Is it time to write the dollar’s obituary?
The past five decades have seen the dollar achieve and maintain an unprecedented position as the leading reserve currency in the world. Reserve currencies are those which are held in large quantities by investors worldwide — essentially, dollars, yen and Euros. From long experience, I know that every nation with fixed currency controls breeds a class of money-changers furiously buying and selling greenbacks for tourists, entrepreneurs and even governments.
Ironically, the collapse of American financial markets in 2008 actually resulted in a surging dollar. Investors worldwide ‘fled to quality,’ pouring their holdings into the perceived value and stability of the dollar. The dollar’s most important buyer is undoubtedly China, with $2.1 trillion dollars in foreign exchange held chiefly in U.S. Treasury bonds. Indeed, China is financing the U.S. deficit, leaving us precariously dependent on their government.
The Chinese government seems to have taken a notable step back from their enthusiasm for the dollar, however. For the first time, it is issuing
sovereign bonds denominated in Renminbi (
RMB), the national currency that some believe China hopes to develop into an alternative to the dollar as the global currency.
Of course, the Chinese government still has a significant stake in a stable dollar –
$2.1 trillion dollars worth, in fact. They’re caught between a rock and a hard place. Any slide in the value of the dollar will hit them hard, and the harder they push the RMB, the more they will weaken the dollar.
That’s why it is unlikely the RMB will be replacing the dollar as an international hard currency any time soon. For one thing, no one is stockpiling RMB notes under their mattresses in Buenos Aires or Lagos. The market lacks depth – there are few physical RMB outside of China, and investors cannot sink large amounts of money into the market without drastically affecting it. The dollar, on the other hand, is the deepest and broadest currency market in the world.
Furthermore, the Chinese government has always tried to maintain tight control over its currency. As it internationalizes and becomes more common in markets, they will find the law of unintended consequences coming into play. Their currency will move in ways they don’t want and can’t predict. There isa great deal of internal pressure in China to let the RMB’s value rise, as its artificially low level ends up hurting a growing class of Chinese consumers in order to stimulate exports.
The dollar is still king, even as its value fluctuates. The financial world has prophesied the collapse of the dollar before – when it sank against the yen in the 1980’s, or when the Euro debuted in the late 90’s. Although its value may rise and fall, its place as a reserve currency remains unchallenged.
I have confidence that the fundamentals of the US economy are strong, and with a quarter of the world’s GDP being generated in dollars, it will take more than Chinese bonds to threaten our currency. If the Euro, backed by all of the developed economies of Europe, could not dethrone the dollar, the RMB will have a hard time doing so. For now, the RMB is just one more currency on the market.
Where the RMB bonds may come into play most strongly is the Chinese financial sector. Increased exposure to international markets will drive newly wealthy and even middle-class Chinese citizens to invest more outside in foreign exchange and international markets. In the end, how and where the Chinese people invest their money will end up determining the fate of the RMB.
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