Historians are still debating what event marked the end of the Roman Empire. Some future historians may choose January 16, 2021 as the fateful moment for the American Empire. It was then that the People’s Bank of China and SWIFT, the global system of international monetary transfers, set up a joint venture to promote the use of China’s digital currency in cross-border payments.
These are early days, but the joint venture may mark the end of the dollar’s role as the dominant medium of international exchange, and, more importantly, the end of more than $ 20 trillion in cheap loans to the United States from the rest of the world. world. The US may approach budget deficits now approaching a fifth of its gross domestic product (GDP), a level commonly associated with Third World countries on the verge of hyperinflation, as the rest of the world reserves foreign exchange and transaction balances equal to ‘ a full year of America’s GDP.
China is already the world’s largest exporter and will become the world’s largest economy in dollars by the end of this decade. When – and the problem is rather than if – the Chinese currency assumes a world status commensurate with its economic position, the dollar’s reserve role will fade like the British pound before it, and the United States will have to learn to within its capacity to spend. This implies a weakening adjustment for a US economy that is dependent on large amounts of foreign credit.
Economists call it ‘seigneuriage’, after the premium a monarch earned by minting precious metals. The value of sea nature has exploded over the past decade. Now it can explode.
The new company is the first official alliance of the Global International Telecommunications Association and the central bank of China. China’s RMB today accounts for only 2% of transactions in the SWIFT system, and China’s financial system is far from ready to accept a reserve role. All of this can change quickly to gather a phrase.
The goals of the new Financial Gateway are tentatively modest; it has only 10 million euros in capital, 55% contributed by SWIFT and 34% by the China National Clearing Center (CNCC), an entity created by the People’s Bank of China as an alternative to SWIFT after the Trump administration apparently considered closing Chinese institutions. from the SWIFT system. Cross-Border Interbank Payments and Settlement Ltd, the CNCC’s currency weapon, owns 5% and the People’s Bank of China’s Digital Currency Research Institute owns 3%.
Digital currencies promise to drastically reduce transaction costs for international trade finance while improving transaction security. In the 18de century, financier Nathan Rothschild said the exchange rate in international trade must taste salty, after the cargo was accompanied on a sea voyage. With Blockchain, goods can be shipped from factory to warehouse to port to container, enabling just on time delivery along with just in time payments.
World trade financing today requires banks to accept barter, and importers maintain ten billion dollars in bank balances as collateral for their overseas orders.
The graph shows that the size of cross-border bank deposits (as reported by the Bank for International Settlements) tracked the volume of world exports over the past forty years, rising rapidly in the early 2000s as trade growth accelerated and after 2008 financial crisis subsided as trade stagnated.
The Bank for International Settlements is breaking down the volume of cross-order deposits by currency, and the dollar is dominating, with more than $ 16 billion outstanding.
These deposits, mostly the collateral for international transactions in goods, services and securities, amount to a $ 16 billion low interest or interest-free loan to the United States.
In addition, foreigners own about $ 8 billion of US securities, most of which are held by foreign central banks as foreign exchange reserves. Together with the transaction balances in the banking system, total overseas dollar investment amounts to more than $ 22 billion, or more than a full year of US GDP.
America’s dependence on foreign credit made possible by the dollar’s reserve role has risen sharply relative to the size of its economy, from about 20% of GDP in 1978 to 110% of GDP today.
The world still uses the dollar because the alternatives are limited. According to data published by SWIFT, the euro recently surpassed the dollar as a favorite currency for international payments. This is likely a reaction to the Trump administration’s talk of excluding China from dollar payments, as well as other US sanctions against European banks violated by US austerity against Iran.
China’s currency, as noted, consists of about 2% of SWIFT transactions. The RMB is not yet ready to be a reserve currency, and the Chinese do not want it yet.
RMB deposits in China remain subject to currency controls, and there is only limited interchangeability between the mainland and the world market. The world holds US dollars because it can be transferred anywhere, used to buy any financial instrument and exchanged in any other currency. The Federal Reserve has also shown that it is ready to support the financial system in times of need, for example following the bankruptcy of Lehman Brothers in September 2008 or the COVID-19 accident at the end of February 2020.
China will need years of cautious steps towards freer capital markets and gradually end currency controls to make the RMB a viable reserve instrument. The digital yuan, with all the potential benefits of blockchain technology, remains an experiment limited to a small number of Chinese consumers.
As for the case, China does not need the benefits of a reserve currency, namely very cheap credit from the rest of the world. China has relied on rapid credit expansion to evade the Great Recession of 2008-2009 and is now trying to reduce leverage in its financial system. A reserve currency implies the availability of more leverage.
In addition, a reserve currency is usually provided by a country with a current account deficit. For the rest of the world to have access to a country’s currency, that country has to provide it, and that means a negative current account. The current account surplus in China has shrunk significantly relative to GDP, and its emphasis on increasing consumption implies even further shrinkage in the current account surplus, but it is a slow process.
However, a digital yuan could rewrite the rules of international banking. Because payments can be directly and reliably linked to the movements of goods, the total volume of transactions (collateral against bank credit issued to buy goods) is likely to drop drastically. In other words, digital currencies can be much more efficient than regular currencies.
A possible outcome of the research currently underway with the new SWIFT joint venture with the People’s Bank of China could be the overthrow of the reserve currency system that has prevailed for more than two centuries, as sterling is the world’s preferred reserve instrument. and the Bank of England acted as the central bank in the world.
The United States will wake up in five or ten years and discover how dependent it was on the rest of the world, and how much it will cost to cure itself of this dependence. The huge crises and austerity budgets that Britain cheated during the 1970s are a good reference point for what the United States is likely to go through.