The US Dollar is the most valuable currency in the world. But that wasn’t always the case. Portugal had most of the world’s reserves until 1530, when Spain took over. After Spain, the Netherlands took over, and then France took over. And until World War I, it was ruled by the pound sterling of the United Kingdom.
But by the middle of the 1920s, the US Dollar had become the world’s main currency. A reserve currency is the most popular and widely held currency by governments and institutions, and it can be traded around the world easily and freely. In recent years, the idea that China’s currency, the yuan, could replace the dollar as the world’s reserve currency has been gaining ground. This is because China’s economic and political power is growing, which makes the yuan a more attractive option. In terms of the size of its economy, China is already second only to the United States. It also sends out more goods than any other country.
So it makes sense that the Yuan is close to being the most important currency in the world. But only 2.7% of international payments are made with Chinese money.
So, the question is why, even though the US has printed more money than any other country, the dollar is still the world’s reserve currency. How does China plan to make the Yuan the reserve currency of the world? But why won’t it ever take the place of the dollar?
The United States gained the most from World War II because it helped its allies by giving them arms and other goods. Most of these countries paid the U.S. in gold, which made it the country with the most gold reserves. Europe had been destroyed by the war, so it was important to make a new international monetary system. To do this, 44 representatives from the most powerful countries met in the United States. This meeting led to the Bretton Woods Agreements, which made the dollar the world’s reserve currency and gold its backing. But the Bretton Woods system ended in 1971, which meant that currencies stopped being backed by gold and started being backed by people’s, companies’, and institutions’ trust in paper money.
But even though the dollar-gold standard was no longer in place, the dollar stayed as the world’s reserve currency because it was the most sensible choice. It is still the best choice, even after 50 years. Even though the U.S. government has borrowed a lot of money and printed a lot of money, the dollar has been doing very well lately. People, institutions, and countries are looking for safe places to put their money because there is so much uncertainty in geopolitics. And based on the numbers, the dollar still looks good. In times of uncertainty, the dollar has grown stronger against other currencies, and its value has reached levels not seen in 20 years. In other words, you now need to trade more of other currencies to get $1.
So, as long as there is a lot of demand for the dollar, the U.S. can produce nearly unlimited amounts of currency. And China wouldn’t mind if its currency had those rights, whether it says so publicly or not. That’s why it wants the Yuan to get to that level. It does this by making deals with other nations. China announced a partnership with five other countries in July 2022. Indonesia, Malaysia, Hong Kong, Singapore, and Chile will each put in 15 billion yuan, or about $2.2 billion, to make a pool of reserves with their currencies. On the other hand, the Yuan makes up 17% of Russia’s reserves. On the Moscow stock exchange, this currency is the third most sought after. Also, in 2022, the so-called BRICS economies (Brazil, Russia, India, China, and South Africa) met to plan the creation of a new global reserve currency based on a basket of currencies. But China wants this group of countries to use the Yuan as their main way to trade with each other.
As these alliances get stronger, the Yuan’s chances of becoming a reserve currency could go up, which would make the dollar less important. However, the Yuan is still a long way from being able to replace the dollar. This is what you think for two main reasons. First, a currency doesn’t become a world reserve currency because of how much it is traded or how big its economy is. A more important reason is that the country that makes the currency gives people confidence in it. In other words, the US Dollar is still the world’s reserve currency in part because the U.S. is seen as a stable country. There is no other way to explain why the world would still trust the dollar in 2022, which is such a bad year.
Even though China is becoming a superpower, it has many problems, such as a lack of natural resources, a population decline for the first time in 60 years, protests in many parts of the country, a real estate bubble, and the slowest economic growth in the last 40 years. These situations send a message of instability, which keeps big money away. It’s more than what happened.
The United States, for its part, has a great location that gives it long-term security and stability. It is next to two friendly countries, Canada and Mexico, and is surrounded by two oceans. It also has the strongest military in the world, which makes it unlikely that any other country will try to invade. All of this means that, even though the dollar isn’t backed by gold, it can still be used to protect wealth in times of uncertainty. Not that this reading is in favor of the U.S. but becoming the world’s reserve currency is not a formal process. It’s more like winning an international popularity contest.
In fact, the International Monetary Fund added the Yuan to the group of currencies that make up its reserves in 2016. People hoped this would give the Yuan the boost it needs to catch up to the dollar. But the dollar, euro, Japanese yen, and pound sterling are still used more than the Chinese yuan. International reserves in US Dollar are worth $6.7 trillion, which is 30 times more than the $221 billion worth of reserves in yuan. That makes sense, because let’s say that 100 people from some European country have saved enough money for 20 years of work. They all like China and dislike the US. Still, if these people could choose whether to save in dollars or yuan, it’s likely that most of them would choose dollars.
This is because they think the U.S. and its currency are less risky. Investment firms, central banks, and most countries do as well. This way of thinking is shown by these facts about international reserves. The second reason why the Yuan can’t replace the dollar is that the price of a reserve currency shouldn’t be set by a government. Instead, it should be set by the market. Both the dollar and the euro change all the time.
The Yuan doesn’t do this all the time, but the Chinese government has a lot of power over its exchange rate. On the other hand, the United States has an open economy, which means that money can move freely in and out of the country. In China, however, the government controls how much money can leave the country. Chinese people can’t send more than the equivalent of $50,000 out of China each year. By making it harder for money to move around, investors risk losing their money if a political or economic crisis forces strict capital controls.
In the end, China is becoming a superpower, but the yuan won’t be able to replace the dollar because most of the world doesn’t trust this currency or the country that makes it, and because no tightly controlled currency has ever come to dominate the world’s reserves. Most likely, the dollar will go through a long-term decline and be replaced by other currencies and precious metals, but not by the yuan.