It Will Be a While Before We Can Say Goodbye to the Dollar

The Chinese government has suggested using its superpower reserve money to solve the Triffin Dilemma and end the era of the U.S. dollar. Considering China’s currency system, the suggestion seems reasonable, but any reform at the International Monetary Fund (IMF) would not be completed in the foreseeable future. It is still not yet time to say goodbye to the dollar.

Dollar Returns as the Hot Topic Around the Globe

On March 18th, the Federal Open Market Committee (FOMC) announced its policy regarding the U.S.’s long-term national debt, which will be worth $300 billion in the next six months. As a result, the U.S. index had its largest single day plunge since the New York stock market crash of August 25th, 1987. The worry of a weak dollar provokes a thriving market of bulk stocks to serve as a cover.

For China, who owns nearly two trillion dollars of the foreign exchange reserve, the FOMC’s decision to lower the interest rate and raise the price of U.S. debt gave China a break regarding its roughly $700 billion investment in national debt. However, it runs the risk that Chinese-owned U.S. assets will continue to shrink. The balance between loss and gain is something that the Chinese government needs to take into consideration.

Getting Out of the Triffin Dilemma

On March 23rd, the governor of the People’s Bank of China, Xiaochuan Zhou, wrote an article titled “Reform the International Monetary System,” where he honestly reflected on the current attitudes of the Chinese government towards thorny U.S. assets. One point in the article that needs to be addressed is Zhao’s representation of the Chinese government regarding the transformation of the Special Drawing Rights initiative (SDRs).

The famous Triffin Dilemma is the reason why Zhao brought up this problem in the first place. Triffin was an American economist who pointed out the paradoxes in the existing Bretton Woods system. As we all know, the dollar’s role as a global reserve currency needs to provide enough liquidity to promote global economic growth. While developing the dollar’s liquidity, the goal of maintaining a stable value has failed. To quote Zhao himself: “The issuing countries of reserve currencies cannot maintain the value of the reserve currencies while providing liquidity to the world.”

Established by the IMF in August 1969, the purpose of the Special Drawing Rights was to supply the international gold reserve with reserve assets issued from member countries. The Bretton Woods system broke down in the 1970s, but the SDRs survive. Today, the SDRs have gradually become a basket of four major currencies working as a unit of account. Although it is not available for commercial use among member countries, it can be exchanged for foreign currencies that are freely usable to make international payments and reach the payment balance on a rationed basis.

Zhou’s initiative to transform the SDRs into a super-sovereign reserve money aims to solve the Triffin Dilemma, breaking the current situation of the dollar solely outperforming other currencies and free the Chinese government from being restricted by their dollar assets. The main ideas include: to establish the currency liquidation among SDRs and other currencies, to directly use SDRs as the account money in international trade, to set the price of bulk stock, investment and corporation entry, to issue current securities that account by SDRs unit, to maintain and increase the value of SDRs and to enhance its attraction to member countries for further investment, to perfect the methods of setting the value for SDRs based on the different GDP of each member country in reforming the standard of the currency basket.

The last point in particular is where the Chinese government expresses their expectation to include the Chinese Yuan (CNY) as one of the major currencies in the basket. China’s GDP has now become the third largest economic body in the world.

However, considering its currency system and the historical role that the IMF has played, China needs more time and effort before it can say goodbye to the dollar.

Currency Policy Cannot be Changed in the Short-Term

At the moment, the People’s Bank of China is controlling the floating exchange rate system based on the currency basket. The bank keeps buying dollars through the foreign exchange market, and therefore could interfere in the exchange rate of the Chinese Yuan, which includes restricting the CNY to increase its value. Given the reasons that the Chinese government promises “never to give up on exports,” and as the new economic bodies in Asia have currently fallen into recession, those new economic currencies are generally under pressure of decreasing value. The Chinese government has to stabilize the CNY as soon as possible in order to save the export industry that constitutes mainly labor intensive enterprises. Under the present circumstances, it is unlikely to substantially increase the value of CNY at such a sacrifice.

It is not difficult to see that as long as the Chinese government did not stop buying foreign assets to lower the CNY’s value, or gave up the thought of saving its export industry through lifting its control over the CNY, the SDRs that formed still cannot escape the fate of devaluation even if the dollar assets can be compliantly changed with the ratio of SDRs among IMF member countries. Of course, when considering the asset risk, the multi-major currencies included SDRs reserve undoubtedly outperforms the current dollar assets. However, it only works on the premise that the CNY can be exchanged freely, which apparently still needs time to fulfill.

IMF Reform is Necessary in Order to Say Goodbye to the Dollar

After World War II, with the boom of its military and economic power, the status of the U.S. internationally was not lower than any other country in the whole world. The IMF is surely not an exception. In order to replace the dollar’s status among currencies in the global reserve, over 85% of the IMF member countries need to support reform. The problem is that the U.S. holds 17% speaking power in the IMF. Without breaking the current power distribution or giving more weight to the new thriving countries, it is impossible to put the super-sovereignty reserve money plan into practice.

The IMF Will Not Change Overnight

In addition, if the status of IMF cannot be raised among international organizations, the influence that it can bring would be limited. During the Asian financial crisis, the IMF did not spontaneously give a hand to help, but requested those new economic bodies to open their markets. That looting stereotype still sabotages the image of IMF, something that also needs to be improved.

In a nutshell, the Chinese government had suggested using the super-sovereignty reserve money to solve the Triffin Dilemma and end the era of the dollar. When considering China’s currency system, that suggestion seems feasible but IMF reform could not be completed in the foreseeable future. It is not yet time to say goodbye to the U.S. dollar, meaning that we should act reasonably.