Exactly a decade ago, I wrote an article called “Of Eagles and Dragons”. The US economy was slumping a bit, and there was talk (even panic among some) about the prospect of China overtaking the US, and the yuan replacing the dollar.
Today we’re hearing much of the same rhetoric, and I’m going to remind you, again, why that’s unlikely to happen any time soon.
For this installment, let’s address the notion that the dollar will soon be replaced by the yuan because it’s, frankly, farcical.
In order for the dollar to be overtaken by the yuan, economies would need to simultaneously stop wanting dollars and start wanting the yuan as a replacement.
Today, the US dollar represents more than 60% of foreign currency reserves (a further 20% being in euros), and the yuan constitutes less than 3%. The dollar is used in roughly 80% of trade worldwide, which is roughly the same as in 1989 (when Japan was the boogeyman of choice). The world is hooked on dollars.
The United States has had the largest economy in the world since 1890. Its ability and willingness to pay its debt obligations without default has meant that people and economies around the world could depend on the dollar as a stable store of value. Some nations even use the dollar as their official currency, and in many others the dollar is more highly prized than the local currency.
In order to entice the world to hold yuan, the Chinese government would need to relinquish control over its exchange rate. Giving up control over anything is not something the Chinese communist party is known to be keen on, but let’s pretend for a minute that it did just that.
One of the first things to happen is that every Chinese citizen who could, would run out to exchange their yuan for some other currency. Given their druthers, not even the Chinese populace trusts the Chinese government, and they’d much prefer to hold euros or dollars.
If you don’t believe it, here’s a short story.
In 2014 I visited Argentina. At the time the currency exchange rate was very tightly controlled at about 8 pesos per dollar. The general population, however, didn’t trust their government, and didn’t want pesos, and I could go out on the street, literally, and buy pesos at a rate of about 12 per dollar. In other words, the people were willing to pay me a 50% premium rather than hold their own currency. Since then, the government has stopped controlling the exchange rate, in the same way China would need to.
Go ahead and Google “USD to ARS”, and see what the rate is today…
So, while the Chinese economy is far better than that of Argentina, in principle, something similar would happen, and the value of the yuan would crash. That’s certainly not something people want to see in a reserve currency.
Consider that Chinese billionaires are buying up incredibly expensive real estate in Europe and North America, and many of these properties are never seen, let-alone lived in. One simple reason for this phenomenon is that these Chinese nationals are using foreign real estate as a store of value that is well out of reach of the Chinese government, and denominated in currencies other than the yuan.
Let’s suppose that the yuan, by some miracle, became freely traded without wrecking its value; it would still need to be seen as a safe alternative to the US dollar in order to gain market share.
Roughly 25% of China’s currency reserve is in US dollars. There are some who say China could dump the dollar and crush its value. Consider, however, that there are two sides to every transaction. In order sell its dollars, it’s got to find a buyer. Who is going to buy all of those depressed dollars, and what will China be trading them for?
The reality is that the US dollar is so widely held, with the US issuing more debt daily, that it is in no nation’s interest to destroy the dollar, and certainly not in favor of the yuan.
Conceivably, the only way the US dollar loses favor in the foreseeable future, is if the US government destroys it itself, through poor fiscal and monetary policy. A massive default, and the ensuing sprint to safety would likely benefit the euro, pound, Swiss franc and yen, but hardly the yuan.
Stephen Kyne, CFP® is a Partner at Sterling Manor Financial in Saratoga Springs and Rhinebeck. Securities offered through Cadaret, Grant & Co., Inc. Member FINRA/SIPC. Advisory services offered through Sterling Manor Financial, LLC, an SEC registered investment advisor or Cadaret Grant & Co., Inc. Sterling Manor Financial and Cadaret, Grant are separate entities.
