Why China's Yuan Is No Imminent Threat To The Dollar - Source Forbes

Some bad ideas just won't die. It seems to matter not that many are silly beyond logic.
 

When it comes to money matters, a big one stands out as ridiculous. That is the recurrent meme that China will somehow imminently oust the U.S. dollar from its role as by far the world's most important currency.

The problem is that the trope doesn't reflect the reality of the world in which we are living.

Better Dollar Ecosystem

The reserve currency is part of an ecosystem of financial systems. The dollar is the paper money that we all know. But there is also the bond market, the commodity market, and the foreign-exchange markets. All of these markets work together to the benefit of anyone using dollars as opposed to any other currency.

Imagine you are an oil trader. You buy your oil in dollars (because all commodities are priced in dollars)  load it onto a tanker that you purchased with dollars, and then you financed both the ship and the cargo with a loan denominated in dollars. Finally, when you deliver the oil to the customer you get paid in dollars.

Of course, the first response would be to say that if you can do that with dollars then surely you can do that with another currency, such as the yuan.

Theoretically yes. But in practicality, no you can't.

"There is simply not enough liquidity in all the other currencies combined to switch away from the dollar," says Jeff Christian, veteran financial markets expert and founder of New York-based commodities consulting firm CPM Group.

Consider these financial markets statistics.

The debt market is dominated by securities denominated in dollars. More than half (51%) of the liabilities are in dollars with 28% in euros. The remainder of the total comprises all other currencies combined, according to data from the Bank of International Settlements. The Chinese yuan doesn't get an individual mention.

The market for interest rate derivatives is dominated by the dollar. Around 70% of the transaction volume is in dollars, with all other currencies combined making up the remainder, according to BIS data.
  The foreign exchange market is dominated by the dollar with almost half of all transactions (44%) by volume involving the dollar, according to the latest (2016) triennial survey from the BIS. The data shows 88% but the total of all currencies comes to 200%.

The dollar's dominance in all these subsector markets means there is more liquidity and hence more efficiency in each of the markets. That efficiency means there is little financial reason to look elsewhere for loans or derivatives.

If nothing else, the mantra of business has long been, "if it ain't broke don't fix it." Chief financial officers know that the dollar market is the biggest and most efficient, so that is what they use. Self-fulling maybe, but that is a fact of life. There's little reason for them to change.

Big Shock Needed

That inertia in the habits of business means that it takes an awful lot to unseat the doiminant reserve currency.

"It would take a seismic-sized shock to unseat the U.S. dollar," says Robert Wright, professor of political economy at Augustana University in Sioux Falls Sout Dakota, and also an economic historian.

We don't have a lot of history of currency regimes chnaging.  But there is some evidence from when the British pound sterling got unseated by the U.S. dollar.

Even during the late 19th century, the U.S. economy was clearly rivaling that of the United Kingdom (not including its colonies and possessions.) However, size wasn;t enough. It took until 1944 for the U.S. dollar to unseat the pound, and it did indeed involve some cataclysmic shocks.

To begin with, there was WWI of 1914-1918 in which Britain lost up to 100,000 men a month. Not only was a huge portion of a generation of men killed, but there was a vast financial cost to the country also. Following that, in the 1920s, an attempt was made by Britain to peg its currency back to gold at the same rate it had been before the war. The result was massive industrial action. Then came the Great Depression and after that WWII with all the associated destruction and death.

In short, there was a lot of economic and geopolitical upheaval necessary in order to unseat the pound from its role of King of currencies.

I have written similar commentary in the past, but somehow some people just aren't getting the message. The dollar will be with us for long time yet.