The War Against Dollar Dominance

Posted: May 26, 2015 in China, Europe, USA
Tags: ,

It takes two to tango, but unless both partners move in perfect cohesion, a sequence of graceful maneuvers can be reduced to a series of clumsy moves. The latter depiction seems to be particularly apt when it comes to explaining the gyrations between the Chinese yuan and the U.S. dollar, thanks to China’s recalcitrance on the topic of yuan appreciation and the United States’ reluctance to be a partner in this currency tango.
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There is a rivalry between the European Union, China, Russia and the United States over the reserve currency or rather, fight for financial supremacy. The entire world is in the midst of a global capitalist crisis since 2007, and it’s imperative that they use the military to keep forces in Africa, Asia, Latin America, and Europe in line behind the dollar as the currency of world trade.

Governments worldwide rely on the United States to manage the global system, but no country is happy with the United States devaluing the dollar by printing dollars, what they call quantitative easing. If the United States of America is putting $65 billion every month on the world market, nobody wants to keep their reserves in dollars. Countries are thus taking small steps toward undercutting this U.S. hegemony. The elites in Latin America and Africa are seeking ways to exit this. The BRICS countries — Brazil, Russia, India, China and South Africa, a bloc of the world’s five major emerging economies — have long sought to diminish their dependence on the dollar as a means of reshaping the world financial and geopolitical order.

The BRICS have already formed New Development Bank, formerly BRICS Development Bank as an alternative to the existing US-dominated World Bank and International Monetary Fund. The Bank is set up to foster greater financial and development cooperation among the five emerging markets. Together, the four original BRIC countries comprise in 2014 more than 2.8 billion people or 40 percent of the world’s population, cover more than a quarter of the world’s land area over three continents, and account for more than 25 percent of global GDP. It will be headquartered in Shanghai, China.

Let’s take a look at China.
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China leads the pack in the quest to set up a new world order. China commenced its transition to a global powerhouse in 1978, as Deng Xiaoping ushered in sweeping economic reforms. In the three decades from 1980 to 2010, China achieved GDP growth averaging 10%, in the process lifting half of its 1.3 billion population out of poverty. The Chinese economy grew five-fold in dollar terms from 2003 to 2013, and at $9.2 trillion, it was easily the world’s second-largest economy at the end of that period. But despite a slowing growth trajectory that saw the economy expand by “only” 7.7% in 2013, China appears to be on track to surpass the United States as the world’s largest economy sometime in the 2020s. In fact, based on purchasing power parity – which adjusts for differences in currency rates – China may pull ahead of the U.S. as early as 2016, according to a report on global long-term growth prospects released by the Organization for Economic Cooperation and Development in November 2012.

China’s rapid growth since the 1980s has been fueled by massive exports. A significant chunk of these exports goes to the U.S, which overtook the European Union as China’s largest export market in 2012. China accounts for more global trade than anyone else on the planet (including the United States), and most of that trade is conducted in U.S. dollars. This keeps demand for the dollars very high, which in turn ensures that the US can import massive quantities of goods from overseas at very low cost.

China has been in a drive to internationalize the its currency and this comes as the International Monetary Fund continues to mull over possible inclusion of the yuan as its fifth reserve currency to a glorious basket that includes the dollar and the euro – currently the dominant reserve currencies with a 63% and 22% share respectively, and as part of the basket that forms the IMF’s Special Drawing Rights. So it has been lobbying core members of the IMF behind the scenes for support, and they’re coming around despite US conniptions. If the US dollar continues to be used, it weakens China’s bid for the yuan to become a truly global currency and to challenge the hegemony of the US dollar.

When it comes to global finance, China is playing chess and the United States is playing checkers. China knows that gold is a universal currency that will hold value over the long-term. As the paper currencies of the world race toward collapse, China could end up holding most of the real money and that would be a huge game changer when they finally reveal that fact. Now even Israel – joined at the hip to the US though the relationship has run into rough waters – has applied to become a founding member of the China-led Asian Infrastructure Investment Bank. Despite US gyrations to keep them from it, over 40 countries, including bosom buddies Australia, Britain, and Germany, have signed up to join. Japan is still wavering politely. 20 central banks including US allies Australia and the UK, have inked $430 billion in currency-swap agreements with China.
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Baby steps, all of them, but part of a slow, methodical, relentless process of elevating the yuan and whittling away at the power of the dollar – and by extension, the power of the long arm of the US government. It would be a huge win for China. Central banks around the globe would start buying the yuan, necessarily at the expense of other currencies, including the dollar. It would create demand for the yuan. It would raise China’s profile on the global stage. It would, in fact, bring China one step closer to being a full-fledged economic, financial, and political challenger to the US in a US-dominated system.

But let’s face it, in our world of computers and global finance, there is really not much of a reason to have a world reserve currency. Anyone from any country should be able to quickly settle up through currency conversion. If a company from Canada is buying something from Japan, why do the two have to use the U.S. dollar as an intermediary? The Canadian company can pay in Canadian dollars, which can quickly be converted back into yen. Or the Canadian company can exchange its Canadian dollars for yen first and then make the purchase. As long as the currencies are floating freely and can be bought and sold on exchanges, I don’t see much need for the U.S. dollar. The only time a problem may occur is when a company does business in a country that either doesn’t have a freely floating currency or has an extremely erratic currency.

China does not have a floating exchange rate that is determined by market forces, as is the case with most advanced economies. Instead it pegs its currency, the yuan to the U.S. dollar. The yuan was pegged to the greenback at 8.28 to the dollar for more than a decade starting in 1994. It was only in July 2005, because of pressure from China’s major trading partners, that the yuan was permitted to appreciate by 2.1% against the dollar, and was also moved to a “managed float” system against a basket of major currencies that included the U.S. dollar. Over the next three years, the yuan was allowed to appreciate by about 21% to a level of 6.83 to the dollar. In July 2008, China halted the yuan’s appreciation as worldwide demand for Chinese products slumped due to the global financial crisis. In June 2010, China resumed its policy of gradually moving the yuan up, and by December 2013, the currency had cumulatively appreciated by about 12% to 6.11.

China is hesitant however in doing a substantial upward revision of the yuan, since such a revaluation could adversely impact exports and economic growth, which could in turn cause political instability. There is a precedent for this caution, going by Japan’s experience in the late-1980s and 1990s. The 200% appreciation in the yen against the dollar from 1985 to 1995 contributed to a prolonged deflationary period in Japan and a “lost decade” of economic growth for that nation. A sudden Yuan revaluation, say an overnight 10% increase in the currency would translate into a $130 billion national loss on China’s U.S. dollar-denominated Treasury holdings.

The fact that US can print up giant mountains of money and virtually everyone around the world uses it has been a huge boon for the U.S. economy. But as the IMF President said, it only a matter of if and not when this changes, and when that changes, the word “catastrophic” is not going to be nearly strong enough to describe what is going to happen.

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