The writer is a lawyer by training who deals with and is involved in technology. Manager of a cryptocurrency investment fund, and lives in Silicon Valley. Author of the book “A Brief History of Money” and the KanAmerica.Com podcast recorder
In recent months, we have been repeatedly informed about international trade agreements that will be executed in the Chinese currency, the yuan. For the most part, China was a party to the deal, whether it was a gas deal with the United Arab Emirates, a trade deal with Brazil, or an oil and gas deal with Russia. In March, the Kremlin even stated: “We will support the use of the Chinese yuan as a currency in transactions between Russia and our partners in Asia, Africa and Latin America.” The accumulation of these announcements about the yuan becoming an international currency has led many commentators to write about the near end of the dollar, but headlines and reality, at least for now.
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As of today and according to the publications of the International Monetary Fund, a little more than 40% of international payments in the SWIFT system, the main conduit for international financial transactions, are in dollars. It is followed by the euro, with almost 40% of the payments (mainly in intra-European trade), the remaining 20% was divided among others by the pound sterling, the Japanese yen, and the Australian dollar. The Chinese yuan accounts for about 2.5% of transfers only – far behind the euro and the dollar.
But the dominance of the American currency is not only expressed in Swift transfers. About 50% of international loans are denominated in dollars, and about 59% of the foreign exchange balances of the world’s central banks are also held in it.
What is an international reserve currency?
As early as 5,000 years ago, humans were engaged in international trade. The ancient inhabitants of Mesopotamia enjoyed an abundance of agricultural produce, but suffered from a lack of raw materials. To compensate for this, they purchased what they lacked from around the Middle East, but for this they needed a single currency that they all prepared The parties exchange for the goods. At the base of the entire system was the belief of the participants that the currency they received could be passed on to future buyers and sellers. Without this belief, no party was willing to accept the “money” as a substitute for hard and real goods.
Over the years, the gold and silver metals became a currency used by individuals and entities that traded in them and became, as the saying goes, “money goes to the merchant”. The physical properties of these metals were critical, especially their durability, relatively light weight and being divisible, but no less important than all of these was the fact that they were relatively rare. This use of gold and silver continued almost unchanged for thousands of years, during which the paper currency – the banknote – also entered the picture.
But then came the First World War. From the outbreak of the war in 1914, the European powers were required to print many banknotes to finance the war, and all stopped the right to convert banknotes into gold. But this was not the only upheaval at that time. From the 19th century until then, the British Empire was the dominant world power and the pound sterling was the currency that captured 60% of international trade. Together with the British military power and the colonies around the world, the London capital market became the significant financial center in Golubs. But after the First World War and following the separation from gold, the pound weakened and the USA – which left the dollar pegged to gold and suffered less war damage – became a world financial center.
At the end of the Second World War, a new international monetary regime was introduced, known as “Bretton Woods”. He determined that all world currencies would be pegged to the dollar at a fixed exchange rate, and the dollar was pegged to gold at a price of 35 dollars per ounce. The US undertook to convert the dollars into gold for other countries at their request and the dollar officially inherited the title of “international trade currency” from the pound.
The President of Russia, Vladimir Putin, in a meeting with the President of China / Photo: Associated Press, Pavel Byrkin, Sputnik
What makes a currency globally tradable?
The need for an agreed global currency is at least as necessary as the existence of reliable national money in the local financial system. If an importer in Nigeria wants to buy televisions from a manufacturer in Korea, or a Turkish dealer is interested in cars from Japan, both parties need a reliable currency to be able to roll on. In fact, the status of the US dollar stems above all from its network effect, that is, a vast user community that gives it the status of “pass to merchant” on the stage of the entire global economy.
This trust in the dollar stems from many reasons, among others its free capital movements, the large dimensions of the capital market traded through it, which makes it possible to make it useful for investment and not just commercial purposes, and the power of the country that stands behind it – the United States, the largest economy in the world and a military and industrial empire. All the reasons These, and many other reasons, created a huge international network of connections of the dollar, both at the level of the individual and at the level of the institutions. Thus, according to the International Monetary Fund, at the end of 2022, about 59% of the cash balances of central banks in the world are held in dollars.
Is America only benefiting from the status of the dollar?
It is widely believed that the status of the dollar as the world reserve currency is a huge profit for America, since it can print its debts without limit and raise international credit easily. Indeed, thanks to the globalization of the dollar, a strong and flourishing financial sector exists in the US, but this is a partial and very limited view, which ignores the heavy prices that America pays both in the domestic arena and in the international arena.
The status of the dollar (along with the Fed’s expansionary monetary policy) was a major factor in the outsourcing of the last few decades, the one that resulted in the export of America’s industrial base to the East. In the early 1960s, about 30% of the US economy was industry, as of today only about 11% remain.
This export was devastating to the working class and industrial people in the center of the US, this, together with the strengthening of the financial sector, dramatically increased the wealth gap in the country. This trend in turn led to severe social polarization and made a decisive contribution to the rise of populist politicians, such as Donald Trump. If not enough In these, the fact that the dollar is the world’s reserve currency also encouraged the growth of government debt. And as much as the federal government wanted these debts, the holders of the dollar reserves wanted to satisfy them. Thus, not only was a large, unnecessary and too cheap debt placed at the disposal of the federal government, the excess money encouraged waste , corruption and structural inefficiency in many sectors of the American economy.
The world currency status also burdened America with great weight on the international level. The US is forced, for example, to generate dollar liquidity for foreign markets, which makes it difficult for the central bank to maintain a monetary policy that puts the US at the center, and the Fed bears responsibility for the global economy. In these circumstances, it would not be surprising that back in 2016, the former chairman of the New York Fed, Bill Dudley, said: “America should not be too worried if additional currencies such as the euro and the yuan usurp the status of the dollar as the global reserve currency. Such a reality is not necessarily bad for America.”
What is missing in the yuan to become a global currency?
But the way for the yuan to replace the dollar is still long. Beyond the lack of the network effect (the reason why China is in the race for trade agreements with Russia and Brazil), the Chinese currency lacks two basic elements. The first is the lack of portability at its price. Unlike the dollar, the euro or the Japanese yen, the Chinese maintain close control over the exchange rate of the yuan and do not allow its price to move freely according to supply or demand. why? China is the largest exporter in the world, about 20% of the Chinese product is exported to other countries – which allows Beijing enough to import the natural resources it lacks, mainly energy.
An uncontrolled strengthening of the yuan will severely damage the competitiveness of Chinese exports and cause Beijing to lose increasing market shares to developing economies such as Vietnam and India. Therefore, already two years ago one of the heads of the Chinese central bank removed any shadow of doubt and clarified that “the current method of managing the exchange rate is the appropriate way for China at the moment, and in the foreseeable future”, and the yuan-dollar exchange rate remains the same as its price in 2007. Despite the progress in the Chinese economy. Furthermore, contrary to all logic, the yuan has weakened against the dollar by about 16% since the beginning of the century. To complement the tight control over the price of the yuan, since 2016 the Chinese government has maintained a regime of severe restrictions on capital movements out of China.
These restrictions, along with the blatant manipulation of the currency’s exchange rate, are a major obstacle to the development of a real international capital market in China – a necessary condition for a global trading currency. While the USA has a stock and bond market with a total value of about 86 trillion dollars, with about 40% of it held by foreigners, the Chinese capital market amounts to 31 trillion dollars, with up to 5% of it held by foreign investors (according to the Chinese authorities). Beijing also makes it difficult for foreign investors to purchase real estate or companies in the country, and if all of this is not enough, the centralized regime in China, combined with the structural weakness of the judicial system, also mean that any protection that apparently exists today for foreign investors can be reversed overnight, with the swing of a decision of a handful of people in Beijing.
What if the dollar is going to fall off the stage after all
The Chinese leadership is well aware of China’s medium-term structural weaknesses, and especially of its demographic problems. In less than twenty years, by 2040, about 28% of China’s population will pass the age of 60, and Beijing is trying to fortify its international and economic position for the day when the proportion of the productive population will be too small. But as things stand now, it is highly doubtful whether the yuan of centralized and unfree China will ever be able to replace the dollar as the world’s reserve currency. The global fiat system will continue on its current course even if the yuan is gnawed at the margins by the dollar’s status. Finally the American currency will come off center stage, in this decade or the next it will collapse on the tower of debt it built. And when that happens, it will not be the yuan that will replace it on the way to the next money system.
What then could be the currency of the next stage? Will gold return in some way? And what about Bitcoin? About that in the next article.
