The BRICS Summit of September declared the establishment of Yuan led international payment in local currencies among BRICS members and also a BRICS credit rating agency. China in August offered Saudi Arab government to accept Chinese currency yuan for oil trade but Saudi leadership rejected the offer. As an important development Venezuela, Russia, and Iran are ready to accept the China’s Gold-Yuan-Oil scheme, Iraq may join soon as well.
This is followed by China’s support for UNO investigation in Saudi led Yemen war and announcement of Venezuela to sell oil in Yuan. So it can be said that finally, the most awaited moment of challenging US Dollar global domination is coming. Here we will discuss how U.S. dollar reached a situation where it is proving to be a liability not only for non-U.S. economies but also the productive economy of U.S. and why since 2007 financial crisis, the objective condition for US Dollar domination is dying out.
What is currency?
Money has two main functions: medium of exchange and store of value. There can be both metal money as well as paper money. The metal money has gold or silver in it with its own intrinsic value in it. A state can issue paper money when it can offer something like gold or silver or any usable which has value in return for paper money. Now the question comes on what does the value of paper money depend on? Definitely, it depends on the amount of gold or silver or different usable that the state has at its disposal to offer the paper money it issues. The amount that the state has depends on the amount its economy can earn from the other economies and also how much gold and silver it produces. That means how much the country exports and how much earned gold, silver, foreign currency reserves the state has. This is why before Brettonwoods Agreement collapse in the 1970s, currencies are linked to gold, silver, etc. This means each country’s currency can be converted into gold in a definite ratio.
Condition for Global Domination of a Currency
In global transactions which currency will be used is determined by the relative economic and military powers among different states. On economic grounds, the state which commands most of the global production can dictate the terms of which currency to be used in global transactions. In short, the largest economy whose production and market are sought after by people of countries beyond that state’s authority can make its currency global currency. But if that state’s military power is not relatively strong then the other states can bargain for their own benefits in global transactions. A state with the relatively weaker economy but the stronger military can respond in two ways: either enforce rent from the superior economy and buy products out of that rent or use force on the superior economy to give credit and continue to live in debt. Is the second option feasible in the long run? To understand the feasibility we have to understand global currency as a store of value.
Global Currency as Reserved Value
When a currency is used in global transactions, many countries will like to reserve some of those currencies for future consumption. Thus, the currency needs to be deposited somewhere. Usually, this is done by different countries by investing in the assets of the country that issues the global currency. If a state representing both stronger economy and stronger military issues global currency then it offers the huge amount of production for the global market as well as huge room to invest for global investors. But if the state represents a strong military only and the weaker economy, it leaves not only a few products for use but also little room for investment. Since the weak economy gives little chance to invest, it has little capacity to absorb credits as well. So the system of imposing currency by a state with a weaker economy and stronger military is not sustainable. Either it has to squeeze rent from the stronger economy or accept currency of the later for international transactions.
Rise and Fall of Bretton Woods Agreement
The U.S. was largest global exporter after World War II, therefore US dollar has been considered natural global currency since 1944 Bretton Woods Agreement. Then, the US dollar was pegged to gold at ratio one ounce of gold equals to thirty-five cents. But by early 1970s Japan and Germany were conquering the global market and that shook the foundation of the U.S. as largest exporter. When Germany asked for gold against U.S. dollar, U.S. failed to do so and Bretton Woods Agreement collapsed. Since then, the U.S. dollar was no longer linked to gold and its price was determined by demand and supply mechanism of the market. The supply of a currency is determined by Central Bank. The demand for a currency is rising or falls when demand for that country’s products in the global market and demand for investing in that country’s assets rises or falls. Since USA was losing its early top exporter rank yearly 1970s the only way it can boost the demand and hence the value of US dollar is by creating massive demand for US assets.
Rise of Finance
Since 1970s finance or asset trading became very important. This is because the U.S.’s economy faced with lack of profit-making investment opportunities in production start to make profits by buying assets cheaply and sell them, dear. This is done by channeling credit to asset market and inflating asset prices. The constant flow of credit to USA asset market is ensured by petro-dollar geopolitical arrangements. According to this arrangement, Saudi led OPEC cartel will sell oil only in US dollar. The USA was then, the largest importer of oil. Since oil is required by all countries in the modern world, all countries have to use US dollar for buying oil. This created an artificial global demand of US dollar which does not require the previously mentioned conditions for global domination of a currency. This demand to use US dollar in global transaction gives rise to the desire to deposit US dollar for future use. Thus entire world began to chase US assets for depositing US dollar. This huge demand for US assets was created. In this way, US financial capitalism started to fledge.
Impact of Finance
If there was no chance to form petro-dollar arrangement then there would have been no chance to form financial profits. In that case, the only option left for the U.S. would have been to devalue U.S. dollar and make U.S. production globally competitive and expand the economy through exports. Given lack of profitable investment opportunities in production, it can be said that the U.S. like most other developed economies would grow slowly with a considerable trade surplus and net exports. But petro-dollar and financial profits took U.S. in opposite direction where the U.S. started to specialize in finance, its production became globally less competitive and entire manufacturing base gradually shifted to Third World countries mainly China. Thus in terms of real economy, U.S. has actually destroyed its production and has created a debt led economy. With top rank military and a weakening economy, U.S. managed to draw credit from the rest of the world and live in debt by using petro-dollar and U.S finance.
Transformed Global Economy
In 1987, the Chinese economy was just 10% of USA economy. By 2000 it is 50% and by 2015 it is 115%. As the USA was concentrating on finance China gradually became a global manufacturing hub. Today 90% of smartphones and laptops in the world are created in China. China gradually became world’s largest exporter. China had world’s largest foreign exchange reserves. By August 2017 China’s forex reserves are USD 3.1 trillion. China has become not only largest earner from exports it also provides huge opportunities for global investors. Thus China’s currency RMB (yuan) has complete chance to become the global currency. But the problem is in the financial capitalist stage, finance gives much more room for profit-making non-productive investment than production. So the champion of finance USA continues to generate demand for US dollar much more than RMB whose demand depends mainly on production.
Though US dollar has huge financial demand, the real basis of its demand is petro-dollar arrangement which forces all countries to store in US dollar. All countries store in the dollar by buying Treasury Bills of Federal Reserve of USA. China being the largest exporter and the largest recipient of foreign investment hold the largest value of Treasury Bills. Japan, Saudi, India come next. It is this real demand for storing global income in US dollar upon which USD 800 trillion value of US derivative market (global GDP is just USD 75 trillion maximum) is based. Once the real external debt is one, internal debt based asset value will be reduced to nothing.
This is why China is gradually shedding its Treasury Bills investment since last five years. Instead, China is now buying more gold gradually. China is also the largest producer of gold in the world. Thus China is able to launch a scheme where if an oil selling country sells China oil in RMB then the oil selling country can convert RMB into gold whenever it wants. It is partly returned to the pre-1970s system where currency was entirely pegged in some ratio with gold. In this case, China is making RMB convertible to gold only to oil selling nations to win them over from US dollar. If this scheme is successful then oil selling countries will sell oil in RMB even to all countries since that would help to accumulate RMB which they can convert into gold.
Thus China is able to launch a scheme where if an oil selling country sells China oil in RMB then the oil selling country can convert RMB into gold whenever it wants. It is partly returned to the pre-1970s system where currency was entirely pegged in some ratio with gold. In this case, China is making RMB convertible to gold only to oil selling nations to win them over from US dollar. If this scheme is successful then oil selling countries will sell oil in RMB even to all countries since that would help to accumulate RMB which they can convert into gold. This may entail doom to petro-dollar arrangement on which U.S. finance and global domination of US dollar are standing. Even if we assume oil sellers start just using RMB to sell oil to China, then also US dollar to get tremendous hit since China is the largest importer of oil.
Polarization of Oil Producers
Although, Saudi Arabia refused to accept China’s gold-yuan–oil scheme, Venezuela, Russia, and Iran are ready to accept the order, Iraq may join soon as well. So soon oil producers may be divided between petrodollar and gold-yuan-oil. This can reduce the use of US dollar in global transactions by 10-15%. Though US dollar can remain most used global currency it will lose its previous unparallel domination.
Oil-Yuan-Gold and Belt Road
Peoples Bank of China in 2015 said that financing Belt Road projects using US dollar will be cheapest while finance using RMB will be costliest. But if RMB can get 10% share of global currency use then Belt Road itself can start to reduce the cost of using RMB. That is why China fought hard to put RMB in IMF’s Special Drawing Rights (SDR) currency basket. If the oil-yuan-gold scheme can help to raise the use of RMB as global currency to a certain level, financing Belt Road in RMB will become cheaper and Belt Road projects itself can start to raise demand for RMB in a cyclical way. This demand for RMB from production may be quite small compared to the demand for US dollar from finance, the moment it generates can destroy the basis of US finance itself.
While in between 2017 to 2025 may be most critical for world history. The dying petro-dollar system can create havoc across the world as death closes for it. The launch of the oil-yuan-old scheme is the final death knell for petrodollar system. It shows the chance for the smooth death of petro-dollar is impossible. Most likely, tremendous economic, political and social upheavals to come across the globe in the next ten years.
DISCLAIMER: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy and position of Regional Rapport.