The U. S. USES IT’S DOLLAR TO DOMINATE THE WORLD?

[Bluechipfan]

Any view whether it is good or bad for USA if usd is strong vs other currencies? USA's economy is driven by consumption. They have large trade deficit and if the usd strengthen or weaken, what's the likely effect on its economy?

[specuvestor]

There are many books/articles available that can explain USD and their role in oil.  I have read quite a few of these while trying to understand how the global order works, and would try and share them here in a few quick points:



Petrodollar System
Until alternative energy becomes a norm, we probably have to agree that whoever controls oil controls the world. The big names have said so

• Winston Churchill once said: “He who controls oil will win the next war.”
  

• Henry Kissinger said : "He who controls oil controls nation"
  

After dropping the gold-backed dollar system, US has to create a demand for the USD internationally. The Petrodollar was introduced, whereby in exchange for US providing weapons and military protection over the oil fields of OPEC countries, OPEC agrees that oil will be traded exclusively in USD. This oil for dollar system allows USD to be in demand as long as oil is in demand. 


Running the Printing Machine
With USD in demand internationally, US can continue to run the printing machine as well as borrow more dollars from other countries with the issuance of bonds.  This helps to solve the economic problems US faced (the big budget deficit and the huge debt, which is still growing), while they can continue with their extravagant spending, including in military and technology. This allows US to build up their military might and technology edge over the world and continue their dominance. 
  

Control over how USD is used
The world recognises USD as the defacto currency and accumulates the dollar. You can then spend the USD by buying US technology or weapons if you are an ally. Or buy their bonds, as in the case of China, if you are not allowed to buy either. In a way, US have control over the use of the dollar.


Challenge from Euro
When Euro was formed to challenge the supremacy of the dollar as a reserve currency, it was taken down quickly. It started with the 3 rating agencies attacking the Euro over sovereign debt issue. It is probably no coincidence that these 3 rating agencies Standard & Poor's (S&P), Moody's, and Fitch Group are all Amercian agencies. This is not to say that Euro does not have its inherent weakness. But over sovereign debt? US certainly has more debt than the EU countries...

Those who do not use USD for oil trades, just to name a few: Russia, Iran, Venezuela, are all considered "enemies". Iraq tried to change to trade oil in Euro from USD in year 2000. We all know what happen next: US invaded Iraq in 2003 over claims of weapons of mass destruction. Of course, they found none, and Iraq continues to trade oil in USD today. 

The next currency that can challenge the USD's supremacy is RMB...   


We can continue the discussion as there are more reasons and rationale but I would not be able to discuss them fully here. I am just dropping a few points that I have gathered over these years and hope they are of help to Temperament.  

Gutman has a good summary. We have actually discussed this in a few threads and here are 2:

https://www.valuebuddies.com/thread-4281...l#pid69635
https://www.valuebuddies.com/thread-4576...l#pid74661

Sometimes I think Econs make things more complicated than they are. Currency is simply a medium of exchange for trade. And commodities especially oil, is a main source of trading. So the medium that is used becomes important and in our world, it has been USD. And USD keeps its dominance through the establishment of offshore LIBOR to recycle petro$. But things are changing after the increasing mistrust between US and middle East since 911. You can actually see the geopolitical upheaval from Iraq to Arab Spring to Egypt Mubarrak to the recent Syria and shale from the US policy shift. I am not sure if oil trading will continue to be USD based in next 15-20 years, which will have huge ramifications for USD.

There's a good simple explanation on this by Ray Dalio: https://www.youtube.com/watch?v=PHe0bXAIuk0

As to the power of the reserve currency, imagine another parallel world where suddenly a genie declares that Ezra shares is legal tender for all trades. What do you think the value of Ezra would become even though the company is inherent bankrupt?

Eurozone tried to counterbalance USD, beside the purpose of constraining Germany's ambition. As China trade grows it becomes apparent why their currency will become reserve currency. It is inevitable. That's why China slowly started invoicing in RMB and trade commodities in RMB. But Russia was more unscrupulous in trying to damage USD during the GFC. As India displaces UK as the 5th largest economy, they will be under the same pressure if they increase their outward trade.

So the USD is unique. And many who reads finance books should be aware that they are written by Americans. Gold as an inflation hedge works for them as they consume in USD, but not necessarily for say Singaporeans. Twin deficit may not be as unsustainable like other nations as long people has faith in USA

[Temperament]

Thank you all who chip in.

i like best this analogy or explanation best:-
"As to the power of the reserve currency, imagine another parallel world where suddenly a genie declares that Ezra shares is legal tender for all trades. What do you think the value of Ezra would become even though the company is inherent bankrupt"?

Pardon me should add not only legal tender but also the only unique one for petrol.

In fact i have this feeling for a long time why the World keeps on producing goods and US is one of the the biggest consumer.
And every year US runs into deficit and yet the World still wants to buy her bonds.
And She (US) still have money (aka bonds to the World) to pay for the imports.

That means the World Monetary System is Bonded to US.
If US collapse, then what will happen?


For a long time i have been thinking U. S. A. is No. 1 in "Financial Engineering".
And their politics only seems to be clean but not for Mr. Duterte.

And there is no genie who declares anything except you know who.

[tanjm]

@Gutman, you have quoted Henry Kissinger and Winston Churchill. The purported quotes do not sound like their usual highly articulate and literate selves. If you will look up their actual quotes, you will know what I mean. Second, I cannot find any primary sources of the purported quotes. If you can find the primary sources, let me know. Otherwise, I would doubt that any of these two said this.

Like I said, any reserve currency has to have certain characteristics and I'll restate them.

First, to be highly acceptable and convertible with out hindrance. No capital controls, no uncertainties about whether you can access your funds. Enough liquidity in the system. Settlement practically guaranteed T+1 or T+2 (some reasonable fixed time). No extra paperwork or admin.

Second, to have the capability to place your funds in any tenor of deposit/loan, no matter how large. i.e. you need to have a very large debt market available to international participants.

Third, to be widely used in trade. This is related to the first point really since liquidity is a function of its wide use.

EUR, as I mentioned, has problems. As a group, the Euro nations have a big enough debt market, but due to the fact that it is composed of many sovereign nations, each with its own credit standing, it is a fractured market. JPY, as I mentioned, is too domestic.

CNY is out of the running. I'll just mention a few reasons. The renminbi market for bonds is split into onshore and offshore (CNH). And the offshore bond market is pitifully small. China does have a fairly big trade with the outside world - but imagine this : I sell 10 billion yuan of goods to the Chinese. But I spend only 5 billion on Chinese goods. What do I do with my 5 billion? Stuff under the mattress? I sell 5 billion yuan of goods to the Chinese, but I spend 10 billion yuan on imports. Do I pay the Chinese in my own currency? If not, how do I get a hold of 5 billion yuan?

The Chinese have attempted to run oil for yuan swaps. Not very successfully. Mainly, in my view, because of difficulty in either keeping the yuan, or spending/converting it. In terms of converting it, why would a country accept yuan and incur a bid/ask spread to convert to a proper holding currency?

There is no conspiracy. The EUR could seriously challenge the USD as a premier reserve currency if only the EU had an integrated monetary/fiscal policy. Even if you take only Germany alone, its economy is less than 1/4 of the US. The JPY is never seriously in the running. The Chinese economy is large enough, but they are sunk by the particular restrictions that the Chinese put on themselves, besides the fact that they run too large a surplus.

The Chinese at one point had 4 trillion dollars in reserves (Currently about 3 because they spent 1 trillion defending the yuan). The US treasury market issuance is 31 trillion. Its daily trading volume is like hundreds of billions a day with tight spreads. To be a player in the reserve currency status, you need a large enough market for the biggest of holders (which are the Chinese now, not the oil countries), with daily volumes and settlement systems capable of handling multiple billions a day from any single player without upsetting the market.

[tanjm]

In fact i have this feeling for a long time why the World keeps on producing goods and US is one of the the biggest consumer.
And every year US runs into deficit and yet the World still wants to buy her bonds.
And She (US) still have money (aka bonds to the World) to pay for the imports.

That means the World Monetary System is Bonded to US.
If US collapse, then what will happen?

In 2016, the US imported 2.7 trillion and exported 2.2 trillion (both goods and services). Its economy is around 18 trillion - about 25% of the worlds economy. In fact, most of the US economy is internally generated. In goods, it exports stuff like aircraft, industrial machines, semiconductors, telecoms equipment, chemicals, automobiles etc. In other words, high end stuff. Most of what it consumes, it generates internally.

A lot of the trade deficit is in cheaper low end consumer products and in automobiles. Petroleum products used to be big, but its share has been declining rather rapidly (take that! Petrodollars!).

Let's not get too carried away by the reserve currency "wars". What should concern the US is its competitiveness in high end goods and services.

[donmihaihai]

In fact i have this feeling for a long time why the World keeps on producing goods and US is one of the the biggest consumer.
And every year US runs into deficit and yet the World still wants to buy her bonds.
And She (US) still have money (aka bonds to the World) to pay for the imports.

That means the World Monetary System is Bonded to US.
If US collapse, then what will happen?

In 2016, the US imported 2.7 trillion and exported 2.2 trillion (both goods and services). Its economy is around 18 trillion - about 25% of the worlds economy. In fact, most of the US economy is internally generated. In goods, it exports stuff like aircraft, industrial machines, semiconductors, telecoms equipment, chemicals, automobiles etc. In other words, high end stuff. Most of what it consumes, it generates internally.

Thanks for the figures. Look simple

[Hippocrates]

I just happened to listen to a podcast on planet money on how USD became the de facto trade currency of the world after world war: http://www.npr.org/sections/money/2017/0...-the-world

It's quite clear that USA is the biggest beneficiary of such arrangement, and historically it accomplished that in an ugly scheming way. I don't really believe that there is a fixed set of criteria/rules to be a reserve currency (disclaimer: I'm not even remotely an economist lol)... but everything will fall into place nicely when a country is the one setting the rules and orders for international trade.

It may be difficult to have an replacement reserve currency based on the trade order created by USA and its allies... but how about that happening under a totally new framework of international economic order? I could foresee that any country that can surpass USA militarily and economically will make that happen. This is a big fish eat small fish world.

[tanjm]

I just happened to listen to a podcast on planet money on how USD became the de facto trade currency of the world after world war: http://www.npr.org/sections/money/2017/0...-the-world

It's quite clear that USA is the biggest beneficiary of such arrangement, and historically it accomplished that in an ugly scheming way. I don't really believe that there is a fixed set of criteria/rules to be a reserve currency (disclaimer: I'm not even remotely an economist lol)... but everything will fall into place nicely when a country is the one setting the rules and orders for international trade.

It may be difficult to have an replacement reserve currency based on the trade order created by USA and its allies... but how about that happening under a totally new framework of international economic order? I could foresee that any country that can surpass USA militarily and economically will make that happen. This is a big fish eat small fish world.

I went to listen to the NPR podcast. Thanks for that - interesting.

First this was 70 years ago. And the NPR podcast was trying to add color to a dry subject, aka sensationalise it (for lack of a better word).

Keynes did try to suggest something else, but it would not fly. The fact is, after the war, the only large economy with an essentially intact infrastructure and economy was the USA. There would have been problems with an artificial currency. Also, by attempting to tie it to a gold standard, only the USA had the gold reserves to support it. Today, that candidate for an international reserve currency is the SDR. The pre-conditions for something to be used as a major reserve currency are as I said. So even the SDR would be difficult without those pre-conditions. Its not that the USD has no competitors - it does.

As for whether it is "ugly scheming way".... you say Po-teh-toes, I say Po-tah-toes. This is a game of international diplomacy.

[specuvestor]

tanjm have you been following how the CNY have progressed in the past 10 years to say it is out of running as a reserve currency? I think I see more UnionPay logo than JCB nowadays, and in the 90s Yen was one of 3 major reserve currency including Deutsche Mark
http://www.chinausfocus.com/finance-econ...ns-future/

The Chinese don't do revolutions nowadays. They plan 2X5 years at a time. HK is a 50 years assimilation plan

People like to extrapolate to the extremes but I'm not saying USD will become like the mighty pound in next 10 years, rather I think CNY is likely to be significant in Asian transactions, maybe accounting for more than 20% of reserve in next 10 years, considering Asian economies including Middle East is the largest holders of reserves. We might forget that China was the largest economy in the 19th century.

[tanjm]

tanjm have you been following how the CNY have progressed in the past 10 years to say it is out of running as a reserve currency? I think I see more UnionPay logo than JCB nowadays, and in the 90s Yen was one of 3 major reserve currency including Deutsche Mark
http://www.chinausfocus.com/finance-econ...ns-future/

The Chinese don't do revolutions nowadays. They plan 2X5 years at a time. HK is a 50 years assimilation plan

People like to extrapolate to the extremes but I'm not saying USD will become like the mighty pound in next 10 years, rather I think CNY is likely to be significant in Asian transactions, maybe accounting for more than 20% of reserve in next 10 years, considering Asian economies including Middle East is the largest holders of reserves. We might forget that China was the largest economy in the 19th century.

Your link is not saying anything new. In fact, its saying much of the same things I am. Like I said, CNY can be a reserve currency, but only if the Chinese govt get their financial markets to behave like the US's financial markets. At the moment, any offshore sovereign bond market is effectively non existent and the Chinese are squeezing the capital controls on flow of renminbi - not a behavior that implies they understand or care (it could be both !) about reserve currency status. Having a large enough economy is only the starting step. If that were true, then JPY and EUR could figure much more prominently as reserve currencies.

For the Chinese to get their financial markets to behave appropriately would imply the govt is comfortable with "losing control" over their yuan. They would need to be comfortable with large numbers of non Chinese owning their sovereign bonds and be happy with people moving yuan around internationally without hindrance.

At least in today's world, you don't dictate to anyone to use USD (or EUR, or Yen, or AUD, or any freely convertible currency). People choose USD because it has the right characteristics. In the same way, the Chinese cannot insist their currency is a reserve currency - no matter how pushy they are in international forums, or how strong their economy is.

If you say "Chinese like to plan long time. 50 years", then I have nothing to say ! 8-).  I can only look at the evidence.

The UnionPay logo example simply means that Chinese people are venturing abroad in large numbers.