China and the Dollar's Global Reserve Currency Status
In 1993, U.S. News & World Report invited politicians, business leaders, academics, and others from around the world to submit questions that they believed would be vital at the end of the next 60 years for inclusion in their 60th anniversary edition. Presidents of major universities were asked to encourage their faculty to participate and many of them did including the president at the University of Virginia where I taught.
As a strategy and leadership professor, I decided to submit a question that I knew would be important, but I really didn't know when it would become important. It had to do with China. This was my question: "How can the United States ensure that it is granted most-favored-nation trading status with China which will be the world's lone superpower?"
I realized that China was on a trajectory that would enable it to surpass the United States economically and that there is a close connection between economic and military prowess. It wasn't that China's economy was setting records at the time, but China's leaders were committed to economic development and U.S. leaders were more concerned about eating the seed corn. In due course, it was obvious to me that our lackluster performance by comparison would catapult China to the prized status that they were seeking.
It didn't take 60 years for my prediction to come true. It's happening now, and only 20 years have passed. The editors at U.S. News & World Report must have realized that I was on the right track because they published my question. It appears on the same page with questions submitted by Ronald Reagan, Hillary Clinton, Mikhail Gorbachev, Helmut Schmidt, and Oliver Stone to name just a few.
China's rise is of utmost importance and at this very moment China's leaders are positioning their country to usurp U.S. global hegemony. According to yesterday's Catholic Online,
The Chinese and Australian move to oust the U.S. dollar as the world's reserve currency gained full steam over the weekend with Australian officials agreeing to start making direct currency exchanges with China.
This will ultimately harm the U.S. economy, although only slightly in the short term. In the long run, as other countries join Australia, it could unseat the U.S. dollar as the world's reserve currency.
The U.S. dollar has been the world's reserve currency since the end of World War II, when it was made such by deliberate international agreement. As reserve currency, most international exchanges are made with the U.S. dollar. This requires foreign traders to convert their money to U.S. dollars to enter the market. When cashing in their profits to spend at home, traders must usually exchange their dollars back into their native currency.
Australia isn't the only country joining hands with China. A few days ago, Brazil and China agreed to a $30 billion currency swap that is aimed at achieving the same objective, and a few months ago, China made a move to begin buying oil from Iran with yuans:
Iran's yuan-for-oil payments won't catch on, yet. Tough sanctions from the United States have pushed the Islamic Republic to accept the Chinese currency as part-payment for crude exports to the People's Republic. But while the yuan should play a bigger role in the world's energy settlements by the end of the decade, Iran's shift won't be the catalyst.
It makes sense for China to use its own currency to pay for oil imports. The move transfers foreign exchange risk away from the world's second largest oil consumer and supports the government's long-term drive to establish the yuan as an alternative global reserve currency to the dollar.
For Iran, the yuan trade is more a matter of necessity than desire. Sanctions have made it hard to deal in freely convertible dollars or euros - the currency of Chinese oil payment to Iran since 2006 - so it has been forced to let its largest customer pay in its own non-convertible currency, just as it let India pay in non-convertible rupees.
I wrote about the importance of this issue in a blog for American Thinker in February:
As the dollar loses the protection provided by its global reserve currency status and countries are no longer required to stockpile dollars for oil trades, the dollar will rise or fall in value based on the strength of the U.S. economy. So will interests rates and inflation. Unfortunately, with deficit spending looming for as far as the eye can see and our debt burden growing more ominous every day, that doesn't bode well for the dollar's ability to compete on an even playing field.
Our government officials in Washington should have dealt with our debt and deficit problems before our economic situation deteriorated to a crisis point, but they didn't and calamity is just around the corner. For example, our penchant for routinely spending more than we collect in tax revenue, subsidizing able bodied men and women who contribute virtually nothing to our economy, paying the bills of illegal aliens who should not even be in our country, and ignoring our burgeoning debt problem because interest rates are at historically low levels have the effect of weakening our economy at a time when we should be doing everything that is humanly possible to shore it up.
I'm not the only one ringing the alarm bell. According to David Stockman, former Director of the Office of Management and Budget (OMB) under President Reagan,
So the Main Street economy is failing while Washington is piling a soaring debt burden on our descendants, unable to rein in either the warfare state or the welfare state or raise the taxes needed to pay the nation's bills. By default, the Fed has resorted to a radical, uncharted spree of money printing. But the flood of liquidity, instead of spurring banks to lend and corporations to spend, has stayed trapped in the canyons of Wall Street, where it is inflating yet another unsustainable bubble.
When it bursts, there will be no new round of bailouts like the ones the banks got in 2008. Instead, America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today's feeble remnants of economic growth.
It's no wonder that Chinese leaders think that now is the right time to make a move on the dollar. President Obama doesn't have enough economic sense to understand the situation. When he's not vacationing, he's telling the American people that the 1% of our fellow citizens who pay roughly 40% of federal income taxes aren't paying their fair share while the roughly 50% of Americans who pay no federal income tax are being victimized. That's ludicrous, but it sells well among the chronically ignorant.
Meanwhile, seemingly unbeknown to President Obama, the U.S. faces imminent economic peril. When our economy nosedives and inflation and interest rates begin to soar, all of us will pay a high price for his incompetence.
Neil Snyder is the Ralph A. Beeton Professor Emeritus at the University of Virginia. His blog, SnyderTalk.com, is posted daily.