It has long been recognized that the US dominance in global affairs is at least partly attributable to the US dollar as the world's biggest reserve and trading currency. Nearly two-thirds of the world's central-bank reserves are denominated in US dollars, according to data from the International Monetary Fund. The euro accounts for about a quarter -- up from 18% when it was introduced in 1999, but less than its predecessor currencies' share in 1995. Because the U.S. is such a huge trading partner for so many countries, the reserve buildup isn't easily unwound.
According to the Wall Street Journal, the dollar is also deeply entrenched in world trade. Businesses lower their transaction costs by dealing in a common currency. More than 80% of exports from Indonesia, Thailand and Pakistan are invoiced in dollars, for instance, according to the latest figures available in research by the European Central Bank, although less than a quarter of their exports go to the U.S.
Taking a page from the history of US rise in the last century, the Chinese efforts on currency appear to be only the first part of its larger push to assert its status as a new superpower of the twenty-first century. In a piece interestingly titled "It’s China’s World. We’re Just Living in It" in the latest issue of Newsweek, the authors argue that the Chinese are looking to reshape the world with China at its center. The larger plan includes the creation of a new framework with a new set of international institutions through which the Chinese can exercise their power.
While many nations want to change at least part of their reserve holdings from US dollars to euros or other alternatives, they know if they sell a significant share of their dollar reserves, it would weaken the dollar's value. That would potentially hurt their own trade competitiveness, and push down the value of their remaining dollar reserves. If they keep the dollars, a buildup of unwanted assets would only mount.
Beijing holds $2 trillion in dollar assets, accumulated through years of exports to America and massive purchases of Treasuries by the Chinese government, according to Businessweek. One way they can reduce their exposure to dollar assets over time is to shift their reserves from long-term Treasuries into shorter-term U.S. bonds. That shift would give the Chinese more flexibility in easing away from the dollar. The New York Times reported recently that the Chinese seem to be maintaining dollar-asset ownership levels, but shifting their holdings into maturities of a year or less—something they have not previously done.
"There is no alternative to the dollar as a trading currency in Asia," Andy Xie, a Hong Kong-based economist told the Wall Street Journal last year. "Eventually, the renminbi [yuan] will replace the dollar in Asia, perhaps in our lifetime. But it will take at least 30 to 40 years."
As China begins to surpass America as a major trading partner of many of the largest economies, it has growing economic clout in the world. But the key question is: Can the Chinese come up with their version of Bretton Woods—a system of political and economic public goods that have benefited not only the United States, but the key US allies as well? Only time will tell.
When the 20th century began, the U.S. was already the world's biggest economy, but the British pound still accounted for nearly two-thirds of official foreign-exchange reserves held by the world's central banks. The dollar didn't become the dominant currency until after World War II. Even then, some commodities still traded in pounds: The London sugar market didn't jettison sterling for a dollar-denominated trading contract until around 1980. The history lesson here is that, while the reserve and trade currencies can and do change, it takes a significant re-architecture of the world economy and trade and significant amount of time for it to happen.
The signing of currency swap agreements with several of its trading partners, including Argentina, Indonesia, India, Japan, Pakistan, Russia and South Korea, is a good start for China. But it will take many decades for yuan to displace US dollar after China becomes the world's largest economy around 2040.
Here's a video clip of NYU's Professor Nouriel Rubini's prediction on yuan:
Related Links:
China's Checkbook Power
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The Future of US Dollar as Reserve Currency
Bretton Woods
China's Growing Role in Afghanistan and Kashmir
China Sees Opportunities Where Others See Risk
Chinese Do Good and Do Well in Developing World
Can Chimerica Rescue the World Economy?
Haq's Musings
