The Biggest Threat to King Dollar Is Not the Chinese Yuan
If the U.S. dollar loses its dominance someday, we have no one but ourselves to blame.
Whether the Chinese yuan is destined to end the U.S. dollar’s dominance in the global economy is a question I have received frequently. Thus, I decided to address it in this week’s newsletter.
The short answer is that the Chinese yuan doesn’t pose a serious threat to the U.S. dollar, not now or in the future. The biggest obstacle for the yuan also happens to be its biggest promoter, the Chinese Communist Party (CCP), or more precisely, the Party’s obsession with control. The CCP regards everything as a tool to enforce, maintain, and strengthen the Party’s control of the country and its people. Thus, China’s monetary policies are no exception. They exist to serve the Party.
From a Fixed to a Managed Float Exchange Rate
Before 2005, the Chinese central bank, the People’s Bank of China (PBOC), managed the Chinese yuan, also known as "Renminbi" or RMB, through a dual fixed rate regime. The PBOC sets an official rate for foreign investments and remittances from abroad and an internal settlement rate solely for international trade. The PBOC published the official exchange rate while keeping the internal settlement rate secret out of fear that foreign investors might exploit the difference between the two rates and cost the Party its control of the Chinese currency.
Both rates, especially the internal settlement rate, reflected the Party’s political needs rather than economic reality. Below is a telling example in Frank Dikotter’s book "China After Mao: The Rise of a Superpower," which I highly recommend, and you can read my book review here.
“The official exchange rate in 1979 was 1.53 yuan to the dollar, but export goods cost an average of 2.54 yuan to produce for each dollar of sales, meaning that for every dollar earned China lost roughly one yuan…As the ministry noted, ‘the more we export, the more we lose’…To address the issue, the currency was devalued to 2.80 yuan to the dollar, a rate reached by adding what the state deemed to be a ‘reasonable profit’ of 10 per cent, or 0.26 yuan, to the average cost of production. The profit margin, in other words, was not driven by supply and demand, but by a nominal spread determined by the state…At the touch of a button, 80 per cent of exports no long made a loss. This was, of course, merely an accounting trick.”
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