Chinese yuan replacing US dollar as global currency: A not so distant prospect

Susmit Kumar, Ph.D.

Published at South Asia Monitor on May 1, 2016

During World War II, only the US and UK deliberated about the future of global economy, culminating into the 1944 Bretton Woods Accord. At that time, entire Europe was under Hitler and countries like India and China did not have any economy to have a say in the Accord. Under British Plan, which was rejected, there would have been one Global Currency (say Bancor) manage by an international bank and also an International Clearing House to oversee export and import of each country. 

The British team was led by none other than John M. Keynes, a genius in economics. Keynesian stimulus plan is named after him. That “neutral” world currency would be exchangeable with national currencies at fixed rates of exchange. Under Keynes’ plan, both debtors and creditors would be required to change their policies. A country with a large trade deficit would pay interest on its account and devalue its currency to prevent the export of capital. On the other hand, a country with a large trade surplus would increase the value of its currency to permit the export of capital. 

A country with a Bancor credit balance more than half the size of its overdraft facility would be required to pay interest on it. Keynes went so far as to propose the severe penalty of confiscation of surplus if at the end of the year the country’s credit balance exceeded the total value of its permitted overdraft. But the US was able to impose its dollar as global currency, as UK was entirely dependent on US, even for food. It also created institutions like IMF where nothing can happen without the wishes of the US. In IMF, nearly all decisions require 85% vote and US, with 16.72% vote share, is the only country which has more than 15% voting share with Japan being the 2nd largest with 6.56% vote share.

Till now taking advantage of dollar being the global currency the US has been funding its twin deficits – trade and budget deficits, by printing its currency whenever it wants. The United States imports goods and services from other countries by simply giving them pieces of paper i.e. dollars. Countries like India, Brazil and South Africa have to “earn” dollars to pay for their imports whereas the US has to just “print” the dollar to pay for its imports. In return, the manufacturing and service-providing countries deposit majority of the same pieces of paper in the United States. It is nothing but a Ponzi scheme run by the United States. According to economist Allan H. Meltzer at Carnegie Mellon University, “We (United States) get cheap goods in exchange for pieces of paper, which we can print at a great rate.” 

It is a little known fact that the Soviet Union collapsed because it could not get external funding for modernizing its economy under Mikhail Gorbachev’s Perestroika and Glasnost policy. There was drastic reduction is price of crude oil, the main Soviet export, during late 1980s and early 1990s after the end of Iraq-Iran War (1980-88). Crude oil price dropped from an average of $78.2 a barrel in 1981 to as low as $7 a barrel one time. These two factors led to a rise in Soviet external debt. In 1985, Soviet oil earnings and net debt were $22 billion and $18 billion, respectively, whereas these numbers in 1989 were $13 billion and $44 billion, respectively. By 1991, when external debt was $57 billion, creditors, many of them major German banks, stopped making loans and instead started demanding repayments, contributing to the collapse of the Soviet economy. Had oil prices increased, like it did during early Putin administration (2000s) or had German banks financed Gorbachev’s Perestroika and Glasnost like Japan and China financed US debts since 1980s, the USSR and communism would not have collapsed in 1991. 

Unlike the Soviet Union, the US has been getting external funds from Japan during 1980s and 1990s, and thereafter from China, in form of treasury bond investment as well as foreign investments in its private sectors and other government bonds, like Fannie Mae and Freddie Mac bonds. Till last year, both Japan and China had more than $1 trillion US Treasury Bonds, each. Even countries like India and Russia had nearly half of their FOREX invested in the US financial system. 

But in last several years, China has become the number one trading partner, replacing the US, of nearly all major countries. For an example, China has become the number one trading partner with the entire Africa continent. It is using its currency yuan, instead the US dollar, as the mode of transaction with its trading partners. In 2009, only 1% of Chinese trade was in yuan whereas in 2014, 19% of Chinese trade was in yuan. As per HSBC CEO, more than 50% of Chinese trade would be in yuan by 2020. Hence in next several years, yuan is going to replace the US dollar as the mode of transaction in global trade. Describing the stranglehold of China over the US economy, Richard Haass, President on Council of Foreign Relations, a premier US think tank, said: 

"Essentially the U.S. took advantage of Britain's Sterling problem to exercise economic leverage over the British government, and that led to a hasty retreat in the 1956 Suez War (despite defeating the primitive Egyptian army on all the fronts, the invading forces had to withdraw). So one can imagine a situation nowadays, where, say, there is a crisis over Taiwan between the U.S. and China—which holds a significant number of dollars—and one can imagine the Chinese might be prepared to threaten the dollar, make some comments to weaken it unless the U.S. backs off some of its support of Taiwan.” 

In 2009, the Pentagon for the first time held a series of economic war games exercises. The soldiers were Wall Street traders and executives, economists, and academics. The weapons were stocks, bonds, and currencies. The participants were divided into teams: the US, China, Russia, Japan, the EU, and so on. Then the teams were presented with different scenarios—North Korea is imploding, a major global economy is melting down—and told to do what was in their best interests. What the exercises showed was that the United States consistently lost to China in economic warfare. China won, without so much as reaching for a gun. 

After creation of two international financial organizations by China, Asian Infrastructure Investment Bank and New Development Bank (formerly BRICS Bank), the IMF and World Bank, dominated by the US, are bound to lose their status to the former two. Once UK joined the Asian Infrastructure Investment Bank, against the wishes of the US, all Western countries, except the US, Canada and Japan, joined it. Commenting on it, Lawrence Summers, ex-US Treasury Secretary and ex Harvard University President, wrote, “[it] may be remembered as the moment the United States lost its role as the underwriter of the global economic system. I can think of no event since Bretton Woods comparable to the combination of China’s effort to establish a major new institution and the failure of the United States to persuade dozens of its traditional allies, starting with Britain, to stay out.” 

Since last year, China has started to sell its dollar holdings, reducing it to $3.2 trillion from near $4 trillion, as per its plan to get rid of dollar as global currency. It is just a question of time that both the former banks would start to lend money in yuan, leading to the collapse of US dollar status as the global currency. Once the US dollar loses the status of global currency, the US economy would collapse in the same way the Russian economy collapsed in late 1980s. But China would not be able to impose its will on the global economy. Instead the collapse of US economy would lead to the global Great Depression. The world will not have an option but to implement the British proposals during the deliberation before the signing of 1944 Bretton Woods Accord.

Copyright Dr. Susmit Kumar 2016

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