Historians still argue about the event that marked the end of the Roman Empire. Some historians of the future may choose January 16, 2021 as the fatal moment for the American Empire. That was when the People’s Bank of China and SWIFT, the global system for international money transfers, established a joint venture to promote the use of China’s digital currency in international payments.
It is the beginning, but the joint venture may denote the end of the dollar’s role as the dominant means 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. The United States is capable of running budget deficits that now approach one fifth of its gross domestic product (GDP), a level generally associated with Third World countries on the brink of hyperinflation, because the rest of the world maintains foreign exchange reserves and balances of transactions equal to an entire year of America’s GDP.
China is already the world’s largest exporter and will become the world’s largest dollar economy before the end of this decade. When – and the question is when, not if – China’s currency assumes a worldwide status compatible with its economic position, the dollar’s role as a reserve will disappear like the pound sterling before it, and the United States will have to learn to spend in. of your means. This implies a painful adjustment for the US economy dependent on large amounts of foreign credit.
Economists call this “seigneuriage”, in honor of the prize that a monarch won for minting precious metals in currency. The value of seineuriage has exploded over the past decade. Now you can implode.
Softly titled “the Financial Gateway Information Service”, the new company is the first official alliance of the Society for Worldwide International Financial Telecommunication and the central bank of China. China’s RMB accounts for only 2% of transactions in the SWIFT system today, and China’s financial system is far from ready to take on a reserve role. All of that could change, and quickly, to coin a phrase.
For now, the objectives of the new Financial Gateway are modest; has just 10 million euros of capital, 55% contributed by SWIFT and 34% by China National Clearing Center (CNCC), an entity created by the People’s Bank of China as an alternative to SWIFT after the Trump administration considered closing institutions Chinese companies outside the SWIFT system. Cross-Border Interbank Payments and Settlement Ltd, CNCC’s foreign exchange arm, owns 5%, and the People’s Bank of China Digital Currency Research Institute owns 3%.
Digital currencies promise to dramatically reduce transaction costs for financing international trade, improving transaction security. In the 18º century, financier Nathan Rothschild said that a bill of exchange in international trade must taste like salt, after accompanying the cargo on a sea voyage. Blockchain allows tracking of goods from the factory to the warehouse, port, container and shipping, and allows just-in-time deliveries along with just-in-time payments.
Financing world trade today requires banks to accept bills of exchange in trade, and importers hold tens of trillions of dollars in bank balances as collateral for their orders abroad.
The graph shows that the size of cross-border bank deposits (as reported by the Bank for International Settlements) has followed the volume of world exports over the past 40 years, increasing rapidly during early 2000 as trade growth accelerated and stabilized after 2008 financial crisis with stagnant trade.
The Bank for International Settlements divides the volume of cross-order deposits by currency, and the dollar dominates, with more than $ 16 trillion in circulation.
These deposits, mainly the guarantee for international transactions in goods, services and bonds, add up to US $ 16 trillion with low or no interest to the United States.
In addition, foreigners hold about $ 8 trillion in United States Treasury bills, most of which are held by foreign central banks as monetary reserves. Together with the balances of transactions in the banking system, the total in foreign dollars amounts to more than $ 22 trillion, or more than an entire year of America’s GDP.
The United States’ dependence on foreign credit, made possible by the dollar’s reserve role, has increased dramatically in relation to the size of its economy, from about 20% of GDP in 1978 to 110% of GDP today.
The world continues to use the dollar because the alternatives are limited. The euro recently overtook the dollar as the preferred currency for international payments, according to data published by SWIFT. This is likely a response to the Trump administration’s speech about excluding China from dollar payments, as well as other U.S. sanctions against European banks that have clashed with American restrictions against Iran.
China’s currency, as noted, comprises only about 2% of SWIFT transactions. The RMB is not ready to be a reserve currency and the Chinese still don’t want it to be.
RMB deposits in China remain subject to exchange controls and there is only limited convertibility between the continent and the global financial markets. The world holds US dollars because they can be transferred anywhere, used to buy any financial instrument and exchanged for any other currency. In addition, the Federal Reserve has shown that it is ready to intervene to support the financial system in times of crisis, for example, after the bankruptcy of Lehman Brothers in September 2008 or the collapse of COVID-19 in late February 2020.
China would require years of cautious steps towards freer capital markets and a gradual end to exchange controls to make the RMB a viable reserve instrument. The digital yuan, with all the potential advantages of blockchain technology, remains an experiment limited to a small number of Chinese consumers.
By the way, China does not need the advantages that a reserve currency brings, that is, a large amount of cheap credit from the rest of the world. China relied on rapid credit expansion to avoid the 2008-2009 Great Recession and is now trying to reduce its financial system’s leverage. 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 must provide it, and that means a negative checking account. China’s current account surplus has shrunk sharply in relation to GDP, and its emphasis on increasing consumption implies an even greater reduction in the current account surplus, but this is a slow process.
A digital yuan, however, may well rewrite the rules of the international banking system. As payments can be directly and reliably associated with goods movements, the total volume of transaction balances (guarantee against bank credit issued for the purchase of goods) tends to drop dramatically. In other words, digital currencies can be much more efficient than ordinary currencies.
One possible outcome of the research underway at the new SWIFT joint venture with the People’s Bank of China may be to overturn the reserve currency system that has prevailed for more than two centuries, since the pound sterling became the world’s preferred reserve instrument. and the Bank of England acted as the de facto central bank in the world.
The United States will wake up in five or ten years and find out how dependent they have been on the rest of the world and how much it will cost to heal from that dependency. The sterling crises and austerity budgets that plagued Britain during the 1970s are a good benchmark for what the United States is likely to go through.