Not least
as a result of Shifting Wealth - the shift of the centre of gravity of the
world economy towards Asia - the BRICS countries are seeking to replace the
dollar as the leading currency with the Chinese yuan[1].
The shocks to the world economy caused by US President Trump's isolationism and
willingness to impose sanctions can accelerate the rise of the yuan as a lead
currency. (Meanwhile, the US are going insane under President Trump, as predicted by the Simpsons already in 2000!).
There is still a lot of plumbing to be done before the dollar dominance can be diminished. This work is in full swing with the establishment of new institutions outside the financial system dominated by the West, the establishment of new transport, energy and digital connections in the context of the Chinese Silk Road Initiative and the disintegration of global trade into regional trading blocks.
There is still a lot of plumbing to be done before the dollar dominance can be diminished. This work is in full swing with the establishment of new institutions outside the financial system dominated by the West, the establishment of new transport, energy and digital connections in the context of the Chinese Silk Road Initiative and the disintegration of global trade into regional trading blocks.
BRICS countries and dollar dominance
The five
BRICS states form an association with different interests and strengths. If one
topic unites these five, it is their rejection of the US-dominated monetary
system. Thus the 10th BRICS Summit in Johannesburg in July 2018 once again
ended with a call against the dominance of the US dollar. Since the Xiamen
Summit in 2017, five selected emerging markets (BRICS Plus[2])
have been invited to promote the de-dollarisation of the global economy.
Since
their first summit meeting in 2009 in Ekaterinburg, Russia, the BRICS states
have been calling for the US dollar to be replaced as the international reserve
currency. In the same year, under the fresh impression of the implosion of the
global financial system in the wake of the Lehman bankruptcy, the UN Commission
on the Reform of the International Monetary and Financial System headed by
Joseph Stiglitz made the demand to replace the US dollar as an international reserve
currency, possibly with the basket of Special Drawing Rights (SDR) of the
International Monetary Fund. However, Special Drawing Rights are a form of art
money that is not traded on foreign exchange markets. They do not fulfil all
the functions of money: although SDRs can function as part of a country's
official foreign exchange reserves, they cannot be used either to intervene in
foreign exchange markets or as an anchor currency. So it's hardly surprising
that the political impetus for the SDR as the reserve currency has silted up,
even though the SDR basket has become more representative since the
Chinese yuan joined in 2016.
The euro
could be a serious candidate to reduce dollar dominance as a reserve currency
if the institutional conditions were created[3].
In order to be attractive for global transactions, especially for reserve
holdings, the euro should be stable in value and crisis-proof. But the reforms
of the euro's financial architecture to date have not succeeded in establishing
this confidence. Germany's restrictive fiscal policy is also curtailing the
supply of risk-free Eurobunds; these would be the obvious alternative to US
government bonds, the hitherto dominant form of official reserve holdings.
After all, the mercantilist German economic model, which is pinned on external
competitiveness, is standing in the way of the internationalisation of the euro
because of the Triffin dilemma[4],
just as it did in the past for the Deutsche Mark.
A Hundred Years of Dollar Dominance
Ever since
the replacement of the British pound as the global reserve currency after the
First World War the US dollar has dominated the world economy - for a century
now. The USA had already overtaken Great
Britain as the largest economy at the end of the 19th century, and politically
it dominated in the wake of the First World War. Today still, the dollar is
enthroned in the bel étage of the
international monetary system:
1. A
large part of international trade, which far exceeds the share of the USA in
world trade, is invoiced and settled in dollars. This is also due to the fact
that the prices for most raw materials are quoted in dollars. The role of the
dollar as the dominant invoicing currency in international trade and its
widespread use as a transaction currency has so far been consolidated by
network effects. The global share of the
dollar in international payments is now 40 percent, followed by the euro with
35 percent. By contrast, the yuan share has stagnated at just below two percent
since 2016 due to devaluation pressure and the implementation of state controls
to prevent capital outflows.
2. Network
effects are less significant in terms of use as a reserve currency, in which
not only liquidity aspects but also diversification arguments play a decisive
role. Nevertheless, the dollar remains the dominant reserve currency. At the
end of the first quarter of 2018, it accounted for 62.5 percent of the world's
allocated official foreign exchange reserves. The euro was in second place at
20.4 percent. The yuan stands at only 1.4 percent[5].
3. The
majority of bank financing outside the USA takes place in dollars: According to
location-based statistics from the Bank for International Settlements, 62
percent of banks' foreign currency liabilities are denominated in dollars.
Similarly, the corporate financing of non-American companies through bank loans
and bonds is more denominated in dollars than in other hard currencies[6].
The lead
currency functions (means of payment, holding reserves and financing vehicles)
are interlinked in multiple configurations[7].
The high proportion of internationally traded goods invoiced in dollars drives
the demand for secure dollar claims. Risk-free investments in US dollars
generally pay lower exchange rate adjusted returns than risk-free investments
in most other currencies. The violation of the uncovered interest parity in
turn favors the dollar as a cheap funding currency. This feedback loop applies
in particular to the export firms of emerging markets. Because of this
violation, taking out dollar loans is generally cheaper than taking out loans in
local currency. This increases the incentive for the company to settle its
exports in dollars, because it can thus plan its future dollar sales more
reliably. This, in turn, enables the company to borrow in cheaper dollars with
lower exchange rate risks.
The USA,
as the issuer of the global lead currency, enjoys the ´extraordinary privilege´[8],
to import foreign capital by providing international dollar liquidity while
non-Americans mostly hold their dollar investments in low-interest US
government bonds. Some of these capital imports are channelled by the US into
high-yield foreign investments, which generates considerable interest gains for
the United States. Nonetheless, the rest of the world has also benefited from
the dollar's status as a reserve currency. The depth and liquidity of the US
financial markets and the economic weight of the US economy make the dollar
attractive not just as a transaction and reserve currency. Countries with less
liquid financial markets, in particular, are benefiting from the dollar as the
reserve currency, partly due to favorable refinancing conditions on the US bond
markets. In addition, the dollar has exhibited low inflation rates and
relatively high external stability in recent decades.
The Dollar Discomfort of Emerging Markets
So what
do the BRICS have to object to the dollar as the lead currency?
1. A most
immediate response is provided by the currency crises in Argentina and Turkey,
which were only recently the preferred borrowers of foreign banks and global
bond markets. Now, in 2018, they have to swallow a rapid collapse in the
external value of their currencies; they are paying heavy fines on the
´original sin´[9]
typical of emerging markets. As many emerging markets have quite illiquid and
narrow financial markets, the violation of the uncovered interest rate parity
tempts them to borrow in foreign currency. If the dollar borrowing is made by
companies or banks that do not have corresponding dollar revenues, currency
mismatches arise in corporate balance sheets. These balance sheet mismatches
are a time bomb for private actors, but equally for public budgets via
contingent liabilities for public bailouts.
2. Another
current concern relates to the United States' ability to impose sanctions. Any
transaction conducted in US dollars or through a US bank automatically results
in trading partners being subject to US jurisdiction. The US is currently
waging an economic war against a tenth of the world's countries with a
cumulative population of almost 2 billion people and a GDP of more than 15
trillion dollars. These include Russia, Iran, Venezuela, Cuba, Sudan, Zimbabwe,
Myanmar, the Democratic Republic of the Congo, North Korea, but also countries
such as China, Pakistan and Turkey, targets of other economic sanctions. The
resulting trade war similarly weakens the attractiveness of the dollar in
international trade and financial transactions. Countries like Iran welcome the
possibility of circumventing US sanctions by exporting goods to China that can
be settled in yuan. In July 2018, SWIFT's RMB tracker[10]
quoted a 9.9 percent increase in the value of yuan payments for July 2018
compared to June 2018, while transactions in all other currencies declined by 2.5 percent that month[11].
3. From a
wealth perspective, emerging markets are worried about the danger of a
depreciation of the US dollar. China (including Kong Kong) and the twelve
largest emerging markets recently held official foreign exchange reserves of
6.7 trillion dollars, almost 60 percent of the world's official reserves. Often
motivated by their vulnerability to sudden stops (of capital inflows), the demand for foreign
exchange reserves is forcing developing countries to transfer resources to the
countries that issue these reserve currencies - a case of "reverse
aid", particularly benefiting the US. Major emerging economies, often net
creditors to the rest of the world and with substantial holdings of US
sovereign debt, fear a deliberate devaluation strategy by the US that would
devalue their vast currency reserves by hundreds of billions of dollars.
China's net foreign wealth has risen steadily over the past three decades, to
half of its rapidly growing gross domestic product (GDP). Due to their
notorious consumption surplus, the US extended their net debt position to 40
percent of GDP over the same period (Fig. 1)[12].
Net foreign assets, 1990 – 2014,, % of GDP
4. Finally,
it also matters when the global economic gravity shift from the USA to China
will also be reflected politically[13].
Shifting Wealth is incomplete and possibly endangered in the long run if its
economic pillar is not safeguarded by military deterrence and a reduction in
dollar dominance. Historically, the global reserve currency came from the
leading economy of the time. According to IMF data, China is the largest
economy in the world after adjustment for purchasing power; its share of the
world product today (2018) is 18.7 percent, while the US share is estimated at
15.1 percent. Since the USA (and the
traditional OECD countries) has lost relative economic weight, the query of the
lead currency has been a recurring theme in the context of Shifting Wealth.
Outlook
The
dollar still dominates the bel étage
of the international monetary system with dominant positions in global
payments, reserves and financing vehicles. In the basement, however, the
Chinese are already busy laying the pipelines for a reduction in dollar
dominance through the yuan. The establishment of new multilateral financing
institutions outside the financial system dominated by the West, new transport,
energy and digital connections along the Chinese Belt and Road as well as the
disintegration of global world trade into regional trading blocs are the
prerequisites for the internationalization of the Chinese currency.
According
to Eichengreen's account of historical changes in the international monetary
system[14],
the sequence of internationalization of a currency is: 1. to promote its use in
invoicing and settlement of trade; 2. to promote its use in private financial
transactions; 3. to promote its use by central banks and governments as a
reserve currency.
According
to the latest data (2017) from the WTO, China was the largest exporting nation
with over 2.26 trillion dollars and a 12.8 percentage share of world trade.
China's imports amounted to 1.84 trillion dollars in 2017, making China the
second largest importing country after the USA with a global import share of
10.2 percent. The USA's departure from multilateralism and world trade is
promoting the rise of the yuan. Mega-projects focused on the US - the
Transpacific Partnership (TPP) and the Transatlantic Trade and Investment
Partnership (TTIP) - were suspended. Instead, the Pacific-Asian region is
negotiating the China-led trading bloc ´Regional Comprehensive Economic
Partnership´ (RCEP), which comprises thirteen countries alongside China, India
and Japan and thus more than half of humanity.
Since the
end of the yuan´s dollar peg in August 2015, there has been an empirically
closer connection (comovement between currencies) between China's bilateral trade
links and the respective yuan correlation. Therefore, the RCEP is likely to promote
a yuan block in Asia. A rising influence of the Chinese currency has also recently
been observed in some Latin American currencies. The growing yuan block will
therefore also promote the yuan as a reserve currency in the future for reasons
of stability and portfolio theory.
China's
Belt-Road Initiative (BRI), with a planned investment volume of over 100
billion dollars, plays a key role in the internationalization of the yuan. The
BRI was announced at the Silk Road Summit in Beijing in May 2017 by Xi Jinping,
head of state and party leader, to 29 heads of state and government of the
participating countries in Asia, Africa and Europe. The use of the yuan is to
be promoted by the payment flows (yuan loans) in the countries along the routes
accompanying the trading activities. The yuan loans originate, among others,
from the Asian Infrastructure Investment Bank (AIIB) founded by China in 2016,
which grants BRI infrastructure loans outside the Bretton Woods system
dominated by the USA[15].
[1] Translated version of an invited contribution to debate the dollar
dominance in Wirtschaftsdienst.
[3] S. Dullien (2018), “The
German barrier to a global euro”, ECFR, 30th August.
[4] The reserve currency country should continuously provide the world
economy with risk-free liquidity through a current account deficit, which may
undermine confidence in the reserve currency in the long run.
[5] IMF (2018), Currency Composition of Official Foreign Exchange
Reserves (COFER), http://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4,
1st quarter 2018.
[6] G. Gopinath
& J. Stein (2018), “Banking, Trade, and the Making of a Dominant Currency”,
NBER Working Paper No. 24485, April.
[9] B. Eichengreen, R. Hausmann, U. Panizza, U
(2003), „ Currency Mismatches, Debt Intolerance and
Original Sin. Why They Are Not the Same and Why It Matters”, NBER Working
Paper No. 10036, October.
[10] SWIFT is the acronym for the private Brussels-based service
provider ´Society for Worldwide Interbank Financial Telecommunication´. RMB
stands for Renminbi, the alternative name for the currency of the People's
Republic of China.
[11] K. Yeung (2018), “ US-China trade war is helping to boost use of yuan in international transactions”, South China Morning Post, 9th September.
[11] K. Yeung (2018), “ US-China trade war is helping to boost use of yuan in international transactions”, South China Morning Post, 9th September.
[12] P. Lane, G.-M. Milesi-Ferretti (2018), “The External Wealth of
Nations Revisited: International Financial Integration in the Aftermath of the
Global Financial Crisis”, in: IMF
Economic Review, International Monetary Fund, Vol. 66(1), S. 189-222,
March.
[13] Many think that US President Trump is “A Recipe for Disaster”, and
the US going insane, as predicted in a Simpsons series in 2000 already.
See “Simpsons writer
says President Trump episode was 'warning to US', The Guardian, 18th March 2016.
[14] B. Eichengreen, “The renminbi as an international currency”, in: Journal of Policy Modeling, 2011, Vol.
33. 5, pp. 723-730.
[15] H. Reisen
(2015), “Will the AIIB and the NDB help reform multilateral development banking?”,
Global Policy, September, https://doi.org/10.1111/1758-5899.12250.