There is much news of countries moving to use currencies other than the U.S. dollar for international trade and investment. In March, Brazil and China agreed to use their real and renminbi currencies for settling import and export bills rather than U.S. dollars. This comes in the wake of China supplanting the United States as Brazil’s largest trading partner, a status that we took away from Britain more than a century ago.
Should we worry?
The issue is the degree to which the U.S. dollar is the “reserve currency” for all other countries for international payments and for maintaining stocks of “foreign exchange.” This still includes gold, but mostly is currencies of other nations that are immediately and automatically accepted. The dollar predominates, but the Euro, pound, Swiss franc and the Japanese yen all meet the standard.
Worry? Yes and no. First, bi-lateral agreements by nations to price or invoice trade in their own currencies are largely symbolic. Moreover, despite China’s huge economy, there really are no viable challengers to the dollar on the horizon.
But yes, the dollar continues to predominate internationally because it remains “the least ugly nag in the glue factory,” as Dallas Fed President Richard W. Fisher pithily described it years ago. Despite fundamental evolution of the global economy, the dollar is the world’s central currency because alternatives have worse problems.
Yet the U.S. economy has fundamental problems. Congress won’t put federal finances on a sustainable basis. Regulation of financial markets is inadequate and shot with loopholes. The Fed increased the money supply excessively for years.
We should rectify these failures on their own merits — or demerits — regardless of our currency’s international status. But doing so would additionally buttress the dollar’s international role. Perpetuating denial undermines it, even if no immediate challenger exists.
So why does this all matter? Understand reasons why the government of another nation or businesses in that nation would want money issued by another nation.
The first category is called “settlement.” A Japanese importer must pay for a shipload of soybeans. The Norwegian health service buys Minnesota-manufactured medical devices. Caterpillar’s factory in Piricicaba, Brazil, needs to remit profits back to Peoria, Ill. Brazilian retailers are invoiced for clothing and housewares manufactured in China. A Chinese steel mill gets 100,000 tons of Brazilian iron ore.
This is settlement in the sense of “now that all the corn is planted, I need to settle up at the fertilizer co-op.” Payments are made related to international trade or the remittance of interest, profits, rents, dividends and so forth. These are short term and immediate. The agreement between Brazil and China overwhelmingly deals with this category.
Longer-term investment flows are more central to “reserve currency status.” A Dutch insurer deems it best to keep a quarter of its investment outside of Europe. Minnesota’s public employees pension plan decides it will generate higher or more stable returns if it puts some money abroad. Policy of Uruguay’s central bank may be to always have enough foreign currency to pay for at least six months of needed imports. A Taiwanese shipping magnate fears a Chinese military grab of the island, and so keeps at least $5 billion in stocks and bonds abroad.
The desirability of a currency for either short-term settlement or longer-term investment parking depends on several factors.
Liquidity is the most important. Can you convert your own currency into or out of the reserve currency cheaply and easily at any time without even a large transaction roiling the exchange rate? This implies large size of the issuing country relative to international money markets. Are enormous values of stocks, bonds and bank loans already denominated in this currency? Is it widely traded in multiple markets?
Stability also is key. Is the currency issued by a government that has existed for decades or centuries? Is there zero chance of a sudden overturn of the system? Has the currency been used internationally for a long, long time?
Then there is transparency, which interacts with liquidity and stability. Are decisions about the quantity of the reserve currency and the markets in which it transacts made in ways and by people visible to all? Is its central bank autonomous within government as in Britain, the United States, the Eurozone, Canada or Switzerland, for example? Are decisions free from politically-motivated direction by the executive or legislative branches? Or can a dictator name a new finance minister or central bank head who will kowtow to their every directive?
There also is acceptability, which is very fuzzy and fickle. Are others accustomed to trading or holding the currency, whether based on objective factors or irrational prejudices or vibes?
Looking at these factors, Switzerland is stable and transparent. The Swiss franc is acceptable and markets for it are liquid — as long as not too many people want to use it. The franc, along with the New Zealand dollar or the Swedish crown, will serve as useful reserve currencies on a small, often localized, scale but can never be the global reserve currency the way the dollar is and the pound long was. The issuing countries are just too small for their use to be scaled up.
China is huge and growing, but it is also moving to one-person dictatorship, central planning and zero transparency in economic and monetary decision-making. Most importantly, the renminbi’s international value is tightly controlled. There are no open free and high-volume markets for renminbi-denominated bonds that are free of government intervention, and it would take decades to establish these even if Xi Jinping’s regime was not resolutely marching in the opposite direction.
So Brazil and China can invoice deals in their two currencies, but their relative value to each other, the real-renminbi exchange rate, will still be determined by what each is worth relative to the dollar. The agreement is largely symbolic. There are other concerns about the status of our own currency, but these must wait for another day.
St.Paul economist and writer Edward Lotterman can be reached at [email protected].
