May 3, 2022 - 1:31pm
Last month a debate was raging in financial markets about whether the seizing of Russia’s foreign exchange reserves signalled the end of the US dollar as the world’s reserve currency. There were multiple theories as to how this might happen. I pointed out that China might start to dump their enormous US dollar reserves to prevent them being seized in the case of military action in the South China Sea.
On Saturday The Financial Times reported that the Chinese central bank and finance ministry held an internal conference discussing how to protect against potential US seizures of foreign currency reserves. Around the same time, leading Communist Party intellectuals were discussing the possibility of dumping US dollar reserves to protect them from seizure.
China has by far the world’s largest reserve holdings. At $3.2trn it dwarfs Japan, which comes in second place with $1.3trn. Since China is by far the largest holder of US dollar reserves, this looks like the beginning of the end of the US dollar as the world’s reserve currency.
If it happens, this will be the single largest economic development since the Second World War — when the US dollar was made the reserve currency at the Bretton Woods conference. By consequence, it would almost certainly mean that Western countries are going to see a sharp drop in living standards over the coming decade, as consumers see inflation eat away at their wages.
The sad fact is that many wealthy Western economies have allowed their manufacturing base to be completely hollowed out over the past 50 years. These countries import much of their manufactured goods from countries like China. In exchange for these goods, we send paper money which is then recycled into paper debt — mostly government bonds. China currently holds just over $1trn in US government debt. Until now, the developing world accepted this arrangement because it helped them develop their economies. No longer.
So, how will this rebalancing work? Presumably, countries like China will be far more reticent to hold Western currencies and debt due to fears that these can be seized. As they move away from accepting our paper, Western currencies will decline relative to currencies like the yuan. Chinese products will thereby become more affordable for Chinese people and less affordable for us. In the West, prices will rise, and wages will not keep up.
Does this hurt China in any way? It will mean that they will have to rely less on exports to the US to grow their economy. But the Chinese economy is far less reliant on trade than it was in the past. Back in the mid-2000s, China ran current account surpluses of anywhere between 7-10% of GDP. During this period, China was completely reliant on the US buying imports to develop and grow, but since the financial crisis of 2008-09, it has moved away from relying so heavily on trade for their economic growth. As of last year, the Middle Kingdom’s current account surplus was just under 2%.
Meanwhile, the US appears to be losing the biggest point of leverage it has over world affairs. If the US dollar becomes just one currency among others, its status as a global superpower will be under threat. This is an extremely serious development — arguably the most serious since the invasion — and it is incumbent on our leaders to develop a response to it. The sands are shifting beneath are feet and yet very little is being done to stop it.
Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics
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SubscribeExcellent article that rightly shines a light on how catastrophic such a currency shift will be for the west. Those naively cheering on the Russian sanctions will eventually realise that it was an act of great stupidity.
Do you not think this would have happened eventually anyway, regardless of the wests sanctions on Putins regime? As China became more assertive and less reliant on the west for its economic development, they were never going to want to be subservient to the US dollar. With an increasing number of developing countries trapped in Chinese debt it is able to exert massive influence on those countries to dance to Chinas tune.
While Ukraine may have sped up this process, I believe it was largely inevitable the financial world would become more fractured anyway
I agree it was going to happen eventually. I’m interested to see how China manages to escape the zero covid trap it set for itself. The massive lockdowns are starting to hamstring its economy and that will impact its geopolitical ambitions.
Perhaps the lockdowns will finally end when Xi Jinping is ratified as President for another term later this year and then he won’t pay a heavy political price for backing away from zero covid.
“On Saturday The Financial Times reported that the Chinese central bank and finance ministry held an internal conference discussing how to protect against potential US seizures of foreign currency reserves. Around the same time, leading Communist Party intellectuals were discussing the possibility of dumping US dollar reserves to protect them from seizure.”
It certainly makes sense that China and Russia, and probably many countries in the developing world, will try to diversify away from the dollar. Mr. Pilkington’s article appears, however, to be based on little more than hearsay.
Can we trust information about discussions within the Chinese finance ministry? Was it a strategic leak designed to send a message to the US about possible Chinese action at a time when, as has been reported, many barriers remain to the Chinese developing a parallel financial system, not based on the dollar, that avoids, for example, the SWIFT monetary transfer system?
“If the US dollar becomes just one currency among others, its status as a global superpower will be under threat. … it is incumbent on our leaders to develop a response to it.”
I would be interested to read an article by Mr. Pilkington describing possible responses to the Chinese and others moving away from a dollar-denominated financial system. What can the US do to stop this trend? Will their response be entirely obstructive, preventing countries that want to trade primarily in renminbi from doing so (and thereby opening the US to charges of financial imperialism)? Or are there ways to encourage the continued use of the dollar as the global reserve currency? And what will the US’s attitude to sanctions be in future? If it continues with the aggressive use of sanctions it risks further undermining the dollar’s role as reserve currency.
Thanks to Mr. Pilkington for another thought provoking article.
Some great observations and questions there. Hopefully Mr Pilkington will write a further article addressing some of them.
The Biden administration must have known the Russian sanctions will speed this process up, there are so many brilliant economic advisers there. So this could be a deliberate action though I don’t yet see to what end. This could just mean they are much smarter than I.
I have a feeling that a lot is going on behind the scenes. The Petrols are sensing weakness and are thus negotiating for better deals. It will take a long time for the US to retool if the value of the dollar drops significantly, as it slowly becomes a net exporter, again.
As someone in an industry that can be helped by a weaker dollar, I want to cheer such a move, but I know the road will be rocky.
Excellent approach, it is required to control the only power broker in the world. US on the basis of the financial upper hand controls the nation to follow their objectives. With the balance of power the balance of economy will come and will lead peace.
I think the biggest reserve holder is Saidia, who slowly withdrawing from reserves. In any case, the countries who maintain reserves have right to withdraw from reserves for spendings. When US secretly promoted Arabspring to create political destability in Middle East, Saudi withdrew large sums from the reserves, which US never dreamt about the consiquences.
Bitcoin fixes this.
Literally two days later Unherd posts an article about Turks turning to Bitcoin because of it’s stability relative to the free fall of their government issued currency.
https://unherd.com/thepost/as-inflation-soars-turks-flee-to-crypto/
Bitcoin’s inflation is a fixed, known amount, that continues to diminish. Do you really still think the US dollar inflation is “transitory?”