Crack on US dollar hegemony is growing
The ambitious infrastructure plan of the US President Joe Biden was downsized, from the original $2.3 trillion to $1.7 trillion, which apparently is still not enough to gather support from the Republicans. Many American economists criticize that the Federal Reserve has run out of options after pouring money in the market and inflation hitting very high levels.
Meanwhile there are numerous data that suggest that the status of the US dollar as a reserve currency around the world is being weakened by the euro, Japan’s yen and China’s yuan. The deadly COVID-19 pandemic also intensified the decline of US dollar hegemony.
As indicated by the IMF, the share of euro reserves held by global central banks stood at 21 percent in the fourth quarter of 2020, the same level as six years before; while the share of US dollar dropped to 59 percent, the lowest level in 25 years.
International financial institutions are voting with their feet, alleging that the US is deceiving the world with its dollar and living a “rich and rich alone” life by devaluing its currency and borrowing without limit.
The unrestrained borrowing from the US government, together with Federal Reserve’s unlimited quantitative easing measures, have directly caused the irrational soaring prices of international commodities, especially copper, aluminum and iron ore among other commodities for which China has been the biggest buyer. However, the economic common sense tells us that the global economy has been hit by the coronavirus for over a year and the fundamentals simply do not support a cyclical commodity price boom.
The increasing cost of raw materials will only mount more pressure on the living standards of the low to middle-income classes in the world.
The rising price of commodities is a financial phenomenon caused by the excessive dollar stimulus but the impact on the real economy has already been evidenced in increasing manufacturing costs around the world.
On the other hand, the pandemic has caused a reduction on people’s income. With a slow recovery in consumption, manufacturers have lost bargaining advantages down the supply chain. Instead of shifting the cost pressure of rising commodity prices to consumers, they might have to bear the loss.
As the real economy is undermined by the hegemony of the US dollar, insightful politicians and businessmen from all over the world have started to discuss how to crack the hegemony of the US dollar.
China’s yuan has been a major “driving currency” that has boosted the growth of global economy over three decades. However, its share as a foreign exchange reserve in the world has just exceeded 2 percent. Cracking the monopoly of the US dollar cannot depend mainly on the Chinese yuan but its potential cannot be underestimated as it recorded the highest strategic growth in foreign exchange reserves in the 21st century, in addition to the Special Drawing Rights (SDR) from the IMF.
World economies are looking forward to a new global monetary order that is impartial and reflects supply and demand in the real economy. Only the US is still expecting to benefit from a currency war in the 21st century while the rest of the world is looking to make money a neutral instrument for trade, rather than relying on monetary signals to guide or dominate the economy.
The pandemic has accelerated this trend. The IMF decided to issue $650 billion SDR in April, to aid developing countries during financial crisis. The world is entering the post-COVID era with a high probability that certain countries may suffer currency crises similar to those in 1997 and 2011. This requires central banks around the world to fully support the IMF through monetary policy coordination to help stabilize global economic recovery.
The US will never give up the hegemonic system of the dollar easily and will block financial cooperation among countries through various means. World economies should firmly promote mutually beneficial opening-up of financial markets and enhance currency swap agreements between central banks. Through economic globalization, the dollar hegemony can be broken.
The article was compiled based on a commentary written by Xu Weihong, Chief Economist at Yongxing Securities. bizopinion@globaltimes.com.cn
The US dollar’s hegemony is looking fragile
The modernisation of China’s exchange-rate system could deal the currency a painful blow
The mighty US dollar continues to reign supreme in global markets. But the greenback’s dominance may well be more fragile than it appears, because expected future changes in China’s exchange-rate regime are likely to trigger a significant shift in the international monetary order.
For many reasons, the Chinese authorities will probably someday stop pegging the renminbi to a basket of currencies, and shift to a modern inflation-targeting regime under which they allow the exchange rate to fluctuate much more freely, especially against the dollar. When that happens, expect most of Asia to follow China. In due time, the dollar, currently the anchor currency for roughly two-thirds of world GDP, could lose nearly half its weight.
Considering how much the United States relies on the dollar’s special status – or what then-French Finance Minister Valéry Giscard d’Estaing famously called America’s “exorbitant privilege” – to fund massive public and private borrowing, the impact of such a shift could be significant. Given that the US has been aggressively using deficit financing to combat the economic ravages of COVID-19, the sustainability of its debt might be called into question.
The long-standing argument for a more flexible Chinese currency is that China is simply too big to let its economy dance to the US Federal Reserve’s tune, even if Chinese capital controls provide some measure of insulation. China’s GDP (measured at international prices) surpassed that of the US back in 2014 and is still growing far faster than the US and Europe, making the case for greater exchange-rate flexibility increasingly compelling.
A more recent argument is that the dollar’s centrality gives the US government too much access to global transactions information. This is also a major concern in Europe. In principle, dollar transactions could be cleared anywhere in the world, but US banks and clearing houses have a significant natural advantage, because they can be implicitly (or explicitly) backed by the Fed, which has unlimited capacity to issue currency in a crisis. In comparison, any dollar clearing house outside the US will always be more subject to crises of confidence – a problem with which even the eurozone has struggled.
Moreover, former US President Donald Trump’s policies to check China’s trade dominance are not going away anytime soon. This is one of the few issues on which Democrats and Republicans broadly agree, and there is little question that trade deglobalization undermines the dollar.
Chinese policymakers face many obstacles in trying to break away from the current renminbi peg. But, in characteristic style, they have slowly been laying the groundwork on many fronts. China has been gradually allowing foreign institutional investors to buy renminbi bonds, and in 2016, the International Monetary Fund added the renminbi to the basket of major currencies that determines the value of Special Drawing Rights (the IMF’s global reserve asset).
In addition, the People’s Bank of China is far ahead of other major central banks in developing a central-bank digital currency. Although currently purely for domestic use, the PBOC’s digital currency ultimately will facilitate the renminbi’s international use, especially in countries that gravitate toward China’s eventual currency bloc. This will give the Chinese government a window into digital renminbi users’ transactions, just as the current system gives the US a great deal of similar information.
Will other Asian countries indeed follow China? The US will certainly push hard to keep as many economies as possible orbiting around the dollar, but it will be an uphill battle. Just as the US eclipsed Britain at the end of the nineteenth century as the world’s largest trading country, China long ago surpassed America by the same measure.
True, Japan and India may go their own way. But if China makes the renminbi more flexible, they will likely at the very least give the currency a weight comparable to that of the dollar in their foreign-exchange reserves.
There are striking parallels between Asia’s close alignment with the dollar today and the situation in Europe in the 1960s and early 1970s. But that era ended with high inflation and the collapse of the post-war Bretton Woods system of fixed exchange rates. Most of Europe then recognized that intra-European trade was more important than trade with the US. This led to the emergence of a Deutsche Mark bloc that decades later morphed into the single currency, the euro.
This does not mean that the Chinese renminbi will become the global currency overnight. Transitions from one dominant currency to another can take a long time. During the two decades between World Wars I and II, for example, the new entrant, the dollar, had roughly the same weight in central-bank reserves as the British pound, which had been the dominant global currency for more than a century following the Napoleonic Wars in the early 1800s.
So, what is wrong with three world currencies – the euro, the renminbi, and the dollar – sharing the spotlight? Nothing, except that neither markets nor policymakers seem remotely prepared for such a transition. US government borrowing rates would almost certainly be affected, though the really big impact might fall on corporate borrowers, especially small and medium-size firms.
Today, it seems to be an article of faith among US policymakers and many economists that the world’s appetite for dollar debt is virtually insatiable. But a modernization of China’s exchange-rate arrangements could deal the dollar’s status a painful blow.
Why The Petro-Dollar Is A Myth, And The Petro-Yuan Mere Fantasy
China’s recent introduction of yuan-denominated oil futures has attracted some fairly extensive press commentary. Partly this is down to a habit of over-interpreting everything happening in China as just more evidence of their unstoppable rise to global superpower status, but it is also due to some profound misconceptions about the importance of oil as a commodity. It is widely thought, for example, that oil somehow underwrites the global financial system and guarantees the U.S. dollar’s hegemonic status.
Inevitably, stories about the toppling of the “Petro-dollar” and the long yearned for rise of an alternative reserve currency, one not dependent on the whims of a capricious political elite in Washington, have proliferated across the alter-net and on the state-backed media platforms of Russia and China.
But we should be clear: the Petro-dollar does not exist, and really hasn’t done in any meaningful way since the 1970s, therefore the “Petro-yuan” has no future. This is not to say that oil will never be traded in yuan, that is likely, but it is to say that trading oil in yuan will not suddenly transform the currency into the global reserve many claim is inevitable. [footnote] (It may be true that the Petro-yuan has no future, or that a change won’t be “sudden”, but this doesn’t prove that having oil trade in dollars isn’t still very important to the US)[/footnote]
Origins Of The Petro-Dollar
The myth of the Petro-dollar comes from efforts in the 1970s to prevent the U.S. suffering severe negative effects in its balance of payments from rising oil prices.[footnote](Couldn’t it be said that the cause of these deficits was also, in part, cold war military spending and the Vietnam war) [/footnote] Until the late 1960s the U.S. had been an oil-exporter, but by also being an oil consumer they had never sought to maximize the rent from oil production by driving prices upwards. OPEC countries, however, never had such qualms [footnote](To portray this as financial opportunism by OPEC ignores other factors, such as the US’s significantly increasing the price it charged for wheat and supporting their enemy – Israel). Whether you approve or disapproval, isn’t it simplistic or misleading to attribute oil price increases to the idea that “OPEC never had such qualms”.[/footnote] when the opportunity arose as the U.S. became an importer, happily restrained supply to drive prices, and their own national incomes, higher. The U.S. was worried about the resultant trade deficit caused by suddenly having to pay vast amounts for necessary imports, and so secured the agreement of Saudi Arabia to only trade oil in U.S. dollars, meaning the U.S. could pay for oil in their own currency. Saudi Arabia, for their part, accumulated huge reserves of U.S. dollars, investing some of them back into the U.S. economy.
The enormous lake of U.S. dollars this created augmented the role of the dollar as the global reserve currency, being a highly liquid, easily-exchanged claim on the products, services and investment potential generated by the U.S. economy. But this was merely one step in the rise of the greenback as the global reserve. The next step came when other economies–East Asia in particular–followed the lead of the oil producers and also built up huge reserves of U.S. dollars, all of which was made possible by the abandonment of the Bretton Woods fixed exchange rate system in the early 1970s. This practice helped to keep exchange rates for exporters low, and kept a lid on inflation in the U.S., which suited everyone up to a point.
Future Petro-Yuan?
Bringing this up to date, it was a long time ago when the link between oil and the dollar mattered much at all beyond the financial returns of non-dollar based oil companies. Since the 1980s, the dollar has been consolidated as the global reserve currency because of the strength and dynamism of the U.S. economy, and oil exporters have demanded to be paid in U.S. dollars because that’s the currency they prefer to hold on to. To do otherwise is to take on exchange risk. Exporters can, and routinely do, accept payment in whatever exchange medium they wish — tanks, planes and construction services — but their central banks demand dollars for reasons entirely unconnected to oil. Because the U.S. dollar is a hard currency, easily exchangeable, underwritten by the U.S. taxpayer, and founded upon decades of broadly consistent macro-economic policy management.
Those who believe that oil being traded in U.S. dollars gives the U.S. economy a unique advantage in the global economy have it exactly the wrong way around. The U.S. economy is the central economy in the global system because it is the most open, innovative, and productive economy in the world, and because of this, the U.S. dollar is the most convenient, liquid and reliable medium of exchange. [footnote](This is the argument that the US Dollar deserves its dominance and the advantages the petrodollar gives it, not that it is unimportant to the US that oil trade in dollars)[/footnote] One can imagine another currency challenging it at some point in the future, but only on the basis of the openness of its underlying economy, and the depth of the capital markets denominated in it. And if the euro can’t do it yet, why does anyone imagine the yuan is up to the job?
Furthermore, the U.S. dollar’s position as the global reserve currency has been underwritten by Chinese economic policy. China has deliberately built up a huge pile of U.S. dollar-denominated reserves which, contrary to much press coverage and occasional threats of a big selloff from China, confirms rather than undermines the dollar’s status.
Yuan-Denominated Oil Futures?
When China, like any other economy, allows the trading of oil futures in yuan, the contract merely promises dated delivery of oil in exchange for yuan. The contract does not supply the oil, it does not forward the yuan to an oil producer, it is merely a transaction that allows a buyer guaranteed delivery of oil by paying for it in yuan. The counter-party has to supply the oil in exchange for the yuan. Somewhere along the supply-chain someone will be paying in U.S. dollars, unless the ultimate supplier wishes to hold yuan. And despite the fanfare over the last few years, the yuan still comprises a tiny share of foreign exchange reserves held globally. Indeed, at 1.1% of the total, the yuan is significantly behind both the Australian and Canadian dollars, meaning that–with pound sterling–Queen Elizabeth II’s head appears on 7.5 times more foreign currency reserves than Mao’s. If China wants to change that, it will need to open up its economy, liberate its capital account and start living up to, rather than repudiating, its reform promises. Shanghai-traded oil futures in themselves have nothing to do with it.