Go on any conspiracy theory or political extremist website, and you will find shrieking about the dollar’s imminent collapse. This concept is often backed up with the idea that the Chinese yuan, backed up by the strength of the Chinese economy, will overtake the dollar as the global reserve currency. As a result, we will all one day wake up to find ourselves with a collapsed dollar and forced to buy our groceries with the yuan.
Yet the data simply does not match up with the narrative. The world’s official foreign exchange reserves by currency as shown by the IMF do indicate that the U.S. dollar’s share of currency reserves has declined. But the dollar still made up 61% of allocated reserves in the 2019 2Q, compared to 62% 12 months earlier, while the yuan rose over the same time period from 1.8% to 1.9%. The euro, not the yuan, is by far the dollar’s biggest competitor.
ValueWalk's Raul Panganiban interviews Dr. Kathryn Kaminski, Chief Research Strategist at AlphaSimplex, and discuss her approach to investing and the trends she is seeing in regards to quant investing and hedge funds. Q1 2021 hedge fund letters, conferences and more The following is a computer generated transcript and may contain some errors. Interview with AlphaSimplex's Read More
China may wish to be the world’s reserve currency and overtake the dollar. But in order to accomplish such a task, their government would need to take on risks and challenges they have indicated an unwillingness to do. While we could see a decline in dollar supremacy over the long term, there will be no sudden collapse and the dollar will remain dominant for the foreseeable future.
Liberalization and the Reserve Currency
The first thing to understand is what it means to be the global reserve currency. A person may buy his daily bread and drink with his local currency. But if you wish to purchase commodities or trade on the global market, most people will use dollars. There is nothing stopping you from using euros or yuan or even Iraqi dinars if you please, but the dollar is convenient, stable, and reliable.
What those who argue that the yuan will soon overtake the dollar fail to understand is that the dollar’s stability and reliability are not solely created by the power of the U.S. economy. I would point to at least three interconnected factors that the U.S. and the dollar possess that China cannot have any time soon.
The first factor is the fact that we know the dollar’s true market value, and we know that the dollar is not going to rapidly appreciate or depreciate as the U.S. government does not dictate the dollar’s value. Instead of a floating exchange rate, China pegs the yuan to the U.S. dollars, as does the yen in forex trading, and must buy dollars in order to keep it down. While that leads to charges of currency manipulation, the idea that China can establish a new currency order superior to the U.S. dollar while having to stockpile dollars is inherently ridiculous.
The second factor is related to the first factor and is the fact that China is still an export-orientated economy with a trade surplus, with an incentive to keep the yuan weak. China cannot just stop buying dollars and let the yuan float freely because that would elevate the currency’s value and make it harder to export Chinese goods abroad. China also has very poor capital markets, and can arbitrarily devalue the yuan whenever it pleases as it did in August as well as back in 2015 and 2016. It is far trickier for the United States to do so, but this is good as it makes the dollar more reliable as a store of value.
And finally, there is the simple factor of “if it ain’t broke, don’t fix it.” Traders and citizens around the world use the dollar, and the dollar is used as a stable store of value in countries like Venezuela where the local currency is not trusted.
RMB to overtake the dollar?
There is little reason for traders to make such a switch, even when the Chinese economy overtakes the U.S. economy. The last great currency shift is proof of this. The U.S. economy surpassed the British economy at some point in the late 19th or early 20th century, but it took the destruction of two world wars and by extension near British bankruptcy for the dollar to surpass the pound as the world’s currency.
Commentators may point to U.S. political instability and Trump’s desire to push the dollar down as factors that could cause the dollar to lose its appeal. But despite these concerns, the Brookings Institute points that the dollar continues to be the main force in global payments, making up 40 percent compared to just 2 percent for the yuan. There is little short of a civil war or Yellowstone erupting which could seriously threaten U.S. dollar dominance in the near-term event, and such event would have major ramifications for the Chinese economy and yuan as well.
Things may change over the long term. If China makes steps towards a true floating yuan, continues liberalizing markets, and works to improve its reputation as a reliable partner compared to the U.S. paralyzed by political infighting, then perhaps someday the yuan may surpass the dollar. But the yuan will have to wait sometime to get its chance.