Thought Experiment
The US dollar Index has nothing to do with it.
Try this thought experiment instead. What Would It Take For the Yuan to Displace the Dollar?
China Would Have To
- Float the yuan
- End capital controls
- Respect property rights
- Have a bond market big enough (China has virtually no gov’t bond market)
- Have global trust
- Be willing to have trade deficits
- Stop export priority mercantilism
- Have a currency market big enough
Perhaps China meets condition 8. It flunks the first 7.
Look closer and those are general requirements, not China-specific requirements.
How many requirements does the Eurozone meet?
The Eurozone meets conditions 1, 2, 3, 5, and 8.
Germany and the surplus states will not easily or willingly give up on points 6 and 7.
The biggest holdup against the Euro is lack of a bond market.
The individual countries have sovereign bonds but they trade at different rates due to different risks. There are no euro-denominated bonds to speak of.
Alternatives
There are no alternatives. To be an alternative, a county has to meet those 8 conditions.
This is why talk of the yuan replacing the dollar is complete silliness. Wake me up when it meets the requirements.
Moreover, and despite periodic talk, China’s actions speak louder than words. Given points 6 and 7 I do not believe China would want to be the reserve currency holder, even if the other requirements could be magically waived.
Political Conditions
Political conditions are such right now that there will not be any alternatives soon. That could change if politics in the US, EU, or China changed, but don’t hold your breath on China.
The Euro may not even survive. It is a fatally flawed currency yet it is 1 of only 2 possible alternates that meets condition 8.
Stable Wagon
The only other thing that could derail this very stable wagon is if the US went totally insane politically.
What if the US went whole hog on AOC’s global warming plan and also gave away $1,000,000 annually indexed to inflation to everyone in the US to fix income inequality?
Yep, something like that would do it.
In the general sense, a political event that caused hyperinflation would suffice.
Faith in Central Banks
Meanwhile, faith in central banks is weakening. For discussion, please see More Gold Hype: No Escape for Shorts.
Monetary Demand and the Price of Gold
Over the long haul, it’s monetary demand that sets the price, not short squeezes, not jewelry, not Martians.
Monetary demand is a function of faith in central banks.
I commented on monetary demand on June 1 in Speculators Dump Gold But Price Goes Up Anyway.
Mish
The American War of Independence started in 1775, coincidently the price Spot Gold settled at this weekend on the Independence Day holiday. -:)
“Have a currency market big enough “
This feels like a statement limited in scope. It reminds me of people who say that there’s not enough gold in the world to go back to the gold standard…..which is untrue IMO.
The question is one of divisibility and acceptance. An IOU backed by gold doesn’t have to be denominated in ounces, it can be denominated however we like to described a physical unit….whether it’s grams or 1/100 of an ounce. That goes for silver too, which is more abundant and historically the “money of the people”.
I’d wager almost every sovereign/state in the world accepts gold/silver as a monetary instrument even if it’s residents were reluctant to do so. They almost all have precious metal reserves….
Yes, I agree. They won’t be too keen on borrowing it though, because they’d have to repay it with the same kind and they wouldn’t be able to deflate. Imagine if this year’s global government virus support programs were borrowed in gold. Our kids would be burdened for years. Or would they be able to keep borrowing perpetually as they do now? I doubt it because no one country would be able to manipulate the interest rate down to zero or lower as currently.
There has to be a viable contender for reserve currency status to change. Maybe in 20-30 years or so China will have gone through come sort of sociopolitical upheaval such that it is no longer a centrally controlled economy and upholds property rights and offers real due process. If that happens then I would say China. Otherwise there are none.
All it would take is enough countries to get upset at USA hegemony, primarily using the dollar to dominate their economies, politics, and global society generally. Already, unfriendly countries avoid transacting in dollars. Add in a global recession….
I suspect those countries accumulating gold have a plan in mind–they will price international transactions in digital gold units, not in dollars. Payments will be made in physical transfers using the Bank of International Settlements, or a replacement.
OK, so what’s the alternative then? You went on for 80-90% of the post detailing how there are no alternatives, then talk about how the US could lose reserve status but to whom (or what)?
Yes, I agree. It feels like the rest of the article is missing. What happens next?
The question is framed incorrectly. The dollar does not have to be replaced by any ‘one’ national currency. The dollar could gradually reduce in % used around the world and other currencies increase. We could go back to something similar to the 18th or 19th century when gold backed national currencies ruled different regions around the world. Ultimately, a multi-polar world with several competing currencies held together by gold, that could be the best outcome.
However, the Electoral College looks like it could still give Trump an advantage, just like it did four years ago. https://fivethirtyeight.com/features/why-bidens-polling-lead-is-different-from-clintons-in-2016/
Mish, I think re the Euro that much of the world is still skeptical of the EU’s ability to remain in one piece. We all suspect that while it probably will not happen, it is still possible that a black swan event could end the Euro overnight. If France goes back to francs, Italy lira, Germany marks, the Euro would be used for wallpaper. All Euro holdings/accounts would be dead. A hundred years from now that may not be true, but for now it is. As long as that gigantic ravenous and excruciatingly unethical russian bear sits along their frontier from Istanbul to the Arctic there will be serious concern about EU stability.
WHAT THE FUCK has the EU’s failing policy got to do with Russia ??? Enlighten me ! Basket case Ukraine would ve been part of the EU, if it wasnt for Russia ? Yeah that is EXACTLY what we need, Moldavia Georgia and Albania too of course, GREAT nations ! As far as I am concerned Russia can have them ALL back, ALL of them ex sovjets …..
Good God, yes. Babies need to crawl before they can walk. The dream was that they would rise to equivalence with EU nations. The reality is sad. Ukrainians vote with their feet, lose advanced industries and flirt with being a failed state.
I reread my post and see nothing about the possibility of former soviet republics becomming accession candidates FB. Russia has become a dictatorship with energy being their only cash export, and the EU is determined to end or so cut back fossil energy use that even that will be forced to find new markets. In fact I think russia will (Putin will) attempt to rebuild the Soviet Union albeit without communism, but rather with him at the helm as some sort of modern day Tsar, and as we just saw yesterday the “voters” approved his new constitution that allows him basically to stay in power for life.
Moldova, Georgia, no, but Estonia, Lithuania, Latvia all have integrated rather better than expected have they not? I think that Putin has been working hard at replacing the US as neclear/military power which is allied with the EU even as China seeks more direct involvement with the EU and North Africa with it’s silk road project.
“Russia supports anti-establishment forces in Europe because it lacks friends among establishments. Its use of unconventional methods is not a demonstration of creative strategy but an attempt to compensate for deficiencies.”
When (not if) Putin decides his military is built up enough to invade the EU say in 2032, if the EU is a functioning entity still, the EU will wish it still had the US and NATO to once again bail them out of a world war they cannot win without us. Good luck with that.
sure sonny sure ….here in Europe we do notice Russian agression on a daily basis …hahaha….In 2032 ? Yeah sure, why not , Russia is such a small isolated nation it simply HAS to expand in order to survive…..and maybe debt free Russia can bail us out in 32 when our mess will be beyond proportion
Empty land they have plenty of, and they certainly have enough resources for their small economy also, what they don’t have is access to markets and credit. In short money. And you can dismiss the threat all you like but in fact Putin is now president for life and he is a known paranoid that weeps for the loss of the old Soviet Union and from his point of view the KGB was a very good thing. He was after all a colonel in the KGB. To his west he sees a scattered EU with virtually no real defensive capability at least once NATO is gone in all but name. He has a clear agenda, first diminish the US role in European trade and diminish the US role in defense there. Then break up of the EU over the next 5 years or so, by 2022/23 we will see him cooking up excuses to reacquire the Baltic states. They will just be complaints at first then grow louder and more strident. Eventually he will invade and re exert control there and in Belarus, Ukraine, Moldova, Georgia, and the Europeans will look on, some horrified, some asleep at the wheel, but that does not mean I predict a Euro-Russian war, because his goal is not to destroy or even acquire Europe, it is merely to replace the US as hegemon, as long as Europe acquiesces there will be no war. A divided Europe cannot and more important will not stand up to Russia.
Oh don’t forget. Civil war. That should destroy the dollar pronto.
Political stability and lack of corruption are exactly why so many nations use the dollar. I believe they are starting to see the same thing we do, it may have been true but no longer is. The article I linked says that 80% of all international business in Asia is transacted in US dollars. Think about that.
CNBC today: https://www.cnbc.com/2020/06/30/the-us-can-change-the-world-by-devaluing-the-dollar-analyst-says.html
Change the world….. but for the better? That would have to take down other over valued currencies (I am looking at you Euro) because if they don’t devalue in tandem then they become grossly overvalued and their exports collapse. And whatever we decide to do the Chinese mercantilist export machine will go just that much better.
And what about nations that use the dollar or are pegged to the dollar but which have no ability to print dollars? Suddenly they have half as much an economy as they thought. Several use the US dollar as their currency or have hard pegs, like Ecuador, where dollars are used, and Panama where they use both dollars and a hard peg for the national currency, or Belize where the Belize dollar is hard pegged at 50 cents to the dollar. Morally we would be in a position of having to effectively put these countries on a US dollar welfare system, though I am thinking we already do when demand exceeds availability and the Fed makes swap lines available.
Nations that use dollars; Zimbabwe, El Salvador, Ecuador, Timor, Palau
Nations where their is either a hard peg or where shops price in and/or accept US dollars openly; Canada, Russia, Panama, Bahamas, Vietnam, Cambodia, Turks and Caicos, Nicaragua, Belize
Also, many Caribbean nations accept dollars for quasi legal tender like Jamaica. All these are unlike nations such as Australia where one must first go to a bank and exchange US dollars for local currency before you can do transactions.
Not that it counts for much, Cambodia also has a dual systems. All major transactions are in dollar.s
I think it is a lot simpler than Mish’s list. I think there is just one criteria to be the world’s reserve currency: who has a military capable of enforcing international debt to big banks? That is only the USA.
Nah, if that’s the case, Mexico, etc wouldn’t have defaulted.
The US Dollar became reserve currency because the US “won” WWII. Full stop.
“The US Dollar became reserve currency because the US “won” WWII. Full stop.”
Because the US dollar was linked to Gold. It was decided at Bretton Woods.
Sure, but that wouldn’t have happened without the US “winning” the war.
The Allies won the war, of which the US was one, it probably wouldn’t have been won without any one of the alliance. The US didn’t enter the war until 2 years into it in December 1941. However, if the allies hadn’t won I’m sure you’re right, Germany would’ve had all the Gold. The US were paid for supplies with Gold during the war and as the dollar was linked to Gold it was a big factor in the decision to nominate it as the Reserve Currency at Bretton Woods. Not to mention that the UK was laden with war debt to the USA, which was only finally repaid this century.
So we’re both right -:)
Why can’t gold just be the reserve currency?
I’ve often thought that the strength of the US Military and the potential threat it can impose have a positive effect on the dollar.
ALL CURREnNCIES ARE EQUALLY BAD
It being given MMT (Zimbabwe method) is applied everywhere only gold keep iits average value
We are now plungedi lnto a stupid revolutionnary period where everybody kneel their leggs and apologize. What about the nobles over here apologizing to white people having lived in slavery for centuries?What about dismantling ther castels and statues?
Ironically in Zimbabwe the US dollar is the main currency now.
It’s more useful to look at the only factors that can change global demand for dollars:
Those are the questions that matter, not “reserve currency” semantics.
I think answer to 1 is trending towards less goods priced in USD as world develops long term, and answer to 2 is trending towards increase in dollar liquidity short term.
who said there must be a global reserve currency? China has been swapping currencies increasingly with its main trading partners, like Japan, Korea, Russia, Brazil etc. which reduces the need to hold dollars. China has also set up markets for several major commodities traded in Yuan in recent years, which should again reduce the need to hold dollars.
Only Americans think there should be a global leader, a global currency, a global etc, etc. Americans believe in freedom as long as the choice is …. America.
We need a multi polar world.
I don’t think we’d like it very much. Seems to me the EU is multipolar and has yet to figure out how to make it work.
The ones that wouldn’t like it are probably used to coasting based on skin color alone.
The EU is of course not multipolar. It’s a UNION. Break it up and it will be multipolar.
This ! Exactly so. I understand that France is already cooperating with China on using the yuan in exchange for goods. Even the ruble will be a minor reserve currency ( which as laughed at when Medvedev said it). Forget reserves, think about the demands of trade – which is slowly turning against dollar use.
More than that, I see contradictions here. So what if the US goes crazy (crazier?)?
If the world refuses to drop the dollar and it’s so infallible, then as long as the Fed keeps going, the dollar never fails, right? And if the dollar is so mighty, how does it ever sink against produced goods and commodities?
You don’t need all, nor even strictly any, of those for your currency to become a reserve currency.
All you need is to be the indispensable supplier of what the rest of the world needs. Like the US was at the end of WW2: If you wanted oil, you couldn’t get around the dollar. And everyone needed that. Ditto Marshall funds in Europe, and similar in Japan. Recovering economies needing aircraft… Again, they’re priced in dollars. Arms to defend against the commies popping up everywhere with Soviet help and encouragement? Again, dollars….
Even after the Aramco and other nationalizations, Middle Eastern producers remained dependent on US arms. Which were, again, priced in dollars.
If Zimbabwe suddenly became the sole supplier of oxygen and water, others simply would have no choice but to to hold Zimbabwean whatever-they-call-their-toilet-paper. Bond markets, deficits nor ultimately even convertibility be darned. If you needed a cushion of Zimbavean toilet paper In order to be certain you could still obtain air to breathe tomorrow, you’d find a way to keep some in reserve. And then, once someone felt he had amassed enough of the stuff to feel confident in his own future ability to breathe, he’d start trading some of his stash, for other stuff feom those not yet so confident……… While the dollar hegemony may not ever have been quite that solidly founded, it was pretty darned close. And for decades on end.
During those decades, institutions and technology grew up around the, implicit even where not explicit, assumption of the dollar as the currency for international trade and settlement. And those things are hard to change, since so much else is then built on top of them, and they are something everyone takes for granted.
But it is still ultimately founded on needing dollars, to obtain much of the most fundamental stuff everyone needs. Not on secondary superstructures, like excessive deficits and attendant America spending itself into ruin while becoming increasingly unable to produce anything of value whatsoever.
Currently, aside from the still somewhat biggie of Arab oil regimes’ dependence on US arms, it is mainly this institutional inertia which is keeping the dollar hegemony alive. If it was just up to some guy named China, he would no doubt have demanded better terms a long time ago. But it is not. Instead, it is hundreds of millions of Chinese mom and pops, working on thin margins and all accustomed to targeting the dollar when pricing their wares for export.
Suddenly throwing the monkey wrench of the Chinese government and central bank no longer attempting to keep local and dollar prices somewhat aligned, would risk serious dislocation for lots of those guys. And since “social disruption” and “instability” are the greatest fears of the Chicoms, they keep buying dollar assets.
Hence keeping price movements for Chinese goods to foreigners, fairly stable in dollar terms. Which enables those foreigners to keep treating the dollar as a reliable reserve currency. Even if most of the stuff they buy and need, is now ultimately Chinese, not American.
In other words it is all relative. Few people understand how the US can have so much personal liberty and freedom and still prosper. But they have their values all screwed up. Freeing people actually allows them to be more productive. Keeping them pinned down under lock and key and not allowing them to do anything resembling liberty is counterproductive. It leads to revolutions. China, Russia and similar countries are a grave risk. They are destined to fail because simply don’t believe in their citizens.
The main currency in Zimbabwe is the US dollar so I suppose you are right-ish on that score. 🙂
Re China, I cannot [rove this but I strongly suspect that the Chinese have worked absolute miracles leaving the 17th century behind and joining the 21st century just since the death of Mao. They did not do this by having 1.4 billion slave laborers making crap in sweatshops to sell to Americans and the EU, they did it by cooking the books and having the US (and EU) look the other way in exchange for cheap imports. As well as for allowing the top 10% in the US and EU buy in for a slice of that now quasi capitalist pie, in fact it was that same top 10% that taught them HOW to cook those books.
In fact there is no recognition in most developing nations regarding uniform standards of account. It is a fools errand to compare Chinese export numbers or GDP to any other nations, there is no way to seriously value hard renminbi against dollars, pounds, or Euro.
I believe that in the Vietnam war Nixon and other mandarins of the western world saw very thinly veiled interference on the part of russian communists on behalf of Hanoi, especially when MiGs were shooting down our air forces, and some were piloted by russians. This had happened in Korea in the 1950’s as well, though China was the main combatant on the side of the North Korean communists.
The west saw that russia was becoming far more aggressive about seeding communism and challenging the west around the globe, and that unchecked this would eventually lead to nuclear war even if by accident. So, we made a deal with China. We would allow them to have a sphere of influence and multiply their economy many fold if they cooperate with us. We would supply money, markets, technology, and capitalist know how that they then could advance swiftly. Recall that they had just gone through the Great Leap Forward, Mao’s purge of all that was decadent and half of everything that wasn’t, it was brutal, tens of millions were killed and more starved. China was foundering and starving by the time the senile old Mao died. And look at what happened post Mao, one only needs to look at the skyline photos of Shanghai
And they did that over the entire nation equal in size to the USA, as well as infrastructure to connect it all, and now doing the same with the belt and road (silk road) to interconnect Asia and Europe while bypassing russia.
This is really what Putin is fighting against. When the USSR failed in 1991 it was partly because of all this. The tripolar world had shifted from The West/Russia/China (and China only because it had nuclear weapons and half a billion potential soldiers) to become a unipolar world with only one power able to project real force in the world, in short we won the cold war and bought Chinese acceptance which benefited China enormously in economics even as it collapsed their main rival with such a long frontier, russia.
Russian influence is a tiny fraction of what it was when Putin was a KGB colonel. And even that is only because of the threat they pose. Even their energy exports mostly to Europe can be easily replaced if the EU sanctions russia, so even that is no real bargaining chip for him. His plan for becoming a player on the world stage again is nested in his nuclear weapons and convincing other nations he is willing to use them if he is not treated with the same gravity as other major powers. Yet, russian economics are dominated by mafia crime lords and utter lack of quality and modern engineering, they make some things but nothing wanted by external markets, except for their oil and nat gas. And even that is hardly worth the headaches of doing business with criminals.
He would be better off with making russia actually competitive in goods and services, they have all the ingredients to do that, but they desperately need reforms, they jumped from a corrupt form of communism to an even more corrupt form of capitalism without much experience in how capitalism even works. And they have not even attempted to build a modern economy. I like russian people, I hate the russian government. It is suicidally incapable of real reform. They really need Tsar Peter the Great again and Putin ain’t he. It would be as if the US had lost the cold war and collapsed and Oliver North rose to take over as president for life. Corrupt and obdurate, backward looking and insisting the US was still great, still a player because we still have our nuclear weapons, but having no real economy functioning. Go into ANY russian shop or gas station, they accept and even prefer US dollars to rubles.
“The main currency in Zimbabwe is the US dollar so I suppose you are right-ish on that score”
Toilet paper is toilet paper, I suppose. No matter where it is made. Make enough of it, and it’s see use near everywhere.
Those pictures aren’t too different from the change in the New York skyline, back when New Yorkers were still competent enough to tie shoelaces, and slap together sufficient covered space so that people and businesses could have places to live and conduct competitive business. We weren’t always completely useless either, you know. We’ve just had a Fed for long enough that it seems that way.
Given the funny math of toilet paper makers
Charmin Ultra Soft Toilet Paper 12 = 48 Mega Rolls
And the PRICE, it might well be cheaper to use dollar bills to wipe soon.
Hi Mish, Here is the alternative reserve currency. State backed cryptocurrency which is also backed by gold. Several countries are developing SBCC and at least one will be backed by gold. Even Bitcoin – people are paying 10,000$ for which has no intrinsic value. The whole world will accept SBCC (gold) which is separated from their own currency ( politics ) instantly.
It’s not about merely “accepting.” Anyone will ultimately “accept” any convertible currency, as he can then immediately convert it to what he feels he needs.
The important thing, is what currency something is priced in. And what something is priced in, depends on what its inputs are priced in. If you sell gasoline, and oil is priced in dollars, your workers need dollars to pay fixed mortgages, and you have to pay taxes in dollars and land rent in dollars; it’s hard to price your resulting end product in anything other than dollars; or at least a currency which don’t fluctuate too wildly in dollar terms (which Bitcoin does.)
Taxes are a biggie, once they are as sky high as the are in the US today. If your Bitcoin drops in value in dollar terms, you still have to pay your taxes in dollars. As do the employees and vendors you paid in Bitcoins….. Clandestine stuff, which flies under the radar of the taxman by definition, is the exception. Which is one reason why clandestine transactions is one area where Bitcoin is fairly widely used.
The central bank cartels won’t allow states to have currency independence, let alone a gold backed one. It would take away their power to create currency, and therefore their ability control people/corporations/nations.
Monetary demand is a function of faith in central banks.
It is more a function of how much of the monetary reserve the world has. Holders cant afford for a given reserve currency they have a lot of to become worth less much less worthless.
So what happens if Biden wins and Republicants lose the Senate ? The US is still the best house in an above average neighborhood.
Gold can go back to being the reserve currency.
US gets defeated in a major war. Heck the US does not have to be defeated. China and Russia can do a proxy war through Iran, and as long as the later does not lose, it’s goodbye my love.
I suspect all it would take, was the Fed and/or Washington acting sufficiently obviously irresponsible wrt the dollar; that the Chicoms felt they could get away with decoupling without their population blaming them for the attendant short term dislocations doing so would cause.
Ultimately, the Chinese would like to see the price of oil and other commodities, which they need by the chinaload to keep their machine running, being more stably and predictably priced in their local currency. And they would at the same time benefit from the rest of the world’s buyers and sellers, bending over back and forwards, in order to keep their local prices synced up with Chinese domestic market developments.
But they don’t want to be the ones getting blamed, for the invariably somewhat chaotic and disruptive transition, to get there. So they will likely keep leaving the US government a good bit of leeway wrt exploiting the dollar’s status.
“If” the US went totally insane politically? I think we are more than half way there already.