- [Presenter] Adjusted for purchasing power,
China is now the world's largest economy.
It's also the world's largest trading nation,
importing and exporting more than the United States
and the European Union.
However, despite its economic growth,
China's currency is not the world reserve,
and that is something that will limit its economic potential
and, perhaps more importantly, its influence.
The American dollar has been doing very well recently,
and a lot of that is due to the world being
in an uncertain economic situation.
Fears around inflation and recession
are causing individuals and institutions with lots of money
to look for safe places to keep their wealth
until this whole thing blows over.
And where safer to keep it
than in the world's default medium of exchange.
Being the world's reserve currency
has a lot of advantages beyond just bragging rights,
and whether they publicly admit it or not,
China would love for their currency to be treated
the same way in the global economy,
and they are doing their best to try and get it there.
So what does it mean for a currency to be the world reserve?
What are the advantages
of being the world's reserve currency?
Why has the US dollar held this title up until now?
What is China doing to try and change that?
And could the yuan realistically be a viable replacement?
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The US dollar has obviously not always been
the world's reserve currency.
It's only existed in its current form
since the early 1900s,
and it wasn't until the mid 20th century
that it effectively took the title from the British pound,
which was the world's reserve
through the colonial era of global trade.
The Bretton Woods Agreement changed all of that, though.
Towards the end of the Second World War,
44 countries sat down and laid out a plan
for an efficient system of global trade and finance.
This agreement pegged the price of the American dollar
to a set amount of gold.
The currencies of all other participating nations
were then pegged to the dollar.
This allowed countries to keep American dollars
in reserve instead of physical gold
because they knew they could always exchange their dollars
for gold at any given time should the need arise.
This made American dollars the default choice
for doing any kind of international trade
because chances are the currencies of the trading nations
were pegged to the American dollar anyway.
It also effectively mandated that countries keep
a certain amount of American dollars in reserve
so that they could always honor currency exchanges
at the agreed upon peg price.
Even today, one of the primary uses for reserve currencies
is to protect nations in times of crises
where their own currency might not be that attractive
to international parties.
Now, if you watched our video last month
on the gold standard,
you will know that the Bretton Woods system fell apart
in the 1970s,
but the US dollar is still the world's reserve,
mostly because even after this rigid system fell apart,
the US dollar was still the logical choice.
Today, being the world's reserve currency
doesn't really mean anything.
There is no international organization or treaty
that says the US dollar is what countries must use.
And the same was true before Bretton Woods, too.
In fact, the Bretton Woods Agreement
was really the exception that proves the rule,
that global reserve currencies become reserve currencies
because they are the best choice available,
not because of any official ruling.
The US dollar is historically very stable.
It is widely recognized,
and there is enough in international circulation
for it to be useful for trade.
It also has a fair value.
It's no longer backed by gold,
but its exchange price is determined
by the international market,
and it's the only way that the citizens
of the largest economy in the world can pay their taxes,
taxes that also go to fund the most powerful military
in the history of humanity.
That kind of helps, too.
Fair value, wide circulation, stability,
and wide acceptance are the four ingredients
that any currency would need to become the world's reserve.
And, at least as of making this video,
American dollars outdo any other currency
in all of these categories.
The best way to personally see why the US dollar
is the unofficial global go-to as the reserve currency
is to consider this.
If you could get paid in any currency
other than the currency of your home country,
what would you choose?
Probably American dollars, right?
If you are an American, you can still play along.
Pick another currency, and remember it for later.
Now, what does this all actually matter?
What are the advantages of being the world's reserve?
America has been the world's largest economy
for 130 years now, so all other things being equal,
it just makes sense that
if any currency was gonna be the world's reserve,
it would be America's.
But does this give any actual advantages
over other economies using other currencies?
Well, yes, a lot of advantages actually.
The first is that it does away with
a lot of the exchange rate risk
when doing business internationally.
An American company exporting goods for American dollars
is not going to run the risk
of the currency it receives being worth more or less
relative to its domestic currency,
because American dollars are its domestic currency.
Reduced foreign exchange risk also makes America
a lot more attractive to international investors.
It's no good making 20% returns
on your international investment
if the value of the currency
those investments are denoted in is down 30%.
Given the inherent stability
that comes with being the world's reserve,
this risk is not as apparent.
And being the go-to for international investment
has some huge advantages.
It makes it easier for the government
to raise money, for starters,
and since the federal government's debts
are entirely denoted into currency that they control,
there is practically zero default risk on their part.
It also makes it much easier
for businesses to find investors,
which means that those businesses will have more money
to put towards creating value in the economy.
The US has some of the most productive workers in the world
not because Americans are particularly well educated
or hardworking or even that special,
but simply because businesses have more money
to put towards tools to make their workers better.
Outside of pure economics,
having control over the world's reserve
also gives the US an unbelievable amount of political power.
International financial institutions
have to fall in line with American laws
even outside of America or risk being cut off
from using the go-to currency for international finance.
This kind of power is obviously very attractive,
and that's why the Chinese government
has not made much of a secret
about wanting their currency to be the new world reserve,
or at the very least a viable alternative
to the American dollar.
So how are they trying to do this?
Currently, the Chinese yuan or renminbi
is the third most common currency reserve
after the euro and of course the US dollar.
The greatest tool that China has
to push its currency onto the world stage is simply trade.
Every time trade is done between two foreign countries,
a decision is made.
Will they settle the trade with the currency
of the exporting nation, the importing nation,
or some third party currency, like the American dollar?
For small-time trades,
the importer normally pays the exporter
in their local currency.
If a small Australian business
was importing engine components from Germany,
they would have to pay the German business in euros
because small businesses like this
are normally only set up to take payments
in their domestic currency.
Larger operations can go either way,
and normally the settlement currency
is something that is agreed upon
in the purchase agreement contracts.
On the scale of global commodity transfers, though,
it is simply easier to use a trustworthy third party,
which is almost always the American dollar.
You might have heard US dollars referred to
as petrodollars, and that is because
almost all international oil sales
are done using American dollars.
This means big oil exporting countries
naturally build up large reserves of this currency.
China does a lot of trade.
It is by far the largest manufacturer of goods in the world,
and it sells those goods to basically everyone.
I would almost guarantee
that every single person watching this video right now
has something within a meter of them that was made in China.
To make these products,
China also imports a lot of raw materials,
fuels, and pieces of machinery.
All of these exports and imports present an opportunity
for China to request that trade be done
using their currency.
They are also taking a more direct approach
with their neighbors.
The Belt and Road Initiative
has been a major infrastructure project
undertaken by the Chinese government
to provide trade infrastructure
to developing nations in their region.
We've already done an entire video
on the pros and cons of this plan,
so I don't wanna repeat too much here,
but a lot of this development has been funded
through loans given out by Chinese state banks,
loans that are denoted in Chinese RMB
and need to be paid back in Chinese RMB.
If sovereign governments have large national debts
that they need to pay back
in a currency different from their own,
they are effectively forced
to have some of that currency in reserve,
or else they risk defaulting on their loan.
The best way to build up these reserves
is by trading with China.
China's mission to push its currency onto the world stage
has also been assisted by the war in Ukraine.
Never let a good crisis go to waste,
and China surely hasn't.
Last month, Brazil, Russia, India, China, and South Africa,
the so-called BRICS economies,
met up to discuss their ongoing trade relationships,
mostly in the context of Western sanctions
being placed on Russia.
These are all very powerful economies,
and trade between them is up 38% this year
as they deal more intensely amongst themselves
since being cut off from trading with the West.
China is benefiting from this
in more ways than getting cheap oil from Russia.
It is pushing the trading block to adopt the RMB
as the de facto medium of exchange.
And given that it is by far
the biggest and most important member of this group,
this is likely to happen
whether the other countries really like it or not.
Western sanctions, particularly those that cut off
Russian reserves of American dollars
have also made a few governments around the world
a bit uneasy about how much safety they really get
from their reserves.
Remember, the four ingredients
that any currency needs to be a reserve currency
is fair value, wide circulation, stability,
and wide acceptance.
If the American government can just choose
to cut off the reserves of a foreign nation
that they decide is being naughty,
then there is nothing to say that it won't happen to them.
For economies that are very politically, culturally,
and economically close to America,
like Canada or Australia and most of Western Europe,
this probably isn't a huge deal
because they are extremely unlikely to be sanctioned
by the US.
But for countries that don't have such strong ties,
these sanctions are acting as a bit of a wake-up call
to say that it's probably worth diversifying
the emergency reserves to include some currencies
that can't be cut off by the West.
As far as hedges against the risk
of being sanctioned by America go,
the Chinese yuan is about as good as it gets.
It's a currency that can be used to make direct purchases
from the largest exporting nation in the world,
and the Ukrainian invasion has shown
that the Chinese government is happy to do business
with economies that have been shunned by the West.
So, with so much pressure behind it,
will the Chinese RMB ever be the world's reserve currency?
Well, probably not.
Yes, its global use is certainly on the rise,
as is to be expected given China's economic growth
over the past three decades.
But when I asked you earlier
what currency you would choose to be paid in
if not your own,
I don't think many of you would've picked RMB.
Holding a reserve currency
is in many ways like holding shares
in the currency-issuing country.
You want to be sure it's run well, it's run sustainably,
and that management won't do anything silly.
China's currency just has a lot of problems
that make it unpalatable in the eyes of many institutions.
There are just direct limitations on how it can be used.
Chinese citizens are not allowed to transfer
more than the equivalent of 50,000 US dollars worth
of the currency out of China every year.
This demonstrates two things.
One, that China thinks it's necessary
to effectively imprison the wealth of its people on shore
to stop them from starting businesses and lives overseas.
And it also shows that even China itself
is so uncomfortable with the true value of its own currency
that it writes laws in US dollars.
If tomorrow Chinese citizens were suddenly allowed
to exchange as much money as they wanted,
there would be a mass sell off of Chinese RMB
in foreign exchange markets, reducing the currency's value.
China also artificially lowers the value
of its currency in foreign exchange markets
to make its exports more competitive.
This is a tactic that has helped to build
the impressive industrial base it has today,
but it also means that its currency
does not have a truly fair value,
one of the important factors to consider
when picking a currency to keep in reserve.
Between limitations on its citizens transferring money
and its foreign exchange manipulations,
China kind of has a currency that is both overvalued
and undervalued at the same time.
Now, as for protections against sanctions, yes,
if foreign currency reserves
are held exclusively in American dollars,
then the US can sanction those reserves,
and many governments aren't totally comfortable
with a foreign government
having that kind of power over them.
Fair enough.
But China isn't really a viable alternative.
It has a much worse reputation
for unnecessarily punitive economic actions.
The US sanctioned Russia
because it started a war of aggression
with another foreign nation.
China sanctioned Australia
because it wanted to conduct an investigation
into the cause of the coronavirus
to prevent another outbreak.
Yes, foreign currency reserves
are subject to the whims of the governments
that issue them, but some governments
are just inherently more stable than others,
and it's not like there are only two options either.
Most central banks are now stocking up
on a range of currencies to keep in reserve.
For now at least, concerns over extended lockdowns,
trade wars, debt crises, housing bubbles,
and government infighting are hurting the case
for the RMB global reserve
far more than any opportunistic gains
and heavy-handed trade deals are doing to help it.
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