The Dollar was officially created in the late 1700s when Congress passed an act declaring the dollar as the official currency of the United States. The dollar has taken its place as the world’s most globalized currency. Over half of the world’s central bank reserves are held in dollars, while citizens on nearly every continent use the dollar in daily transactions. Arriving at this point of global dominance was neither quick nor easy for the dollar.
The United States Dollar
During the 18th and 19th centuries, most global trade was settled in British pounds. The pound’s dominance resulted from Britain’s industrial solid raw material imports and its housing of some of the most crucial commodity exchanges. During the Pound’s dominancy, the dollar was held back by factors like the United States’ complete lack of a central bank, the absence of liquid financial markets, and a shortage of investors participating in the U.S. trade acceptance market.
As the U.S. embarked on a strategic journey to improve its financial markets and expand its export markets, the situation for the dollar began to change. After nearly two years of political debate, the U.S. made a pivotal decision to establish a central bank in 1913. This bold move allowed U.S. banks to gain an international presence and stabilize the previously volatile financial markets. While the U.S. began dominating export trade worldwide, simultaneously, the European Trade Credits Market faced challenges, pushing banks to look to U.S. banks to obtain endorsed bills for their clients.
In addition, New York banks offered an interest rate lower than their London counterparts, further adding to the dollar’s emerging attractiveness. Accordingly, the dollar continued growing, with American banks beginning to issue European bonds denominated in dollars and marketed to U.S. investors.
By the 1920s, the dollar had not just surpassed the pound in terms of its usage on an international scale, but it had also become a symbol of global economic power. It demonstrated its resilience by maintaining its position even during the tumultuous period of the Great Depression. As the world’s leading global exchange currency, the dollar became the main currency for invoice trade, quote prices, and settling transactions, a role it still plays. Fifty years later, the 1970s proved to be a challenging time for the dollar. It faced stark devaluations, further underlining its global significance and the weight of its impact on the worldwide economy.
However, this devaluation did not create a shift away from the dollar, as many expected. Instead, central banks continued holding on to their dollar reserves, and the dollar maintained its relevance in international trade and transactions. The U.S. economy’s exponential growth contributed to the dollar’s ability to withstand challenges like devaluation.
The Petrodollar
Petrodollars are not a currency but the exchange of U.S. dollars for crude oil exports. The term rose to economic and political prominence in the mid-1970s amid growing interdependence between the U.S. and crude oil exporters. The term was created in the 1970s through a 6-page agreement signed by US President Richard Nixon and Saudi officials. While the US provided military supplies and equipment to the Saudi Kingdom, Saudi Arabia agreed to utilize US dollars for the oil agreements. Afterward, the petrodollar system implicated the US dollar globally as being accepted for oil exports. In other words, it became the international practice of trading oil for American dollars rather than another currency. The oil-importing nation followed the same path, and paying the oil-extracting country in US dollars became necessary. Such advantages proved irresistible to oil exporters, and their reliance on the dollar extended its dominance.
The dollar has held onto its dominance for nearly a century. However, with changing times come changing threats and challenges to the dollar. One of the main threats the dollar is currently facing is shifts away from the dollar within nations sanctioned by the U.S. Russia has remained a prime example of this following its annexation of Crimea several years ago. Along with sanctioned countries, financially distressed nations are also at the top. Following periods of economic recession, falling exports, unemployment, and rapidly increasing inflation, nations like Argentina have begun de-dollarizing economies and shifting toward the Chinese yuan.
The Chinese Yuan
The Chinese yuan first came into circulation in December 1949. Issued by the People’s Bank of China, it fluctuates under a floating exchange rate regime. From 1997 to 2005, the yuan was pegged to the dollar until the floating exchange rate regime replaced the peg. This move was well received by the international community, who believed that the dollar peg made the yuan immensely undervalued, giving Chinese companies a financial advantage.
As of 2023, the yuan is the fifth most common currency in foreign exchange reserves. Though its significance compared to the dollar is slim, the currency has been making strides to uphold its importance in the global economy. The yuan’s usage in settling Chinese cross-border payments increased by 15% from 2021-2022. In addition, the international usage of the currency increased by 27% in 2022. These statistics make clear the increasing usage and importance of the yuan globally.
China’s “Debt-Trap Diplomacy”
Since the early 2000s, China has established itself as a foreign creditor and lender of last resort by offering yuan-based swap lines and funds from state-owned banks. More than 40 nations have been offered a swap line. Since the 2000s, China has lent nearly $250 billion in sovereign debt, much of which was emergency funds.
These increases in funds provided through yuan-based swap lines have highlighted the yuan’s escalating importance in the global economy. However, China’s role as such a large sovereign creditor has not come without controversy. Many of these nations receiving the funds face situations of extreme financial instability. Some, such as Sri Lanka, have already defaulted on the loans, forcing them to figure out a payment plan while neglecting other basic needs.
While the loans are often intended to support infrastructure growth, these heavily indebted nations usually struggle to repay these Chinese loans. They cannot see a tangible increase in the intended areas. China has also established a reputation as an unforgiving lender, often jumping to the front of repayment lines and remaining unwilling to accept any losses on defaulted loans. Because of this, many deem China’s lending to be predatory, leading to the term “debt-trap diplomacy” being coined. Many of these loans have been related to China’s Belt and Road initiative. However, whether or not this lending can be considered predatory is under debate. With several nations tapping into their convenient yuan-based swap lines, record numbers of central banks globally are accessing these loans offered by the People’s Bank of China.
While China does not typically disclose which nations have utilized their swap lines, it does disclose the nations offered access to them. Interestingly, most of these countries are in a situation of financial stability. This further raises the question of China’s interest in lending to a country with such a low creditworthiness, especially given that it does not typically offer the lines to nations with such low credit ratings.
The answer to this question might lie in countries’ natural resource reserves and China’s interest in obtaining them. For Example, Argentina may not possess an impressive credit rating or project confidence that it will pay back its debt, but it is one of the largest exporters of lithium. As the world’s second-largest lithium exporter, Argentina is essential in producing this highly-demanded metal. Over 60% of the world’s known lithium is in the Lithium Triangle—Argentina, Chile, and Bolivia.
This makes the region incredibly valuable to nations looking to increase their access to lithium. The metal, also frequently referred to as “white gold,” has rapidly escalated demand due to its role as an integral component of electric vehicle batteries. The mineral is most commonly found in brine pools or salt-rich deposits, of which Argentina is abundant.
With EV sales running three times last year’s, China needs to secure its lithium access. In late May 2023, a Chinese lithium miner named Tibet Summit Resources announced a $1.7 billion plan to build two new lithium mines in Argentina. In February of 2022, the Chinese miner Zijin Mining announced a $380 million plan to build a lithium carbonate production plant in the Catamarca province of Argentina. These plans are just two of the many instances of Chinese lithium miners investing millions and even billions to construct lithium mines and production plants within Argentina. The significance of this goes beyond the construction of lithium plants. The Chinese government has invested in various Argentine infrastructure projects for several years.
In May of 2022, the Bank of China and China Development Bank announced a $4.7 billion investment into constructing a hydroelectric dam in the Santa Cruz province of Argentina. In mid-2022, another plan was announced for a $1.25 billion investment into building a fertilizer plant. Countless other examples exist in terms of Chinese investments in Argentine infrastructure. The nations also signed an agreement in February of 2022 for Argentina to join China’s Belt and Road Initiative.
Future Implications for the Yuan and Dollar
With China conspicuously engaging in efforts to increase the yuan’s international presence, it becomes clear that one route China is taking to try and bring the yuan to hegemony is serving as a last-resort lender to financially insecure nations. Furthermore, the provision of these funds makes these nations more likely to commit to further future usage of the yuan, often through agreeing to settle future trade in the yuan. The question arises then of what this de-dollarization can indicate about the future landscape for the yuan and dollar. With nations beginning to de-dollarize, could the yuan one day supplant the dollar as the world’s dominant currency? If so, what would it take for this to happen?
The dollar’s rise to dominance was a long process with many obstacles and challenges that had to be overcome. The path would be no more straightforward for the Chinese yuan. Despite recent rises in central banks tapping yuan-based currency swap lines, China still faces several significant barriers to genuinely expanding the yuan’s international presence. While the dollar and yuan may provide similar prospects regarding credit risk and currency risk for asset allocation, the situation is different for liquidity risk.
The U.S. Treasurie market is frequently denoted as the world’s most liquid government securities market. The situation is different for China, whose economy is subject to solid capital controls. There are particular regulations on the amount of money that citizens are allowed to move in and out of China. Because of this, foreigners can have difficulty moving their funds out of China. It is also difficult for foreigners to open offshore accounts at Chinese banks. Some banks require monthly deposits of a specified amount to open an account. If citizens can open an account, they can only wire money up to a certain point, which is called the foreign exchange quota. These capital controls deter many investors from Chinese markets. Liberalizing these stark capital controls would be necessary if China truly wants the yuan to one day see hegemony. The likelihood and timeline of such an event are debated, but it would not occur in the short term, even if it were to happen.
The de-dollarization of financially unstable countries provides insight into some of the dollar’s biggest future challenges. It is important to note that de-dollarization is not because the yuan is a more attractive currency but because it is an initiative undertaken in response to record-low dollar reserves. These low dollar reserves resulted from a severe drought, destroying the market for their largest export.
This is important to note, given that this de-dollarization occurred because of a rare weather event and in a situation of economic downturn, not in a situation of promising economic growth. Russia is an example of a country undertaking recent efforts to de-dollarize. Once again, Russia has not begun de-dollarization because it saw the yuan as necessarily more attractive, given its lack of convertibility, but rather in response to U.S. sanctions related to the Russia-Ukraine War. Once again, this is an instance of de-dollarization associated with a rare and undesirable circumstance. While Russia has been attempting to de-dollarize for many years, its motivations have always been a response to political conditions. Because of this, there is no significant reason to believe that economically thriving nations will be motivated to turn to the yuan rather than nations in severe economic recessions or rare circumstances. Until we see economically thriving and financially sound nations start de-dollarizing for the yuan, there is no reason to believe that these instances indicate the yuan posing a significant threat to the dollar’s dominance. While it may be possible that countries in certain circumstances or recessions will de-dollarize, these instances are rare. Together, they may weaken the dollar, but it would likely not be enough to challenge its dominance genuinely.
