A new struggle may be transpiring on the global front as it is being speculated that Europe and China are quietly and strategically planning to shore up the Euro and Renminbi, respectively, to rally against the international pre-dominance of the US Dollar.
As of the third quarter of 2018 (Q3 2018), US dollar accounted for approximately 62% of all the known central bank foreign exchange reserves. Euro is the second closest reserve currency and made up for 21% of the known central bank foreign currency reserves in Q3 2018.
The Currency Composition of Official Foreign Exchange Reserves (COFER) is depicted in the chart below.
The relative strength of the US economy fortifies the status of dollar as the de facto global currency. It is accepted for trade and transactions throughout the world. US bills worth $ 580 billion are used outside the country, which represents around 65% of all the dollars and most of these bills may be found in Latin America and former countries of the Soviet Union.
Over one third of the global GDP is accounted for by the nations that peg their currencies to dollar. As far as the foreign exchange market is concerned, around 90% of forex trading occurs in USD. Besides, around 40% of the world’s debt is also issued in dollars which causes foreign banks to need sufficient dollars to conduct businesses.
The significance of USD was also confirmed by the scenario during the 2008 financial crisis. Even recently in 2017, the banks of Germany, Japan, France and the United Kingdom held more liabilities termed in dollars than in their own currencies.
US China Trade War
In July 2018, the Trump administration imposed sweeping tariffs (25% border tax) on $34 billion worth of Chinese goods, including aircraft parts and flat-screen televisions, as well as medical devices, delivering on its months of threats to do the same. So far, the US has already slapped tariffs on USD250 billion worth of Chinese products, and Trump has threatened to get the tariffs going. This initiated one of the biggest trade wars in the global economic history. To this, China retaliated by imposing 25% tariffs on $ 34 billion worth of US goods entering its borders.
In its defence, US claimed that it was in response to some of China’s most controversial trade practices. With neither Trump nor Chinese President Xi Jinping willing to compromise, the market participants do not foresee a resolution being reached anytime soon.
As the recent news suggest, the two presidents have agreed to meet at the upcoming G20 Summit to be held at the International Exhibition Center in Osaka, Japan. As of now, the best the world can hope for is a pause between the two nations with neither side willing to “give in”.
Due to the escalated tensions, both the countries will have to bear the burden of the trade war.
China aiming for de-Americanised world
China, with its giant economy, has a huge influence on world economies, particularly those connected to it. It is one of the largest export partners of the United States, with around $ 129.9 billion of goods and services exported in 2017 and it is also the largest import partner whose imports were valued at $ 505.5 billion as of 2017, according to the Office of the United States Trade Representative.
The Chinese are just putting in place the financial plumbing that could, if it finds support from relevant reforms and the essential political action, lay the grounds for a future where RMB would be of immense global prominence.
Under the controversial global development strategy, Belt and Road Initiative, which is aimed at financing infrastructure projects in 152 countries as well as international organizations across regions, China offered incentives to the recipient countries to use the RMB as an invoicing currency. Beijing also launched a contract in RMB-termed oil futures in 2018 that gained quite the prominence and may prove to be threat to the US dollar with expanding volumes.
The Chinese government has eased down interest rates to zero, that helps in making the Chinese bond market quite attractive for the foreign investors. However, although a flourishing Chinese economy is backing the RMB’s international stature, there are some limitations in terms of China’s fixed-exchange rate regime and rigid capital account. The nation restricts capital movements to maintain control over its domestic economy. Moreover, RMB is not a freely convertible currency that poses another shortcoming to become the global currency.
While China’s quest for the internationalisation of its RMB is recent, the Europeans have been contemplating to do so with their explicit ambition.
Europe hopes to rival US dollar as second global currency
Last year in September 2018, the 19-member European Commission presented ideas to strengthen Euro’s role as an international currency. According to the Commission, the efforts and initiatives in this regard would provide protection to its citizens and businesses and promote interests in formulating global affairs based on multilateralism and cooperation amongst different governments.
Source: European Commission
It is also believed that having more than one international currency would reduce the susceptibility of economies across the world to disruptions and shocks linked to the strong reliance of many sectors on a single currency.
In recent months, Washington has flexed its muscle by using the global role of the dollar to impose powerful sanctions on companies doing business with Iran.
With the so called extra-territorial impositions by the US, the European companies find it difficult to sustain trade ties with other countries, specifically Iran, and a significant portion of Iran’s international trade is billed in US dollars.
Thus, European Union seeks to safeguard its interest and reflect its political, economic and financial weight. However, competing with US dollar comes with a number of challenges. To bolster the resilience of the EURO, the member states would have to work and integrate the bloc’s financial sector and promote the use of the EURO in international energy transactions.
Over the years, the eurozone’s capital markets have been fragmented and fail to act as one unit so as to exercise global financial influence.
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