Why China Can't Quit the US Dollar

Summary

The 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

00:00

💵 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.

05:01

📉 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.

10:03

⚖️ 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.

Keywords

💡Dollarization

Dollarization is when a country pairs its currency with the US dollar to stabilize its economy. This happens when there is little trust in the domestic currency. In the video, Argentina's leader Javier Milei is considering this to avoid recurring currency crises. The term relates to the main theme as it contrasts with China’s efforts to 'de-dollarize' and establish more control over its currency.

💡De-dollarization

De-dollarization refers to the process by which countries reduce their reliance on the US dollar for international trade and reserves. In the context of the video, China is aiming to reduce its dependence on the US dollar to gain greater economic sovereignty and mitigate risks, such as sanctions from the US. This is a central theme as China looks to establish itself as an economic superpower.

💡Reserve currency

A reserve currency is a currency held in significant quantities by governments and institutions as part of their foreign exchange reserves. The US dollar is the dominant global reserve currency, but the video explores the potential shift in global economics if China were to reduce its dependence on the dollar. The dominance of the dollar in international trade gives the US significant economic influence.

💡Managed float system

A managed float system is a currency exchange system where a currency's value is allowed to fluctuate in the market, but a central authority intervenes to stabilize it. The video explains that China uses this system with its yuan, where the People's Bank of China intervenes to manage its value. This system allows China to exert control over its currency while still participating in global trade.

💡People's Bank of China (PBOC)

The People's Bank of China is the central bank of China responsible for managing the country’s monetary policy and regulating its financial institutions. In the video, PBOC’s role in managing the yuan’s value by holding US dollars and intervening in the foreign exchange market is highlighted as critical to China's financial strategy.

💡Capital controls

Capital controls refer to measures taken by a government to regulate the flow of foreign capital in and out of a country’s economy. The video discusses China’s approach to capital controls, limiting how much money can leave the country to stabilize its economy. These controls are crucial in understanding China’s attempt to maintain a managed float system while navigating its economic policies.

💡Impossible Trinity

The Impossible Trinity is an economic concept stating that a country cannot simultaneously have a fixed exchange rate, an independent monetary policy, and free capital movement. The video explains that China is trying to balance all three, but this creates significant pressure. Eventually, China will have to give up one of these to maintain stability, shaping its future economic decisions.

💡SWIFT system

SWIFT (Society for Worldwide Interbank Financial Telecommunication) is a global messaging network used by banks and financial institutions to securely communicate about transactions. The video discusses China’s reliance on the US dollar in SWIFT transactions and the geopolitical power the US holds by controlling access to this system, illustrating the challenges China faces in reducing its dollar dependence.

💡Foreign exchange reserves

Foreign exchange reserves are assets held by central banks in foreign currencies, used to back liabilities and stabilize the domestic currency. The video highlights that over 54% of global reserves are held in US dollars, demonstrating the dollar’s dominance. China holds large US dollar reserves to manage the yuan’s value, but it also creates a dependency on the US.

💡Global trade flows

Global trade flows refer to the movement of goods and services across international borders. China’s economy heavily depends on importing raw materials and exporting manufactured goods. The video explains that China’s ability to engage in global trade is at risk if it loses access to the US dollar or is cut off from systems like SWIFT, further emphasizing why China wants to reduce reliance on the dollar.

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