You Heard it Here First: China’s Plan to Dethrone the Dollar Continues to Unfold

October 12, 2010
By Don Miller, Associate Editor, Money Morning

The U.S. dollar is on the way out as the world's top reserve currency. And as Money Morning Chief Investment Strategist Keith Fitz-Gerald predicted more than a year and a half ago, the yuan could be set to replace it. The greenback has served as the world's benchmark reserve currency since the mid-20th century, but soaring deficits and the U.S. Federal Reserve's loose monetary policy have drained the dollar's value. Meanwhile, emerging markets - many of which are vibrant manufacturing hubs, net creditors, and have rich caches of commodities - are more fiscally sound than the United States, which has a $1.3 trillion budget deficit. "If you look at the fundamentals of a lot of these emerging markets, they are considerably better than developed markets," Kenneth Akintewe, a Singapore-based investment manager at Aberdeen Asset Management PLC told Bloomberg in an Oct. 11 interview. "Who wants to be holding U.S. dollars at this stage?" China, which leads the world with more than $2 trillion in currency reserves held mostly in U.S. Treasuries, is chief among the countries seeking respite from the dollar's decline. Beijing has long bemoaned the depreciation of the dollar, stating outright that it should be replaced as the world's main reserve currency.
As U.S. policymakers ratchet up criticism of the yuan, Bank of China (BOC) Governor Zhou Xiaochuan said Sunday that China would continue to move away from U.S. debt, and instead pursue more favorable long-term investments."We can diversify more the foreign reserves, to consider not only smaller countries, but some emerging-market economies," Governor Zhou said at an event during a meeting of the International Monetary Fund (IMF) in Washington. With increased assets, "you can shift some to riskier, but higher-return investment instruments."China almost tripled its holdings of South Korean government bonds to $4.6 billion (5.15 trillion won) in the first nine months of this year, according to South Korea's Financial Supervisory Service. Peruvian central bank President Julio Velarde said in an interview in August he is "surprised" to see several monetary authorities buying government bonds denominated in the sol. Mexico is seeing "very active" interest from Chinese investors in the country's local-currency government bonds, Octavio Lara, deputy general director of debt issuance at Mexico's Ministry of Finance, said Sept. 15. Of course, this is hardly a dramatic shift. To the contrary, China has been telegraphing the move for years. In March 2009, Zhou himself released an essay entitled "Reform of the International Monetary System" on the BOC's Web site. The report called for the "re-establishment of a new and widely accepted reserve currency with a stable valuation" to replace the U.S. dollar - a credit-based national currency. "The price is becoming increasingly higher, not only for the users, but also for the issuers of the reserve currencies," Zhou said. "Although crisis may not necessarily be an intended result of the issuing authorities, it is an inevitable outcome of the institutional flaws."Zhou recommended that the IMF's Special Drawing Right (SDR) be given special consideration, but China's true intent - as suggested by Fitz-Gerald - seems to be to have the yuan take over."China's currency is likely to be granted a global status on par with the current major currency trading pairs for purposes of settling international transactions, whether the West wants that to happen or not," Fitz-Gerald wrote in a May 2009 article. "In fact, I'd even go so far as to say the dollar's days of dominance are numbered and with each new round of bailout chicanery, the clock is winding down ever faster." China has arranged currency swaps with many of its trading partners to accelerate the transition. These agreements allow China to receive yuan, instead of dollars, for its exports. Previously, as the dollar has been the primary reserve currency for international trade, an importer would have to cross two "spreads," first converting, for example, Korean won to U.S. dollars, and then the dollars to Chinese yuan. But the swaps make it easier for emerging markets to buy China's goods, and in the process symbolically raise the yuan's profile on the global economic stage. So far, China has set up currency swaps with Argentina, Russia, South Korea, Hong Kong, Indonesia, Malaysia, and Belarus. As China builds a larger network of swap agreements it can trade directly with its trading partners without ever having to put their currency on the open market - and with no need to settle in dollars. For instance, Brazil could use its yuan to buy goods and services from Indonesia or Malaysia.This strategy undermines the dollar while steadily building a global marketplace for its currency, the yuan. "For Westerners who are struggling to come to terms with the notion of a disarrayed dollar, the thought of oil, gold or other commodities being priced in yuan instead of dollars has to seem about as likely as having another country put a man on the moon," says Fitz-Gerald. "But the Chinese yuan is already well on its way to becoming that globally accepted standard unit of exchange and the proverbial genie, as they say, is out of the bottle."Global foreign reserves have more doubled from $4 trillion at the end of 2005, according to data compiled by Bloomberg and the IMF. Developing nations held $5.5 trillion as of June. However, the dollar's share of worldwide reserves has declined to 62% in June from 73% in 2001, according to data compiled by the IMF. The euro's share, the world's second-largest reserve currency, fell to 26.5% in June this year, from a record 28% in September 2009.