Former President Donald Trump has expressed concern that China could displace the U.S. dollar as the global reserve currency. The warning follows reports of agreements between various nations to use the yuan in commodity transactions.
For years, rumors have circulated about the demise of the U.S. dollar as a global reserve currency, but the greenback continues to be the most traded and extensively used currency in the fiat world.
The euro, the Japanese yen, and the pound sterling remained the second, third, and fourth most traded currencies, respectively. The euro continued to be the second most traded currency in April 2022, accounting for 30.5 percent of all transactions (slightly less than in 2019). The Japanese yen and the British pound were involved in 17 percent and 13 percent of all transactions, respectively, which is virtually unchanged from the 2019 survey.
The Chinese renminbi showed the greatest increase in market share since the 2019 survey, accounting for 7 percent of all transactions in 2022 (compared to 4 percent in 2019). Despite the yuan’s rise to the fifth most traded currency, its market share of 7 percent is still disproportionately small compared to the size of the Chinese economy in the global context.
How can two countries with closed or heavily intervened financial systems promote a global reserve currency? This is a query that investors have in response to the possibility of a joint currency between China, Russia, India, and Brazil. How could investors be confident in a currency’s status as a reserve of value if it’s promoted by nations renowned for continually devaluing their currency?
China doesn’t pose a threat to the U.S. currency. It’s, if anything, threatened by the U.S. government and the central bank. Let’s examine why.
Today, there’s no alternative to the U.S. dollar. It’s the world’s reserve currency due to its open and flexible financial market, freedom of capital movement, investor and legal security, and its status as a secure haven during times of uncertainty, as the year 2022 once again demonstrated.
The yuan’s appeal as a global currency is severely hampered by capital controls and currency price fixing by the People’s Bank of China. It’s impossible to simultaneously have a global reserve currency and capital controls. No global investor or company desires a currency whose exchange rate is fixed by the central bank in accordance with a purported stability procedure, which you must presume is equivalent to a floating value. It’s too dangerous to undertake. The same issue affects the Russian ruble. With capital controls and a confined financial system, investor and legal security is questionable.
We tend to overlook how crucial it is to have an independent, stable, and transparent legal and investor security framework for a currency to be extensively used internationally. When the independence of the legal and regulatory system is in question, the state currency is always going to be an anecdote. Independent institutions, transparency, freedom of capital movement, and legal security are what matter. Because of this, the Japanese yen, the euro, and the British pound are more frequently used in international transactions than the yuan, and the Swiss franc, the Canadian dollar, and the Australian dollar are global reserve currencies.
However, we must recognize that opening the financial market, allowing the currency to float, and instituting a transparent and independent legal framework are all things that nations can do. If China awakens and decides to increase the value of its currency, it can do so by adopting the open and free market systems that other nations enjoy. China can’t anticipate having a confined and regulated financial system as well as a global currency.
For a currency to be considered money, it must function as a store of value, a unit of measure, and a universal means of exchange. Numerous state-issued currencies are neither universal means of payment nor reserves of value.
Is the euro a risk to the U.S. dollar? 2022 demonstrated that it isn’t. The euro remains a robust currency, but it’s predominantly used for cross-border transactions within the European Union. It’s also fragile due to the redenomination risk that remains, as some euro area members may decide to leave the monetary union at some point, a risk that tends to increase with populism and political unpredictability.
So far, we have only discussed international state fiat currencies. Obviously, gold and silver exist. In addition, Bitcoin is beginning to demonstrate some potential as a universal payment system and unit of measure. The denationalization of money, as described in Hayek’s “Choice in Currency,” may be closer than we believe.
Who then can jeopardize the status of the U.S. dollar as the world’s reserve currency? Only the U.S. government, with the assistance of the Federal Reserve, can dethrone the dollar.
How? By inflating the deficit and debt to uncontrollable levels and monetarizing them. If the world perceives that the issuer of money has abandoned its commitment to maintaining the reserve of value of monetary units and that the government is constantly eroding the purchasing power of the currency through deficit spending and diminishing investor and legal security, confidence in the currency may be lost.
The disastrous experiment of 2020 and the subsequent monetary and inflationary burst have cast the first shadow of doubt over the U.S. dollar.
The United States may commit “world reserve status” suicide if it continues to believe it can do whatever it wants and continues to transfer its fiscal and monetary imbalances to the rest of the world, thereby eroding the purchasing power of its currency through the monetization of higher debt and larger deficits.
To date, the U.S. dollar has maintained its status as the world’s reserve currency because all other alternatives have implemented the same or larger monetary imbalances without the global demand that the U.S. dollar enjoys due to the legal and investor protections it provides. The United States can only retain its monetary throne if it demonstrates a firm commitment to sustaining the value reserve, an open market, and legal security.
Governments believe they can test the limits of their citizens’ forbearance by eroding the purchasing power of the currency and incessantly increasing the debt and fiscal imbalances. Until it fails. Defending a solid monetary and fiscal policy is, therefore, the most patriotic endeavor.
A government that believes it can do whatever it wants with deficits and debt because the rest of the world will tolerate it is the only threat to the dollar’s position as the leading global reserve currency. All empires fall when their rulers believe they can do whatever they want and simply print their way out of their problems.
The U.S. government must recognize that it has all the instruments necessary to maintain the dollar’s status as the world’s reserve currency. It must also recognize that it’s employing the instruments that could destroy the currency. This is its decision. The only way fiat currencies can retain their status is if the world continues to have faith in them. It’s imprudent to exceed the limits of fiscal trust.
