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February 26, 2018 | Forget the Yuan: King Dollar is Here to Stay

Mike 'Mish' Shedlock

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.
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 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

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February 26th, 2018

Posted In: Mish Talk

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