.S. can easily do this by forbidding any U.S. bank to do business with its enemies. And since most foreign banks heavily rely on U.S. Banks to facilitate Dollar transactions, this means that the U.S. was even able to force big Chinese banks to stop working with Russian banks. Of course, we know that China now trades more with Russia than ever. But, it had to do so via its smaller banks, for which it didn’t matter so much if they were excluded from the Dollar system.
Add to this that the U.S. and its allies froze a large chunk of Russia’s foreign currency reserves last year, and you can imagine that China is quite motivated to come up with a plan to end dollar dominance.
But, at this point you might ask, this should be simple, right?
China could just ask other countries to pay it in Renminbi, or any other currency? But, yeah, actually it’s not that simple. While China’s government is really powerful, forcing foreign companies and countries to accept Renminbi payments would be far too expensive. So, it will have to convince them by using the power of economics incentives for it’s
2 Bold New Plan to End Dollar Dominance
A plan that is, partially about encouraging the usage of multiple currencies, but mainly about making China’s currency, the Renminbi, a viable alternative to the mighty U.S. Dollar. So, how can China do this? Well, to convince people outside of China to accept Renminbi’s, China will need to make it more attractive for traders and countries outside of China to use the Renminbi and I believe that it can do so in three main ways.
First, it will need to make it easier to spend Renminbi’s internationally. Second, it needs to make it both more attractive to ****save**** in Renminbi denominated assets, and finally, it will need to make it easier for foreigners to ****obtain**** Renminbi’s by increasing the currencies liquidity.
Okay, for each of these categories, let’s use a scale of 1-10 to rate how the Dollar, the current Renminbi, and the planned future Renminbi score on these three categories, spend-ability, save-ability, and liquidity.
2a Spend-ability
The first category is spend-ability. Imagine that you are an exporter outside of the U.S. and China. Would you be willing to accept Dollars or Renminbi, rather than your own currency? For me this is not so hard to imagine, since I have essentially become a European exporter of services by running this YouTube channel. So, if you want to sponsor one of my videos, I do indeed accept both Dollars, and Euro’s. But, I will not accept payment in Renminbi.
Why? Well, even though, Euro’s are obviously easiest for me, I actually have to make some of my payments in Dollars. For example, when I worked with editors from South America and South Africa, both of them requested payment in Dollars rather than in their own local currencies. What’s more, I was able to open a Dollar denominated account at my local bank here in Europe, making it possible to receive Dollar payments directly and relatively cheaply.
And therefore, if we look at the data, it is not surprising that exporters outside the United States currently invoice between 70% to 80% of transactions in U.S. dollars, with Europe being a notable exception. And, given that a whopping 88% of transactions in foreign exchange markets involve the U.S. Dollar on at least one side of the trade, it also makes sense that it is the cheapest currency to exchange in and out of. On the other hand, the Renminbi is only the 8th most traded currency, and most people are moving through the Dollar system to convert their local currency into it.
So, when it comes to spend-ability, I’d give the U.S. Dollar an 8/10 and the Renminbi a score of 3/10.
At least, for now… because this is where China’s bold plan comes in. In his speech to the Gulf states, Xi promised full
Renminbi (RMB) settlement in oil and gas trade.
And, if the Gulf countries accept, they will join other major energy exporters such as Russia, Venezuela, and Iran, which already accept payments in Renminbi. This would make the Renminbi much more spendable, given that you can now spend it on oil.
What’s more, Xi promised the gulf countries to
deepen digital currency cooperation and advance the multiple-Central Bank Digital Currency Bridge project.
This will also greatly help in making the Renminbi easier to spend internationally. You see, when mr. Xi is talking about the multiple central bank digital currency bridge project, he is talking about re-routing core global payments from big, sanctionable private banks, to a group of four central banks that would rapidly expand, if it is up to China.
And, if China can pull that off, it could can be a pretty damn effective way to dodge U.S. sanctions in the future, while at the same time making the Renminbi more spendable on the global stage.
Of course, we don’t know how many countries will actually start using this system. But, the thing with spend-ability is that once some people accept a currency, it is immediately much more spendable for others, which might then also start accepting and so on. Economists call this a network effect.
And, while this is highly speculative, it could raise Renminbi spend-ability very fast indeed. Maybe even to a 7 or even 8 score if you follow the line of thinking of prominent financial analysists, like Credit Suisses Zoltan Poszar.
However, in my opinion, he didn’t sufficiently take into account the second category of what makes a currency internationally attractive:
2b Invest-ability
You see, once exporters like me get their hands on a currency, they might not want to spend or convert all of it right away. But, how attractive is it for people outside of China, or the U.S., to actually save their wealth in US Dollars or Renminbi?
Well, for a small fish like me, it’s actually really hard to keep my savings in Renminbi assets because European banks and brokers simply don’t offer access to financial markets in mainland China. For U.S. financial markets though, they do, when I checked, I could easily invest in U.S. financial markets. That is, if I wasn’t spending all my savings on making this channel better of course.
Anyway, Dollar based saving and investment opportunities are a lot more accessible for small exporters than Renminbi denominate opportunities. However, for the big exporters, it recently became possible to open Renminbi accounts with big banks in places like London and New York. Even more importantly, since 2009, Chinese asset markets have opened up to big investors, which in response have been pouring in money into China.
However, China still heavily restricts access to its financial markets for foreigners. And while that is somewhat annoying for big global companies, it is an absolute nightmare for a gigantic exporter like Saudi-Arabia. You see, Saudi-Arabia earns so much foreign currency by exporting oil, that it cannot possibly hope to spend it all. But, since it is so big, if it moves money into, and especially, out off the small portion of China’s markets that are available to them, it will actually move the markets when doing so. This means that the country can move up, and profit in, Chinese markets by investing there. But, it also will have to accept big losses if it wants to get it’s money out of the country quickly.
This is what made the Dollar so attractive to big exporters such as Saudi-Arabia and, indeed China. You see, U.S. markets are so deep that they can easily store these large money flows without significantly impacting the price of U.S. markets.
However, made the U.S. market quite a bit less attractive to countries like Saudi Arabia is that the U.S. decided to freeze the assets of several Russian investors as well as it’s central bank last year. At that point, many semi-friendly countries immediately started wondering, is our money really that save in the U.S.?
But, okay, while foreign investors seem reasonably well protected in China at the moment, they also worry that China can abruptly change the rules of the game if it sees fit or that it will impose economic sanctions of its own.
So, let’s get back to the scoring part. Given that it’s markets are super easily accessible, can take in tons of money, and are fairly safe, I’d give the U.S. Dollar a 7/10 for investability. On the other hand, while China’s markets have grown tremendously, they are still not as deep as those in the U.S. and would score a 6/10 if it wasn’t for all of these financial restrictions. But, with those still in place though, I’d currently give the Renminbi 3/10.
For now… because during his visit, Xi said that he wanted to
facilitate the entry into China’s capital market for Gulf Cooperation Council (GCC) companies.
In other words, he is proposing to open up China’s financial markets further for oil exporters, potentially increasing invest-ability in these countries from 3 to 5.
So, while China’s plan is a step in the right direction, it’s not quite so threatening yet. And, even though, on the surface, it seems that China could just simply open up it’s financial markets, it might not be so easy since China has recently again had to resort to heavy restrictions to prevent large flows of money leaving the country.
So, let’s see if it can make up for that in our final category of currency attractiveness.
2c Liquidity
Now, liquidity or obtainability is a bit of a tricky category. What I mean by it is that a country should be able to easily obtain a foreign currency without moving the price too much.
How can they do this?
Well, there are basically two strategies that countries are currently pursuing. On the one hand, there is the development strategy that Asian economies like South Korea, Japan, and indeed China followed. It involves promoting exports while heavily restricting imports. That way these countries were able to accumulate large quantities of Dollars, which they then saved in U.S. markets. On the other hand, there are countries like Pakistan, Sri-Lanka, and Turkey, which borrowed Dollars to fund their imports while forgetting to make their countries export sector particularly competitive.
And then, when the Dollar loans stopped, these countries got into a lot of trouble when they could no longer afford to buy crucial imports such as fuel and food.
But, you might wonder, couldn’t they just print their own currency to then buy Dollars on the markets, and use these buy food and fuel? Well, yes. But, as you can imagine, that would reduce the value of their own currencies quite quickly, making food and fuel more and more expensive, producing inflation, which the population typically doesn’t like.
After all, this is why Sri-Lankans rose up last year to throw out their leaders.