The race between the US Dollar and Chinese Renminbi to be the world’s predominant currency

ERIC PROUZET-UNSPLASH

For nearly a century, the US dollar has been the world’s default currency for international trade and the base currency for foreign reserves of nations. This has given the United States an unprecedented advantage over the global economy.

As one can imagine, such an advantage does not sit well with America’s Cold War enemy, China. In the last 20 years, China has moved to kill the dominance of the US dollar. Is it working? Let’s put it this way — at the turn of the century, 71% of the currency reserves of the world were denominated in US dollars. That number has decreased to just 59% today.

Chinese economic planners aspire for the renminbi to be the world’s predominant currency by the year 2050, and to this end, have designed an elaborate plan to dethrone the American currency. But before I delve into the plan, let me first tell you why the US dollar is the world’s predominant currency.

The United States emerged as the most powerful economy after World War I, gaining even more strength after World War II. It then declared that gold was the true measure of the value of a currency. Thereafter, the Federal Reserve Bank (the Fed) guaranteed that it would exchange an equivalent dollar value for every ounce of gold it received.

The Fed’s guarantee allowed countries with weaker economies and fluctuating currencies to trade with each other with confidence for as long as the medium of exchange was the US dollar. Such confidence paved the way for the greenback to become the preferred currency for cross-border trade.

In 1971, President Richard Nixon suspended the Fed’s guarantee. Even then, no other currency could match the stability of the dollar and strength of the US economy. The world continued to use the dollar as its preferred currency for trade.

The second reason is due to an agreement inked between President Franklin Roosevelt and Saudi Arabian King Abdul Aziz in 1945. In that agreement, the United States agreed to defend Saudi Arabia from external threats and in exchange, the Arabian country agreed to sell its oil exclusively in US dollars. Thus, countries importing oil from Saudi Arabia needed to denominate much of their reserves in the American currency.

The third reason is linked to the US-controlled Society for Worldwide Interbank Financial Telecommunication or the SWIFT system. The SWIFT system is the primary means by which banks around the world transact with each other. It uses the US dollar as its base currency. More than 200 countries are enlisted in the system.

Countries that use the SWIFT system keep their dollar reserves in the US for easy debit and credit. As of the end of 2021, the Philippines had the 25th largest reserves deposited in the Fed, amounting to $52.5 billion. Let’s say only $20 billion is needed for trade transactions, the balance of $32.5 billion is invested in US bonds and equities. And here lies the “undue” advantage of the US. Deposited in the US treasury is a whopping $7 trillion in reserves from various nations, a large chunk of which is invested in the American financial system.

So, how does China plan to dethrone the US dollar as the world’s default currency?

It is all about leverage. Not only is China the country of origin for 20% of the world’s manufactured goods, it is also one of the biggest lenders. As many as 165 countries owe China some $365 billion on the back of official development assistance, mostly for infrastructure development.

About 14% of Chinese loans are denominated in renminbi, hence, debtor countries must maintain a portion of their reserves in the Chinese currency for repayment. But for loans denominated in US dollars, China offers generous discounts if they are repaid in renminbi. This incentivizes countries to maintain the Chinese currency in their reserves.

With a combination of trade and loans, weaker countries like Pakistan have agreed to conduct its bilateral trade with China not in US dollars but in renminbi. Doing so effectively overrides the SWIFT system.

As for wealthier countries, China encourages them to trade in renminbi through a financial tool it calls the Bilateral Currency Swap Agreement (BCSA). In principle, both counties sell their respective currencies to the other at a predetermined rate, pegged to the US dollar. If one country buys goods from China, or vice versa, both can transact in the local currency and bypass the SWIFT system. So far, Beijing has signed BCSAs equivalent to three trillion renminbi with 40 countries including the United Kingdom and the European Central Bank, among others.

Does this mean the days of the US dollar dominance are numbered and the rise of the renminbi unstoppable? Not necessarily. Certain factors still stand in the way of the Chinese currency.

First among them is the lack of transparency on the part of the Chinese government on the true state of its economy. Second, it is widely known that China manipulates the movement of the renminbi to prevent capital flight and currency fluctuations from undermining its export-driven economy. Third, China’s reputation as a disturber of the peace works to its disadvantage, what with its death traps on poor countries and illegal territorial occupation. Fourth, the US still has the lion’s share of the world’s money supply and it can push back against the renminbi.

The race between the US dollar and renminbi rages on. But as we have seen through history, the currency whose mother-country has the largest economy always reigns supreme. It will be interesting to see how this saga unfolds.

Andrew J. Masigan is an economist

andrew_rs6@yahoo.com

Facebook@AndrewJ. Masigan

Twitter @aj_masigan