It was a wonderful drive home the other day. Spring has finally arrived. The trees are green again and the air warm. Windows down, volume up. I listen to podcasts when I’m in the car. Finance and politics, primarily. Suddenly a dark shadow settled over my carefree ride. It wasn’t a storm cloud. The shadow was cast over my mind. It was something the podcast host said:
The dollar is going to lose its reserve currency status! Because CHINA! Or something.
I really should switch to listening to music. This kind of talk grinds my gears. It’s sensationalist and it’s often presented by someone who has no idea what they’re talking about. Though it can be presented in a compelling manner:
The government has weaponized the U.S. dollar! China’s economy is going to overtake ours! OPEC countries are accepting yuan for oil! YUAN! The dollar is doomed! Currency hell is right around the corner!
Of course, there is never any context provided. No nuanced discussion of why the dollar is the reserve currency or what that entails. Just PANIC! Plenty of clicks and listens for the panic merchants in the media.
It reminds me of the other times this talking point has circulated:
The Economist, 2004:
(Repeat offender) The Economist, 2007:
The Financial Times, 2011:[i]
“Dedollarization” is the ominous term assigned to the theory the U.S. dollar will soon lose its reserve currency status. As you can see from the foregoing headlines, it is a talking point that gets tossed around every few years. Dedollarization discussions are long on emotion and short on nuance. There are a few inherent requirements for a currency to be crowned the global reserve currency. Mike Shedlock offers a cogent summary of the prerequisites for the yuan to dethrone the dollar:[iv]
- China must float the yuan
- End capital controls
- Respect property rights
- Have a bond market big enough
- Inspire global trust
- Be willing to have trade deficits
- Stop export mercantilism
- Have a currency market big enough
With all this yuan-replacing-the-dollar-as-the-reserve-currency talk, you may think China must have crossed a few boxes off this list lately.
Not even close.
They meet condition #8 – they do have a large currency market. But that’s it. They’re not even close on points #1 - #7.
Perhaps most important is point #1, which is closely tied to points #6 and #7. Most advanced economies use a floating exchange rate for their currencies. The dollar and the euro both float – their value is determined by supply and demand in the global marketplace. You may remember the headlines about Euro-Dollar parity a few months ago. Market forces led the Euro to depreciate relative to the dollar and we reached a fun moment where $1 = €1. Basically, a good time for Americans to vacation in Europe (stuff priced in Euros cost less dollars). That’s how floating currencies work.
The yuan does not float. It is pegged to a different currency. And that currency is… King Dollar. The People’s Bank of China buys dollars and sells yuan to artificially devalue the yuan and keep its value pegged to the US Dollar. That might sound foolish. Why devalue your own currency? Because it increases your domestic companies’ competitiveness in global markets. If the yuan is cheap relative to the dollar, people/firms paying with dollars (the U.S. and the rest of the world) find goods manufactured in China (priced in yuan), relatively less expensive. Hence “Made in China” sticker proliferation. China is the world’s largest exporter.[v] Now you know why. This presents an interesting question…
Does China want the yuan to be the global reserve currency?
If somehow the yuan did become the reserve currency, China must run a trade deficit (point #6). That is, the value of their imports must exceed the value of their exports. This is an inescapable, mathematic reality. Their domestic manufacturers would suffer, having lost the competitive edge of the artificially devalued yuan. And if China’s export sector suffers, its economy suffers. Exports are the Chinese economy.
You see articles like this from time to time:
Saudi Arabia Considers Accepting Yuan Instead of Dollars for Chinese Oil Sales – WSJ[vi]
China is Reportedly Taking the First Steps to Pay for Oil in Yuan Instead of Dollars This Year - CNBC[vii]
Petrodollar Dusk, Petroyuan Dawn: What Investors Need to Know - Forbes[viii]
Yes, yes. It sounds very scary. Especially to those who style themselves sophisticated and like to use words like “petrodollar” in conversations. Petroyuan! The inconvenient fact these articles always leave out is the yuan is pegged to the dollar. Saudi Arabia can accept as much yuan as it wants for oil, it will not impact the dollar’s reserve status. The value of the yuan remains tied to the dollar (by the Chinese government’s own doing). It’s a distinction without a difference. But it makes for great headlines!
For a historic perspective, Brent Donnelly compiled this chart using data from the Bank of International Settlements:[ix]
King Dollar is the King of Consistency. The yuan (CNY) has gained a marginal share of international transactions over the last decade or so, primarily at the expense of the euro (EUR) and the Japanese yen (JPY). The data also solidifies one of the simplest (and perhaps most effective) arguments against dedollarization… what on earth would replace USD? Which takes us back to point #6: who wants to run a trade deficit?
As far as point #2 (ending capital controls) and #3 (respecting property rights)… China? Yeah. Haha. Right. Call me when that happens. I’ll be watching my daughter ride her unicorn.
Bottom line: neither the yuan nor any other currency comes close to meeting the eight conditions required for reserve status. And it is questionable whether China even wants the reserve currency crown given they’d have to sacrifice their export-based economy to obtain it.
There are plenty of things to worry about. Don’t waste your time worrying about King Dollar. He’s not going anywhere anytime soon.
Sean Cawley CFP ®
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