China has since 1994 operated some form of currency peg, harder or softer, between its yuan and the U.S. dollar. While China’s state-run Xinhua news agency has in recent years railed against U.S. management of the dollar, and has called for “a new, stable, and secured global reserve currency,” this week’s Geo-Graphic illustrates why China has little incentive to press for such a thing.
During the 1956 Suez crisis the Eisenhower administration threatened to create a sterling crisis in order to force Britain out of Egypt. A collapse in sterling would have caused minimal collateral financial damage in the United States owing to trivial U.S. government holdings of British securities – amounting to just $1 per U.S. resident. In contrast, China’s holdings of U.S. securities today amount to over $1,000 per Chinese resident. Any major fall in demand for dollar-denominated assets would cause a collapse in the global purchasing power of China’s massive dollar hoard.
Davos-Klosters, Switzerland, 26 January 2013 - China's currency, the renminbi (RMB), will probably not supplant the US dollar as the world's reserve currency, except possibly "in the very long term", said Lawrence H. Summers, Charles W. Eliot University Professor, Harvard University, and a former US Treasury Secretary, in a televised session at the World Economic Forum Annual Meeting today.
While the RMB will continue to internationalize, "the centrality of the dollar is unlikely to change in a major way," Summers said, adding, "just as there is a basic inertia in languages of communication, there's a basic inertia in mediums of exchange."
John Zhao, the Chief Executive Officer, Hony Capital, however, expects freer exchange of the RMB "will come much sooner than most of us expect." He cited the Chairman of China's Communist Party Xi Jinping's recent trip to Shenzhen, during which he visited Qianhai, a special zone set up for experimentation in RMB internationalization, as a sign of China's intent to globalize its currency.
Summer also spoke of "the reality that China holds some trillions of dollars of liquid financial assets around the world, on which it is earning an extremely low rate of return, while at the same time there are important shortages of investments in key sectors of the world". Huge amounts of capital flowing from poorer countries to richer countries is "unprecedented territory", he said, and will require important deliberations.
The panellists discussed how an ascendant China needs to communicate its intentions to the world. China's world power status arrived decades earlier than expected. "It has been a bigger surprise to China than probably to the rest of the world," said Kevin Rudd, Member of Parliament, Australia, and a former prime minister of that country. He cited a speech given by Xi, in which he spoke of China's "rejuvenation", and the lack of clarity of what that means. China has benefitted from an international rules-based order; the international community "would like to know soon if [China] would like to make changes to the rules," he said.
Gordon Brown, the UN Special Envoy for Global Education, and Prime Minister of the United Kingdom (2007-2010), said that the rise of China is taking place in an interconnected world, a "totally different context than any other power in any other century". He urged international communication among China and other countries.
No less an authority than Goldman Sachs CEO Lloyd Blankfein said at the Clinton Global Initiative last week that the United States could risk its status as the world's reserve currency if congress fails to act and the "fiscal cliff" program of spending cuts and tax increases is enacted January 1.
Actually Blankfein's statement was the reverse of the truth; enaction of the "fiscal cliff" program, halving the US budget deficit at a stroke, is one of the few outcomes that could AVOID the US losing its reserve currency status. But on the assumption that thepoliticians continue to misbehave after November 6, that trillion-dollar deficits continue, and the US does indeed over time lose its reserve currency status, what will a world without a reserve currency look like?
There is no relatively recent historical parallel we can examine to answer that question. The world has had the dollar as undisputed reserve currency since 1945, or really since 1939. Between 1914 and 1939 there were two reserve currencies, the dollar and sterling, with sterling more used in the 1930s than the 1920s, because that decade, once Britain went off the Gold Standard, was a period of robust health for the British economy, while the United States was mired in depression and isolationism. For more than a century before 1914, the world's undisputed reserve currency was sterling, although there were various regional alternatives.
To see a world with multiple reserve currencies, you thus need to go back to a world before sterling's sway, which in practice means before Britain's smashing victory in the Seven Years War (1756-63) took it to both military and economic supremacy.
Lehrman, Lewis E. The True Gold Standard. Greenwich, CT: Lehrman Institute, 2011. ISBN 978-0-9840178-0-5.
Nothing is more obvious than that the global financial system is headed for an inevitable crack-up of epic proportions. Fiat (paper) money systems usually last about forty years before imploding in the collapse of the credit expansion bubbles they predictably create. We are now 41 years after the United States broke the link between the world's reserve currency, the U.S. dollar, and gold. Since then, every currency in the world has been “floating”—decoupled from any physical backing, and valued only by comparison with the others. Uniquely in human history, all of the world now uses paper money, and they are all interlinked in a global market where shifts in sentiment or confidence can cause trillion dollar excursions in the wealth of nations in milliseconds. The risk of “contagion”, where loss of confidence in one paper currency causes a rush to the next, followed by attempts to limit its appreciation by its issuer, and a cascading race to the bottom has never been greater. The great currency and societal collapses of the past, while seeming apocalyptic to those living through them, were local; the next one is likely to be all-encompassing, with consequences which are difficult to imagine without venturing into speculative fiction.
I believe the only way to avoid this cataclysm is to get rid of all of the debt which can never be repaid and promises which can never be met, pop the credit bubble, and replace the funny money upon which the entire delusional system is based with the one standard which has stood the test of millennia: gold. If you were designing a simulation for people to live in and wanted to provide an ideal form of money, it would be hard to come up with something better than element 79. It doesn't corrode or degrade absent exposure to substances so foul as to make even thrill-seeking chemists recoil; it's easily divisible into quantities as small as one wishes, easy to certify as genuine; and has few applications which consume it, which means that the above-ground supply is essentially constant. It is also very difficult and costly to mine, which means that the supply grows almost precisely in synchronism with that of the world's population and their wealth—consequently, as a monetary standard it supports a stable price level, incapable of manipulation by politicians, bankers, or other criminal classes, and is freely exchangeable by free people everywhere without the constraints imposed by the slavers upon users of their currencies.
Now, when one discusses the gold standard, there is a standard litany of objections from those bought in to the status quo.
This book dispenses with these arguments in order. If we step back from the abyss of a financial cataclysm into a past with stable prices, global free trade, and the ability to make long-term investments which benefitted everybody, what's so bad about that? It doesn't matter how much gold there is—all that matters is that the quantity doesn't change at the whim of politicians: existing currencies will have to be revalued against gold, but the process of doing so will write down unpayable debts and restore solvency to the international financial system. A gold standard is inflexible by design: that's its essential feature, not a bug. Flexibility in a modern economy is provided by the myriad means of extension of credit, all of which will be anchored to reality by a stable unit of exchange. Finally, this work provides a roadmap for getting from here to there, with a period of price discovery preceding full convertibility of paper money to gold and the possibility of the implementation of convertibility being done either by a single country (creating a competitive advantage for its currency) or by a group of issuers of currencies working together. The author assumes the first currency to link to gold will be called the dollar, but I'll give equal odds it will be called the dinar, yuan, or rouble. It is difficult to get from here to there, but one must never forget the advantage that accrues to he who gets there first.
European debt problems have kept financial markets on edge during much of the last two years, but it is the debt problem in the United States that is far more likely to precipitate a global crisis.
Recently, Lawrence Goodman, a former crisis-prevention analyst at the U.S. Treasury, sounded the alarm that investors balked at low coupon rates last year, forcing the Fed to buy “a stunning … 61 percent of the total net issuance of U.S. government debt.” His view that ballooning deficits and excessive debt put the U.S. economy and markets at risk for a sharp correction also explains why the recovery is so weak and why trillions of dollars remain sidelined. The other dimension to the story that may trigger the next financial crisis is the loss of the reserve currency status of the U.S. dollar.
What saved the greenback after Richard Nixon removed the U.S. dollar from the gold standard in 1971 — ending the postwar Bretton Woods international financial order — was making the dollar the reserve currency of the world. This began with Saudi Arabia agreeing in 1973 to accept only dollars as payment for oil in exchange for U.S. protection of the Saudi monarchy and its oil fields. By 1975, the reserve currency status of the dollar was firmly established, with all OPEC members agreeing to trade only in dollars. Trading of other commodities has followed suit, which reinforced the dollar’s reserve currency status.
Central banks around the world have maintained disproportionately large reserves of dollars to facilitate trade, which enabled the United States to print excessive amounts of its currency with seemingly little inflationary consequences. The reserve currency status has also allowed Americans to import more than they exported, to consume more than they produced, and to spend more than they earned
But all that is about to change.
The U.S. dollar is already being abandoned by a number of countries in favor of the Chinese yuan. In December, Japan and China agreed to dump the dollar and trade in yen and yuan. China’s trade with Vietnam, Thailand, and Russia is now also settled in yuan. In January, the 10 nations of the Association of Southeast Asian Nations strengthened the linking of their economies with those of China, Hong Kong, Japan, and South Korea with a $240 billion equivalent nondollar credit agreement, thus moving further away from the dollar.