- BLOOMBERG - David Fickling - MAR 16, 2022 -
In an increasingly divided world it makes sense to look for a good alternative to the greenback. This isn’t one of them.
Is there a situation more absurd than two of the world’s most dollar-dependent economies promising to free themselves from the exorbitant burden of the dollar?
The Chinese yuan rose Wednesday after Dow Jones reported that Saudi Arabia was in talks with Beijing to price some of its oil sales in that currency, instead of the greenback. At a time when the world appears to be splitting into rival democratic and authoritarian blocs, it’s inevitable that the perennial chatter about the yuan challenging the dollar’s status as the world’s reserve currency should be revived. Such talk has always been fanciful — but it’s even more unlikely right now.
Let’s set aside, for the moment, the fact that there is no sign of the yuan reaching the status of even the Swiss Franc as a medium of exchange, let alone the mighty greenback. Dollars were used for 88% of foreign exchange transactions in 2019, compared to just 4.3% for the yuan:
Big Trouble for Little China
The yuan punches far below its weight in terms of foreign exchange transactions, and the dollar punches above its weight.
If you don’t think the $18.1 billion in cars that euro-denominated Germany sold to the sterling-denominated U.K. last year represent a threat to the dominance of the dollar system, then it’s hard to see why the settlement currency for some portion of the $43.7 billion of crude traded between two dollar-pegged economies is going to make a difference.
Still, something has certainly changed in the past few weeks. Saudi Arabia receives dollars in return for its barrels of oil and refined products, which are in turn exchanged for dollar-denominated securities such as U.S. government bonds. The long-term strategic value of those sorts of assets — especially to oil exporters given to waging wars on neighboring countries — is looking markedly more shaky since the White House imposed sanctions on Russia’s central bank last month. A circumspect government that doesn’t think it can count on friendly relations with Washington in perpetuity might be wise to diversify its foreign holdings into a currency that’s less under the thumb of the Federal Reserve.
Here’s the thing, though: Such a currency already exists, and it’s called the U.S. dollar.
Exorbitant Privilege
The value of credit to nonbank borrowers denominated in U.S. dollars vastly outstrips that in other major currencies, making dollar-denominated funding far more liquid.
The greenback’s centrality to trade finance isn’t due to any enthusiasm for U.S. financial regulation, and it’s not grounded on issuance of dollars by American banks regulated by the Fed, either. Quite the opposite — the bedrock of the international financial system is not so much the U.S. dollar as the eurodollar, the rather obscure market in short-term loans and bonds issued by banks outside the U.S. but denominated in dollars.
The eurodollar market owes its origins to precisely the sort of wariness about the U.S. order that Saudi Arabia, Russia and China are showing now. It evolved in the years after World War II so that Communist countries could store their dollar deposits in European banks where they wouldn’t fear their assets might be frozen by the U.S. government. It’s since become a behemoth, with $13.42 trillion in credit outstanding last September, compared to about $4.26 trillion in euro-denominated offshore funding and $412 billion in yen. It’s not an exaggeration to say that international trade and finance would crumble overnight if it failed.
The growth of dollar swap lines to backstop the eurodollar since the 2007 financial crisis and the growing willingness of the U.S. to wield secondary sanctions on a global basis have certainly increased Washington’s oversight of this market — but at bottom it remains largely unregulated.
Cash Rules Everything Around Me
Even in China itself, the value of cross-border claims held by banks that are denominated in dollars vastly outweighs those denominated in yuan.
That goes a long way to explaining why the dollar remains so dominant in cross-border transactions. If you don’t want foreign governments meddling with your overseas assets, the eurodollar is about as close as you can get, short of selling your crude in Bitcoin. Even in China itself, investors seem to prefer greenbacks: The value of overseas debt denominated in dollars held by Chinese-based banks jumped $474 billion in the five years through last September, compared to a $127 billion increase in yuan-denominated securities.
If Saudi Arabia doesn’t want a foreign sovereign to control its overseas assets, switching more of its trading into yuan is about the worst way to go about it. China’s closed capital account means that just switching in and out of renminbi requires permission from the government. Add to that the sweeping asset forfeiture rules incorporated into Beijing’s anti-sanctions law introduced last year, and you’d be naive to think that China was any more secure a place for Riyadh to store its wealth in the long term.
In times of peace, it’s easy to forget that whenever you invest or sell a product overseas, you’re dependent on the goodwill of a foreign government to ensure you get paid. Washington has undoubtedly taken more advantage of the dollar’s status in recent years to achieve its foreign policy goals. Those issues are still very far from outweighing the convenience of transacting in the world’s most liquid currency market, backed up by its largest stock of sovereign debt and a system grounded in the rule of law. The yuan is the global reserve currency of the future — and it always will be.