A seismic move that might flow from last week’s meeting between China’s President Xi Jinping and Gulf Arab leaders in Saudi Arabia is news that the latter is actually considering China’s offer to buy oil and gas in yuan. Such a decision, long sought by China, would support Beijing’s goal to establish its currency internationally as a substitute for denominating world trade in dollars. This would weaken the U.S.’. overwhelming control over trade and allow China to flex its power along this critical avenue.
The precedent that China is hoping to follow, of course, is the US dollar replacing the British pound sterling after WWII as the major currency for world trade, after two hundred years of dominance. After two World Wars and the Great Depression, the US economy had far surpassed the British, and with the new global financial institutions such as the Bretton Woods IMF and World Bank under their effective control, the dollar was facilitated to become the world reserve currency.
However, as one commentator has argued, “A successor reserve currency would need to have a large enough economy with capital markets open to foreign investors with perceived-to-be-fair trading markets and well-regulated institutions. Foreigners who wind up holding the reserve currency will be subject to the rule of law of the reserve currency country, such as it is. Even if they simply keep it in cash at a bank in their country, they will need either to have a banking license in the reserve currency country or be a correspondent with one of its banks. And that correspondent agreement will be subject to reserve currency country law. If the foreign party would rather hold securities, the foreign party again has to be mindful of the integrity of securities regulation and the oversight of brokers and exchanges.
Ironically, the US model of highly efficient markets with investors having extremely weak governance rights helped support the US as a reserve currency. The US could tolerate having foreign investors in public US companies so long as they did not buy a stake in a perceived-to-be-important player big enough to give a foreign owner influence. The US does meddle if that looks likely to happen.
The Euro was once seen as a potential competitor to the dollar, but its protracted post-Global Financial Crisis banking/sovereign debt crisis, which was never fully resolved, put paid to that idea.
The Chinese renminbi is the logical successor to the dollar, but China does not seem willing to take the steps to have that happen. In the post-Bretton Woods regime, a country wanting to have its currency serve as a vehicle for transactions outside the country (as in independent of bilateral transactions with the country) needs to get in circulation outside its borders. That means running trade deficits. China (would never be) willing to do that, since a trade deficit is tantamount to exporting jobs. Wage growth and high levels of employment are imperative to the legitimacy of the regime.
China would also need open capital markets, transparent regulation, credible measures to prevent bad practices like front running and insider trading, and at least a reasonable prospect that foreign investors who got into disputes with their bank or broker would be treated not much worse than locals when seeking recourse (as in officials and courts need to realize that giving foreigners too much of the short shrift is bad for business).”
As another analyst concluded, “(D)o not expect some overarching alternative to the dollar as a global reserve currency to be in place any time soon. Institutional stickiness and the relative lack of attractive currencies to hold drive that, as well as the realization that a Euro / SDR / Keynesian Bancor-type arrangement concedes national sovereignty. Instead, we are likely to end up with a multiplicity of arrangements associated with bilateral relationships between “non dollar” states who may choose to hold each other’s currencies on a portfolio basis, for example.
However, the dollar will likely stay hegemonic as a reserve currency in the “western” bloc.
