The escalating trade war between the United States and China, with the Trump administration considering $100 billion in punitive tariffs in response to China’s $50 billion in retaliatory tariffs, obscures a more important source of conflict: China’s desire to someday establish the yuan as a global reserve currency, on a par with the dollar.
The dollar’s status is inextricably linked to international trade. Because the dollar reigns supreme in the trading system, other countries need to accumulate dollars. Most international trade is conducted using the dollar, even if the United States is not a party to the transaction.
The United States wasn’t always so dominant. After the 1971 decision to end the link between the value of the dollar and gold reserves, the dollar became a currency much like any other. But in 1974, the United States and Saudi Arabia struck an agreement in which the Saudis and the other Gulf states supported the dollar as the primary medium of exchange for oil exports. Thus, oil and other commodities are priced in dollars, so any country that buys oil must build up its dollar reserves to pay for it — mostly by exporting its goods and services so that it can receive dollars as payment.
Once established as a global reserve currency, the dollar has been kept strong by sustained demand for it, and a strong dollar makes American exports expensive to the rest of the world. American exports decline, imports increase, and a result is the trade deficit. Testifying before Congress in 1960, the economist Robert Triffin observed that the dollar’s global reserve status depends on the willingness of the United States to run trade deficits. This relationship, known as Triffin’s Dilemma, doesn’t always hold true (other countries have had reserve currencies and a trade surplus), but the American trade deficit with China, $375.2 billion last year, offers perhaps the best example of how a strong currency and trade deficits are connected.
Still, there are enormous benefits to being able to print paper money and have the world treat it as if it were gold. Other countries need American dollars, and they are willing to pay a premium to hold them. Valery Giscard d’Estaing, finance minister of France from 1962 to 1966, called this an “exorbitant privilege.” Once they have amassed those all-important dollars, countries use them to buy United States Treasury bonds. (China alone held $1.2 trillion dollars of United States government debt at the end of 2017.) This enormous global demand for American debt means that the United States can borrow at relatively low interest rates, financing its budget deficits away.
The “exorbitant privilege” extends to ordinary Americans, who have access to a vast supply of credit and can borrow to buy homes and cars at lower interest rates.
As the trade war rhetoric escalates, some raise the fear that China could sell off its dollar-denominated assets, which could trigger a rise in interest rates, inflation and possibly devaluation of the dollar. Even the threat of a sudden sell-off can stir up trouble in global currency markets. China could also diversify its cash reserves away from the dollar and acquire yen, euro or sterling instruments, or commodities such as gold. Indeed, China has already been accumulating gold, ranking as one of the world’s largest importers of it.
China and the United States are too closely economically intertwined via the dollar to make that a credible fear. United States treasuries are still the world’s safe haven of choice. And selling off American debt would cause the yuan to appreciate, which would put China’s exports at a disadvantage.
Still, China is clearly taking steps to ensure a larger role for its currency. In 2015, the yuan was designated by the International Monetary Fund as one of five elite currencies in the world, along with the dollar, the euro, the pound and the yen. China is putting in place a pilot program with Russia and Angola, in which it can buy oil with yuan instead of with dollars. As the biggest importer of crude oil in the world, China believes it has the purchasing power to push for settlement in yuan. Even Saudi Arabia, a stalwart American ally, is under increasing pressure to accept yuan for its oil trade. If the yuan does become a global reserve currency, China, too, could see its influence and economic power expand even further.
This is a strategic priority for China, and it is willing to wait. Although it is impossible to predict whether or when the dollar will be dethroned, history offers some clues: The pound sterling reigned supreme before the dollar gradually dislodged it. While the president and his supporters raise doubts about open trade, the dollar’s supremacy is closely tied to it. There is nothing guaranteed about that status, or all the benefits that come with it.
