Why China Can't Quit the US Dollar
Summary
TLDRThe video discusses the perception of the US dollar losing its dominance as the world's reserve currency. It explores China's efforts to reduce reliance on the dollar through 'dollarization,' a strategy used to stabilize economies by pegging to the dollar. China aims to weaken the dollar's global role, but this is complicated by its economic reliance on imports and US dollar reserves. The video explains China's managed float system and the challenges it faces in balancing capital control, independent monetary policy, and exchange rate stability. The narrative touches on the broader geopolitical implications, including the risk of China invading Taiwan.
Takeaways
- 🌍 China's desire to move away from the US dollar aims to gain greater economic independence and reduce reliance on adversaries' currencies.
- 💵 Dollarization refers to countries adopting the US dollar to stabilize their economies, while de-dollarization is when countries move away from it to gain monetary sovereignty.
- 🇨🇳 China employs a managed float system for the Yuan, where it intervenes to maintain the currency's value against a basket of currencies, but the US dollar is still a primary reference.
- 📉 Even though China's trade with the US is below 20%, nearly 47% of its cross-border payments were denominated in US dollars in 2023, highlighting their dependence on the currency.
- 🔒 China faces challenges balancing its need for global trade with its desire for control, particularly in its approach to the free movement of capital, domestic monetary policy, and exchange rate management.
- 🔗 The international financial system relies heavily on SWIFT for transactions, where the US dollar dominates, accounting for 48% of transactions, compared to the Chinese yuan's 4%.
- 🚧 China’s capital controls complicate efforts to reduce reliance on the US dollar, as capital flows in and out of the country are tightly regulated.
- 🇺🇸 The US dollar still holds an overwhelming share of global foreign exchange reserves, at 54%, which dwarfs other currencies like the Euro and Yen.
- 💣 If China opens its capital account or gives up its fixed exchange rate, it risks economic instability, potentially leading to a severe asset bubble burst, similar to Japan's 1990s crisis.
- ⚔️ China’s precarious economic situation, compounded by its reliance on imports and capital controls, could heighten tensions, increasing the risk of military action such as an invasion of Taiwan to distract from domestic issues.
Q & A
Why is there concern about the US dollar losing its dominance as the world's reserve currency?
-The concern stems from factors like the rising debt in the US and global geopolitical shifts, such as China's efforts to weaken its reliance on the dollar. Some believe these factors indicate that the US is entering a late-cycle debt crisis, which could threaten the dollar’s dominant role.
What is dollarization, and why is it relevant to Argentina?
-Dollarization is when a country pairs its currency with the US dollar to stabilize its economy, often due to a lack of trust in its own currency. Argentina's new leader, Javier Milei, is considering this strategy to manage the country’s ongoing currency crises.
Why is China looking to reduce its dependence on the US dollar?
-China wants to reduce its reliance on the US dollar to exert more control over its economy and avoid the influence of American economic policies. This is part of its larger goal of becoming a more independent global economic power.
How does China manage its currency, the yuan?
-China employs a managed float system for the yuan, allowing it to fluctuate in foreign exchange markets but with intervention from the People’s Bank of China (PBOC) to manage its value. This system references a basket of currencies, with the US dollar as the primary benchmark.
What role does the US dollar play in China’s international trade?
-Despite China’s desire to reduce its reliance on the US dollar, 47% of its cross-border payments in 2023 were still denominated in dollars, even though less than 20% of its exports were sent to the United States.
How does the SWIFT system factor into China's dependence on the US dollar?
-The SWIFT system is crucial for global financial transactions, and 48% of all SWIFT transactions are denominated in US dollars, compared to less than 4% in yuan. This dependence on SWIFT highlights China’s continued reliance on the US dollar for international trade.
What are the three economic policy trade-offs that countries face, and how do they apply to China?
-Countries can choose only two of the following: a fixed exchange rate, independent monetary policy, or free movement of capital. China tries to balance all three by managing its currency exchange rate, conducting independent monetary policy, and restricting capital outflows. However, this balancing act is becoming increasingly difficult.
What risks would China face if it opened its capital account or abandoned its currency peg?
-If China opened its capital account, it could face an asset bubble similar to Japan's in the 1990s. Abandoning its currency peg could lead to significant currency devaluation, making imports more expensive and destabilizing its economy.
Why is the idea of China overtaking the US dollar as the global reserve currency considered unlikely?
-The US dollar still accounts for about 54% of global foreign exchange reserves, far outpacing other currencies like the euro (19%) and yen (5%). Despite China’s ambitions, its currency plays a much smaller role in global finance, and it faces significant challenges in loosening its dependence on the dollar.
How could China’s economic struggles lead to a military conflict over Taiwan?
-If China’s economic situation worsens, its leadership might use military action, such as invading Taiwan, as a distraction from domestic problems. This could rally public support and shift the blame for economic issues onto foreign adversaries like the US.
Outlines
💵 The Debate Over the US Dollar's Decline
This paragraph explores the speculation surrounding the potential decline of the US dollar as the world’s reserve currency. It discusses the growing debt crisis and how global powers, particularly China, are strategizing to reduce dependence on the dollar. The example of Argentina’s dollarization strategy is introduced as a contrast, illustrating how countries stabilize their economy by pegging their currency to the US dollar, while others seek sovereignty.
📉 China's Managed Float System and Global Power Play
This section delves into China’s financial strategy, particularly its managed float system, which allows the Yuan to fluctuate while being controlled by the People's Bank of China (PBOC). It highlights China’s reliance on the US dollar for international trade and the potential risks it faces from the US economic influence. The paragraph also touches on China’s goal to lessen its reliance on the US dollar to gain more global economic power and independence.
⚖️ Navigating the Policy Trade-Offs in Currency Management
This paragraph explains the impossible trinity of economic policy trade-offs: countries can choose only two of three options—fixed exchange rate, independent monetary policy, and free movement of capital. It explores how different countries, including China, Hong Kong, and Panama, handle these trade-offs and the challenges they face. China’s attempt to manage all three simultaneously, by controlling its capital flows, is detailed alongside the potential consequences.
🇨🇳 China's Struggle with Capital Control and Economic Flexibility
This paragraph discusses China’s complex system of capital controls and the growing difficulty in managing these flows due to the sheer volume of international transactions. It explains how China attempts to balance its economy through delayed outflows and how its efforts to maintain a grip on its economy might force it to abandon one of its core strategies, either capital controls or the currency peg, with significant risks either way.
💡 Misconceptions About Dollarization and China's Economic Future
The final paragraph puts the discussions of dollarization into perspective, asserting that concerns over the US dollar’s decline are exaggerated. It emphasizes the dominance of the dollar in global reserves and transactions, especially through the SWIFT system. The paragraph concludes with an analysis of the Chinese economic situation, suggesting that internal pressures could push China towards drastic geopolitical moves, like a potential invasion of Taiwan, to distract from domestic economic challenges.
Mindmap
Keywords
💡Dollarization
💡De-dollarization
💡Reserve currency
💡Managed float system
💡People's Bank of China (PBOC)
💡Capital controls
💡Impossible Trinity
💡SWIFT system
💡Foreign exchange reserves
💡Global trade flows
Highlights
The US dollar may be losing dominance due to a late cycle debt crisis, where there is an oversupply of debt and a shortage of buyers.
Dollarization refers to a country pairing its currency with the US dollar, which Argentina's new leader Javier Milei is pursuing to stabilize their economy.
China seeks to de-dollarize to gain greater economic independence and weaken the US dollar’s role as the global reserve currency.
China’s economy is heavily reliant on imports to meet its energy and food needs, and weakening the yuan could threaten this reliance.
47% of China’s cross-border payments in 2023 were denominated in US dollars, despite less than 20% of their exports going to the US.
China's People's Bank of China (PBOC) manages the yuan using a managed float system, referencing a basket of currencies, with the US dollar as the primary fixture.
If the yuan weakens too much, China must use its US dollar reserves to buy yuan to stabilize its value in international markets.
The US dollar accounts for over 48% of all SWIFT transactions, while the Chinese yuan only accounts for less than 4%, demonstrating the dollar's global dominance.
China faces significant risk if the US Federal Reserve imposes sanctions, which could freeze their dollar reserves and disrupt international trade.
China’s authoritarian system tries to manage capital outflows, setting limits to prevent too much money from leaving the country at once.
China attempts to balance having a fixed exchange rate, independent monetary policy, and control over capital flows, but experts suggest this is unsustainable in the long term.
China may eventually have to give up their currency peg to the US dollar, which could devalue their currency but avoid a massive domestic economic crisis.
The US dollar still dominates foreign exchange reserves globally, accounting for about 54% of them, far surpassing other currencies.
A significant devaluation of the yuan would make it harder for China to purchase basic necessities like energy and food from abroad, weakening its international spending power.
There is a risk that China might consider military action, such as an invasion of Taiwan, to distract from economic challenges and blame foreign adversaries.
Transcripts
why does everyone seem to think that the
US dollar is going down is the US dollar
losing its dominance we should prepare
to lose our position as holder of the
world's Reserve currency in my opinion
we are at the beginning of a very
classic late cycle late big cycle debt
crisis when the supply demand Gap when
you're producing too too much debt and
you have also a shortage of buyers and
one of the key arguments in favor of
this worldview is the fact that the
world's second largest economy wants to
dollarize dollarization is when a
country pairs its currency with the US
dollar it's a move to stabilize your
economy particularly when there isn't a
lot of trust in your domestic currency
this is a strategy that the new leader
of Argentina Javier mle is pursuing
since Argentina has had multiple
currency crises over the the last few
decades dollarization is the opposite
when a country moves away from the
dollar it's aiming for sovereignty over
its own currency and control of its
monetary policy and China sees itself as
an ascending superpower worthy of
Greater economic strength and
Independence weakening the US Dollar's
role as the global Reserve currency
would be an enormous geopolitical coup
the key question is can they do it in
this video we'll unravel China's desire
to dollarize their unique Financial
strategy and examine whether they're
capable of fundamentally reshaping our
financial
world all currencies trade against one
another some currencies like the Hong
Kong dollar are pegged to a fixed
exchange rate relative to the US dollar
other currencies like Japanese Yen have
a floating exchange rate that shifts to
reflect the relative economic sentiment
between two economies the Chinese Yuan
employs what is referred to as a managed
float system this means that the yuan is
allowed to fluctuate in foreign exchange
markets but People's Bank of China or
pboc intervenes to manage its value to
do this the pboc references a basket of
currencies that it wants to trade
against it includes the US dollar the
Euro the Yen some other currencies but
the US doll is the primary fixture
47% of China's own crossb payments were
denominated in the dollar in
2023 even though less than 20% of
China's exports head to the United
States in order to exert more economic
power on the world China must lessen its
dependence on its adversaries currency
in the pboc's ideal scenario the Yuan
would remain strong enough for China to
buy what it needs abroad because it
relies on Imports to meet the energy and
food needs of its population to defend
that trading band The pboc must hold US
Dollars here's why if Yuan weakens too
much the pboc must intervene and use
those dollars to buy up Yuan boosting
its value internationally unfortunately
this means that American Economic Policy
makers can exert substantial economic
and political power on the Chinese
economy meaning the US Federal Reserve
can influence domestic Chinese politics
for example if China were to become the
target of sanctions perhaps for invading
Taiwan which I already made a video
about then their dollar reserves could
be frozen or seized they'd also struggle
to transact globally the backbone of
international finance is a system called
Swift which connects over 11,000
institutions in a secure network vital
for Global transactions Chinese Ian
accounted for one side of less than 4%
of all Swift transactions that's in
dwarfed by the Greenback which accounted
for over 48% of all Swift transactions
so who has more influence to deny access
to Swift exclusions from Swift would
a country's ability to engage in
International Financial transactions
cutting it off from the global economic
community and China's rise has been
built on being an in immediate Goods
manufacturer where they import raw
materials process them then export those
components for final assembly a value ad
manufacturer which is a majority of
Chinese businesses would be destroyed if
it was cut off from global trade so you
can see why they'd want to dollarize
let's talk about what gets in the way
every single economy faces a set of
policy trade-offs that they must make
Financial authorities can choose only
two of the following one a fixed
exchange rate where the country pegs its
currency's value to another major
currency like the US dollar this can
promote trade and investment through
stability two an independent monetary
policy where a country can set its
interest rates and control its money
supply based on domestic economic
conditions or three the free movement of
capital also called an open Capital
account which allows for the
unrestricted flow of capital in and out
of the country this can lead to
increased investment opportunities but
can also make the economy vulnerable to
sudden Capital flight no one can have
all three not even the US most large
globalized economies choose to have
control over their domestic monetary
policy and an open Capital account this
means that they cannot fix their
exchange rate the US Australia UK Japan
and South Korea all follow this model
model their currencies fluctuate freely
which means they're open for business
with foreign investors hard
authoritarian countries like North Korea
do not allow for the open flow of
capital out of the country their capital
account is closed it's an island
financially and economically in exchange
their independent monetary policy and
fixed exchange rate keep things steady
smaller economies like Hong Kong lvia
Panama
give up domestic monetary control in
order to have an open Capital account
and a fixed exchange rate this move
creates stability and makes their
economies more credible to outside
investors which allows them to integrate
into global trade the tradeoff is that
they end up importing someone else's
monetary policy for Hong Kong and Panama
it's the US Federal Reserve for Baltic
states like lvia it's the European Union
China is an interesting case the managed
float of the Yuan keeps the currency at
a relatively fixed exchange rate they
also conduct independent monetary policy
setting interest rates in response to
domestic politics but this is an
authoritarian regime they' prefer that
it be difficult for people to get their
money out of the country just one
problem they conduct over four
trillion of gross trade flows annually
that is a lot of money moving across the
border so what do they do if you were to
think of the ideal Capital control
system you would think of a surveillance
state where every single transaction was
tracked and some Central Authority could
look at each one and say yep you're good
or no no no you're not good but since
China opened to the global economy under
D xal ping in 1978 that's more than 50
years ago there are over 1 million
entities in China licensed to do foreign
transactions it is impossible to sort
the flow of capital in and out so
instead China sets a limit on how much
can flow out of the country at any given
time transactions out of the country
will be delayed until enough Capital
flows back into China to even things out
that means if there's $5 billion set to
leave China today and only 3 billion
flows in 2 billion of that outflow is
going to be held back until more money
comes in the door it's forced balance
ing of flows by Central decree China is
trying to partially hold all three sides
of the impossible Trinity and its grip
is slipping eventually China will have
to give up one of these three they could
completely close their capital account
and give up their globalized economics
they'd be like a larger North Korea but
that is completely incompatible with
she's vision of China as a great power
if they open their Capital account and
keep the fixed exchange rate they would
no longer be able to stimulate the
economy create Easy Money conditions and
prop up their domestic assets inevitably
they'd face an enormous asset bubble pop
akin to what Japan went through back in
the 1990s when real estate prices fell
More than 70% this would be extremely
risky for a single party State like the
CCP they'd take 100% of the blame in an
economic crisis and if Chinese
households lost 70% of their net worth
citizens will not be happy so the only
rational path forward is to seed their
currency Peg if the current ratio is 71
to each dollar a currency adjustment
could see that climb to 10 12 13 or
higher in that world all the debt that
has built up in the Chinese system gets
devalued they avoid default but their
ability to spend internationally
weakens substantially as Yuan weakens a
far larger portion of their budget would
have to be allocated to basic
necessities like energy and food imports
it would be a humbling move and it would
require China's onep party state to
relinquish the control that it has clung
to so tightly for more than half a
century so hopefully you now understand
that all the stories about
dollarization are wildly overblown to
put an even finer point on it the US
dollar accounts for about 54% of Foreign
Exchange reserves dollar reserves dwarf
the volume of all other Reserve
currencies and two US allies the Euro
and Japanese Yen account for 19 and 5%
of reserves respectively the result of
all this pressure is coming to a head
within the Chinese system and this
precarious situation makes me more more
nervous about the risk of China invading
Taiwan I made an entire other video all
about it but suffice to say if China's
economic situation gets worse I could
see a military move being used by
leadership to distract the public from
domestic problems and use a foreign
adversary like the US to pin the blame
on let's hope it doesn't
happen
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