CHINA´S YUAN IS NOWHERE CLOSE TO DISPLACING THE GREENBACK / THE ECONOMIST

China’s yuan is nowhere close to displacing the greenback

The only way the dollar will lose its supreme role is at America’s own hand

AFTER THE collapse of the Bretton Woods system of fixed exchange rates in 1973 the prestige of the dollar looked gutted. 

America had devalued its currency twice in scarcely a year. 

“The dollar is regarded all over the world as a sick currency,” said a writer in the New York Times; predictions of falling use of the greenback were rife. 

Those views, notes Barry Eichengreen of the University of California, Berkeley, in his book “Exorbitant Privilege”, could not have been more wrong. 

America’s share of the global economy, measured at PPP, did fall from 27% to 23% by 2000. 

But as the rest of the world parked its growing wealth in New York and governments built up reserves with which to defend their currencies, demand for dollars grew.

In the 21st century the pattern has been repeated. 

Amid predictions of a loss of its status—and despite a further fall in America’s share of world output to 16%—”king dollar” has kept his throne. 

For trade, cross-border investment and foreign-exchange transactions, the dollar remains by far the currency of choice (see chart). 

Its appeal gives America a seemingly endless supply of credit and the power to cripple foreign financial entities with sanctions. 

Its strength means that at market exchange-rates America counts for over a quarter of the world economy, the same as in 1990.

It is not that there has been no change at all. 

Dollar dominance has declined in reserve holdings and trade-invoicing. 

The fraction of reserves central banks keep in dollars peaked in 2001 at 73% and has since fallen to 59%, according to IMF data. 

Strip out distortions such as the effect of dollar-appreciation and the greenback’s share has in fact fallen to 56%, according to research by Serkan Arslanalp of the IMF and two co-authors, including Mr Eichengreen.

China is responsible for the dollar’s decline in invoicing for trade. 

As it has attempted to internationalise the yuan and escape the grip America has on the financial system—demonstrated by sanctions against Russia after its invasion of Ukraine—the Chinese government has spent the past decade trying to do more business in yuan.

It has got its trading partners comfortable with using the currency by, for instance, opening swap lines with them to provide a line of yuan credit and launching a cross-border payments system. 

About 25-30% of China’s goods-and-services trade is now settled in its own currency.

Taken together, these declines for the dollar as a reserve currency and as a basis for trade-invoicing could be seen as a harbinger of a spiral. 

It is most useful to hold a currency as a reserve today if it brings lots of options for trade tomorrow. 

So a high share of reserves and trade-invoicing should, in theory, reinforce one another, according to research by Gita Gopinath of the IMF and Jeremy Stein of Harvard University. 

Reverse that idea and in theory the dollar is in trouble.

But the twin declines are not interlinked enough to dent the dollar’s standing. 

On the IMF data, the dollar’s share of reserves has fallen back only roughly to where it was in 1995. 

And it has not been China absorbing its share, or even the euro, which Europe uses for most of its own trade and is the dominant currency in parts of Africa. 

Rather, it is, as one joke goes, other currencies called “dollar” or “krone”: those in Australia, Canada, New Zealand, Singapore, Denmark, Sweden and Norway. 

“They are the currencies of small, open, well managed, in the main inflation-targeting economies,” says Mr Eichengreen.

It’s good to be the king

They are also mostly America’s allies, making it hard to sustain an argument that the fall in reserve share says much about lost Western hegemony. 

And among remaining official holdings of dollars, three-quarters are owned by governments with a military tie to America, says Colin Weiss of the Federal Reserve. 

Strikingly, note Mr Arslanalp and his colleagues, the yuan’s share of international reserves has shrunk since 2022, when Russia invaded Ukraine, sparking American sanctions and much speculation that countries would jettison the dollar for fear of similar treatment.

As for trade, flows involving at least one advanced economy but not China account for two-thirds of the global total, calculate Gerard DiPippo, now of Bloomberg, and Andrea Palazzi of the Centre for Strategic & International Studies. 

It is hard to see why they would ever switch to yuan, because rich countries are mostly America’s allies. 

Exclude them altogether and only 25% of global trade would be left on the table, three-quarters of which is between emerging markets other than China. 

Changing these flows to yuan is a tall order given the risks in holding the currency.

Looking in the round, researchers at the Federal Reserve concluded in 2023 that dollar dominance “has remained stable over the past 20 years”. 

Why is it so tough to displace?  

One reason is network effects: the more people use dollars, the greater the incentives to use them. 

This is visible in currency-trading, where the dollar’s liquidity means that for some currency pairs it is cheaper to trade through the dollar—ie, to sell a holding for dollars, then buy the desired currency—than to trade two non-dollar currencies directly.

Network effects do not guarantee the status quo for ever, as shown by the fall of past reserve currencies such as the British pound and the Dutch guilder. 

The problem faced by rivals now is that they simply cannot offer as safe and liquid a store of value, and in such quantities. 

China’s authoritarian system and controlled capital account, which restricts how much money can be taken out of the country, make investors skittish. 

Europe lacks safe, jointly issued assets on the scale of the Treasury market. 

Nowhere offers America’s combination of the rule of law, deeply liquid markets and an open capital account, meaning that investors know they can get their money out easily.

Stop making cents

More likely than another country gaining these traits is America giving them up, by design or by accident.  

There are plenty of American critics of dollar dominance. 

In the influential book “Trade Wars are Class Wars”, Michael Pettis of Peking University and Matthew Klein, a financial writer, argue that the dollar’s status as the default location for the world’s savings means that mercantilist countries like China, whose policies lead to consistent trade surpluses, accumulate vast quantities of American assets.

Because these global capital flows, it has long been thought, both reduce America’s interest rates and, by making the currency strong, increase the purchasing power of its people and companies, the dollar’s status is often said to confer an “exorbitant privilege”—that is, an unfair and extreme advantage. 

But Messrs Pettis and Klein say it raises the cost of America’s exports and hurts its manufacturing workers. 

J.D. Vance, Donald Trump’s running-mate, has made a similar argument. 

Robert Lighthizer, the US Trade Representative during Mr Trump’s presidency, has floated bringing the dollar down by levying a “market access charge” on foreigners holding American assets.

It is not an illogical argument. 

But it is hard for researchers to identify how much the foreign buying of dollars makes the greenback stronger versus how much that same foreign demand pushes down interest rates (which weakens rather than strengthens the greenback). 

Simple comparisons of bond yields show little exorbitant privilege. 

In fact, American interest rates tend to be higher than those elsewhere in the world, in part owing to its strong economy.

It is easier to see the advantage the dollar confers not in interest rates but in quantities of debt issued. 

America has run up net public debts worth 99% of its GDP and continues to runs an enormous deficit worth 7% of GDP. 

Britain faced a bond-market crisis in 2022 at lower levels of debt and borrowing.

The private sector benefits too. 

American assets make up over a quarter of the stock of global investment in financial instruments, up from less than a fifth in the mid-2000s, says Goldman Sachs. 

A paper by William Diamond of the University of Pennsylvania and Peter Van Tassel of Caption Partners, an investment firm, finds that demand for dollar assets reduces all American interest rates versus a counterfactual, not just those of the government. 

American firms, then, can simply borrow more cheaply.

An American administration that meddled with the dollar’s reserve-currency role would risk giving up these benefits—which is why it has generally been the policy of the Treasury to support the status quo. 

Despite Mr Vance’s worries, and Mr Trump’s laments of a strong dollar, the Republican Party’s platform promises to keep the dollar as the world’s reserve currency.

That leaves an accidental loss of status. 

The Bretton Woods agreement collapsed because America could not satisfy the world’s demand for its assets, given the dollar’s peg to gold, without compromising their safety. 

The problem was known as the “Triffin dilemma” after Robert Triffin, the economist who identified it. 

Now economists talk of a “new Triffin dilemma” whereby the appetite for dollars encourages American indebtedness, threatening the very conditions that make greenbacks so appealing.

The new Triffin dilemma is unlikely to bring about a dramatic crisis so long as there is no suitable alternative into which investors could flee suddenly at scale. 

But it is conceivable that American indebtedness could gradually make dollar debts look less safe. 

That would not mean the triumph of another currency. 

It is more likely the world would have to live without a liquid, safe and plentiful asset at all. 

Seen this way the real exorbitant privilege is more broadly conferred than critics claim. Americans get cheap debt, foreigners get a safe store of value. 

Were that service ever to disappear, the whole world would pay the price.