The global reserve currency has been closely aligned with the dominant power in the world at that time in history. China being a rising power sees itself as a great power (at least in its mind) that would be in the minds of many as “who decides” what the next global currency would be.
While in theory China wouldn’t mind if most of the world’s trade was done in yuan, but given the Triffin dilemma facing the United States today, it would be a hindrance. . Triffin’s dilemma is the conflict of economic interests that arises between short-term national goals and long-term international goals for countries whose currencies serve as global reserve currencies.
The use of the US dollar for global trade creates a strong demand for dollars from around the world, causing the dollar to strengthen against other global currencies. This strong dollar has made US exports uncompetitive with its peers abroad. This has led to the exhaustion of the US manufacturing sector and a flight of jobs over the past decades. This imposed high costs on those working in blue-collar jobs in many parts of the United States, including the so-called “Rust Belt”.
China, being an export-oriented economy, would not want to fall into the same trap as the United States. While they would in principle like world trade to be denominated in yuan (out of national pride), one doubts that they want their exports (which represent a large part of their economy) to become more expensive. Moreover, for all trade to be settled in yuan, China would have to export yuan to many other countries that would need yuan to settle their trade with their trading partners. Given the strict capital controls in China, it would be surprising if China allowed a large amount of yuan to flow out of the country to foreign shores.
China has taken advantage of the dollar system (generating trade surpluses year after year) where it can have its exports cheaper due to the strength of the dollar, so it wouldn’t mind if the currency of reserve is something other than its own currency.
Even if China wanted to make the yuan a default reserve currency, the question is, would other states fully embrace it? Today, due to tensions with the West, Russia is forced into a friendship with China, but they weren’t always on the best terms, including a military skirmish in 1969. The Chinese occasionally bring up their territorial claims in the Russian Far East, including Vladivostok, which they claim have been abandoned by China under unequal treaties during their “150 years of humiliation” with foreign powers, and now they want it back.
Many other Asian neighbours, including India, Vietnam, South Korea, Japan, etc., with whom China has adversarial relations, would also be reluctant to adopt a yuan-based reserve currency where they would depend on China to get yuan for their trade. Also, in the event of military hostilities with China or its allies (like what Russia is currently facing), they could be “cut off” from the reserve currency yuan which would be decisive for them.
A return to a system like the BANCOR (neutral reserve currency) proposed by Keynes in 1944 would require active cooperation between many nations around the world. With active geopolitical tensions between the various sets of nation pairs: Russia and US, US and China, Europe and Russia, Saudi Arabia/UAE and Iran, etc., the chances of another kind of consensus ” Bretton Woods” are almost nil.
Many macro watchers, Luke Gromen, macro analyst and Founder and Chairman of Forest for the Trees (FFTT), mentioned that in the future, a world where neutral assets like gold or even Bitcoin could be used to settle transactions for cross-border trade. Since gold and bitcoin are neutral assets, they remove Triffin’s dilemmas for nations while providing options that are also, to some extent, free of counterparty risk.
GOLD: It has been around for centuries and was used as a medium of exchange in ancient times. Gold reserves can be kept locally, eliminating the dependence on other nations to buy, say, dollars or yuan or some other currency to affect trade. Russia is reportedly already considering accepting payment in gold for natural gas from “hostile nations”. This eliminates the need to convert dollars into rubles they receive for oil/gas payments, which is now more difficult given the sanctions.
Russia has one of the highest gold reserves in the world, at over $130 billion, which it can use as collateral to trade (instead of now hard-to-find dollars). Greater adoption of gold-backed trading can only increase the price of gold, in which case, given their large reserves, it will benefit them the most. Nations could trade gold directly with each other, eliminating the threat of third-party sanctions.
However, transporting huge quantities of gold between nations would have its unique transportation, security and insurance challenges for such transfers. Gold also requires rigorous auditing for its weight, quality/purity which would be other added overheads in this type of monetary system. One can, in theory, settle trade between two nations on a “net basis” (instead of trying to pay in gold for every small transaction between the two), but that would require the government to pay individual entities up to that the overall trade is settled as a final transaction.
Bitcoin: The other possibility for the next global reserve currency being floated by some (especially Bitcoin enthusiasts) is Bitcoin. Unlike gold which is physically difficult to move given its weight and the cost of security/transportation, Bitcoin has no such challenges.
The amount of Bitcoin on the open ledger can easily be verified, and there is no counterparty risk if held securely by individuals/nations. Additionally, gold requires large-scale gold auditing and verification of the gold itself (i.e., its purity), which Bitcoin does not.
Russia has recently indicated its willingness to even accept Bitcoin for its oil and gas. Accepting Bitcoin for all global commerce right now would be a Bitcoin purist’s ultimate dream, but given the amount of liquidity in the Bitcoin market, it would be interesting to see how such a thing plays out. More development in the L2 (Layer 2) application space like Lightning Network could help overcome this challenge.
While over time the volatility of Bitcoin decreases (on a relative basis), but for some traders the volatility may be unattractive to trade. A mitigating mechanism like instantly converting Bitcoin transactions into local fiat currencies would help overcome the volatility issue. Bitcoin, whether on the mainchain or through L2 applications like Lightning Network, with its low fees, would be cheaper in terms of costs to transfer money from buyer to seller compared to traditional funding channels.
An example of this is the Lightning Network used by Salvadoran expats who send money to relatives back home via the Lightning Network versus traditional methods such as Western Union. Money is sent home at a fraction of the cost compared to Western Union, and their family members do not need to make an arduous journey to the nearest Western Union office, which could not only take time, but also be subject to prohibition. by criminal gangs who might demand their “cut” instead of safe passage.
Because the Bitcoin network is decentralized, it would be extremely difficult for nation states to prevent other nations from trading in it, which makes it highly resistant to censorship and sanctions. A nation does not have to remain in fear that opposing Nation A, where it stores its foreign exchange reserves or angering Nation B, which owns the world’s reserve currency, might inflict economic hardship if it does not bid for the other nation. With Bitcoin, no government or set of actors can inflate the currency or manipulate it to the detriment of other nations.
Recent events have highlighted the pitfalls of a reserve currency where other nations cannot control their own reserves and therefore their own economic destiny. Once friendly nations could, in the future, turn on each other, resulting in sanctions against the smaller nation and/or cutting it off from the global economic system. A large nation could use the threat of sanctions to “shape the behavior” of a small state as it sees fit.
This highlighted neutral assets that are more difficult to sanction, block and seize, such as gold and Bitcoin. Once derided as fancy thefts of “gold bugs” and “bitcoin maxis,” a transition to using them to settle cross-border payments doesn’t seem as far-fetched as it did just months ago.
Russia and even other states could opt out of the current system by explicitly calling in the future a barrel of oil in ounces of gold or a cubic foot of natural gas in Satoshi (i.e. a smaller bitcoin unit). Given the current commodity price spikes, many countries (unless they quickly diversify into other sources, which is time-consuming and expensive) could be forced to pay Russia through these new mechanisms. due to lack of choice. [i.e. forced to the new payment system “kicking and screaming” vs gradually adopting it voluntarily]
This does not mean that the US dollar will lose its reserve holdings tomorrow, but it is on the way out. Like on the geopolitical front, as the world moves from a unipolar US world to a multipolar world, there could be something similar in the economic sphere where we could have multiple reserve currencies operating at the same time! Legendary investor and billionaire Stanley Druckenmiller, in a interview last summer, said he did not expect the dollar to become the reserve asset within 15 years.
The 2020s was a decade of massive upheaval with all sorts of issues: pandemic, supply chain issues, massive central bank printing, inflation, geopolitical tensions, great power rivalry, war, commodity price shocks premieres, etc. Given the events of the last two years of this decade, it would be hard to say what the future holds in terms of the next reserve currency, whether it’s gold or bitcoin or whatever, but it would be no wonder the dollar won’t have global reserve currency status by the end of this decade.
This article was originally published on Crowd Wisdom on February 15, 2022.
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