Forget the Yuan: King Dollar is Here to Stay

Many believe deficit spending will kill the US dollar as a reserve currency and the yuan will take over. They are wrong.

Economist Daniel Lacalle asks Can China Really Kill The US Dollar Supremacy?

>Why China Will Fail to Dethrone the US Dollar

First, because it wants the world to widely accept the Yuan while maintaining monetary repression via capital controls. As the British say, they want to “bake the cake and eat it.” What kind of global reserve can be created when capital controls are imposed? None. No economic agent will accept it.

Second, because most economic agents are aware that the huge imbalances of the Chinese economy will likely be disguised with a huge devaluation. The average of estimates assumes between an 18% and a 20% additional devaluation against its main trading currencies in the next five years. The more this inevitable correction is delayed, the less the possibility of reinforcing the credibility of the yuan as a world reserve currency.

Third, the financial balance is against them. The reason why China maintains completely obsolete capital controls is that domestic economic agents, as soon as markets open, do everything possible to get rid of their yuan in the face of the evidence of a huge devaluation. That is why China has lost almost one-third of its reserves in foreign currency in a few years.

The only way in which China and Russia could pose a threat to the US dollar would be to defend sound money and end the disastrous monetary policy that governments are conducting. A commitment to a return to a gold standard and avoid massive money supply increases. However, that does not seem to be the case, rather to spread China’s monetary imbalances to the rest of the world.

Yuan Use in Global Transactions

The US dollar is not only the most traded currency in the world but its use has increased since 2013 from 87% to 87.6% of global transactions according to BIS data from 2016. The total is 200% not 100% because currency transactions count twice.

The yuan is only used in 4.0% of transactions even though China accounts for over 15% of the world economy.

Lacelle stated "A currency is not a world reserve because it is decided by a government or group of them or because it is imposed militarily. If a currency could have been imposed by military might or political repression, the Soviet ruble would have been a world reserve currency, and the Chinese yuan would not be a mere 4% of world transactions. A currency is a global reserve when confidence in it as a means of payment and reserve of value is maintained throughout the world in the face of the evidence of risks with local currencies."

Lacalle is correct on that point and also points one through three above. There are additional reasons Lacelle missed.

Addition Reasons King Dollar Will Remain King

  1. The US runs a continual trade deficit with much of the world. As a result, foreign countries mathematically "must" accumulate US dollar assets. This mathematical necessity should be at the top of any list.
  2. The US has the largest, most open bond market in the world despite constant meddling by the Fed. China does not have a bond market of any size worth mentioning. Bond markets are critical. When foreign countries accumulate US dollars via trade surpluses, they must put those dollars somewhere. That somewhere is US treasuries. China's bond market is in no shape to compete globally.
  3. The EU's bond market is arguably big enough but the Euro is a fatally flawed currency, the Eurozone bond market is more manipulated than the US bond market, and Germany is still running huge trade surpluses. Those surpluses explain why Euro-denominated trade fell from 33% to 31% of transactions.
  4. The yuan does not float. The yuan might crash if it did float. This is why China needs capital controls, a point Lacelle mentioned.
  5. China has a repressive society with no freedom of speech, freedom of movement or persons or capital, and no court system that anyone could every trust.
  6. China does not respect property rights. Until it does, don't expect people to hoard the yuan.

The increase in the use of the dollar in trade is not despite increasing trade deficits, but because of them.

Expect the dollar to gain global trade share regardless of the value placed on a dollar. Trump's budget busting deficits will lead the way.

It's important to understand that we are talking about the dollar's role in trade, not the value of the dollar itself.

I fully expect a currency crisis at some point, and I also expect it will start outside the US. Why? For all of our problems, I see bigger problems elsewhere.

Where? When?

To both questions, I don't know.

Meanwhile, every month we see articles on the death of the dollar, by China, by SDRs, etc. Ignore the hype.

Mike "Mish" Shedlock

Comments (9)
No. 1-9
Snow_Dog
Snow_Dog

The Thai baht, of all damn things, was implicated in starting the “Asian Contagion” back in the 1990s. Who knows where the next melt down (melt up?) will occur. Tons of new debt added to the global bonfire kindling in the last ten years.

Maximus_Minimus
Maximus_Minimus

So you have to have a deadbeat government that cannot control it's spending to have a vibrant bond market, and run continuous trade deficits so foreigners accumulate your currency, which they recycle into your bonds. What a brilliant strategy!

killben
killben

"Where? When?"

May be Italy, may be Mar 4, 2018. Europe is probably where the fun starts!

formula57
formula57

The British expression is "have their cake and eat it too" (i.e. want to use something but still (impossibly) retain it for future use) rather than “bake the cake and eat it" (which presumably means create something and then consume it). So, per the author, China wants to have its cake through the world using the Yuan but simultaneously wishes to eat it by keeping capital controls.

philbq
philbq

To support your point, Mish: Chinese with money are desperate to get their money out of China and the yuan and turn it into Western assets. Here on theWest Coast, Chinese money is pouring into real estate from Vancouver and Seattle to California. Chinese want to recycle their yuan into dollar-denominated assets. They have no confidence in the yuan or their government. Their economy is run on government debt.

philbq
philbq

Adding to the fear is the intent of Xi to be dictator-for-life. So people just want out.

sebmurray
sebmurray

You mean you don't think Bitcoin will unseat the dollar? /sarc

ElPoquitoGrande
ElPoquitoGrande

...until your children can't afford rent or a mortgage because the foreigners have bought up your country. It's the repatriation of 30 years of Everyday Low Prices.

KidHorn
KidHorn

What exactly is a reserve currency? It's whatever currency foreign countries hold. So it seems the US is a reserve currency simply because we run big trade deficits with countries. There's absolutely no reason for any country with a large economy to have any cash reserves at all. They can print whatever they need and people will take it. IMO, the biggest competitor to the USD is gold. Not another currency. When countries use their excess USD to buy gold, then that will be the beginning of the end of the USD as a reserve currency.