The U.S. dollar has reigned supreme as the reserve currency of the world for decades. This reserve currency status appears to be ending, albeit at a slow pace. Shifts in reserve currency don’t happen overnight, as they become entrenched in the financial system. The U.S. dollar took over reserve currency status from the British Pound following World War II. The new player in the game that wants to become the new reserve currency is China, with its yuan.
There have been numerous reports lately that the Chinese authorities are preparing for the day when the yuan will be the reserve currency for the world. They’ve started establishing business capabilities that ease the ability for investors and companies to trade using the yuan. Just recently, it was announced that the People’s Bank of China is allowing direct trading between the Japanese yen and yuan. It used to be that an investor or company would need to perform a currency cross to make this trade happen—in which one would sell the yuan, buy the U.S. dollar, and then sell the U.S. dollar and buy the Japanese yen. This ease in trading will just add more credence to the possibility that the Chinese authorities’ end goal many years from now is reserve currency status.
Another worrisome sign for the U.S. dollar is news that the Shanghai Futures Exchange will be introducing a new oil contract that will be listed in both the U.S. dollar and the yuan. This added legitimacy for the yuan as a reserve currency will only grow if more products that are globally traded are transacted in that currency. The head of this Chinese market exchange stated that this oil contract traded in yuan is strategic for its long-term goal of being a global international trading center. With more contracts being planned to trade in Shanghai in the yuan, there are large cracks forming around the dominance of the U.S. dollar as a reserve currency.
Chart courtesy of www.StockCharts.com
One way to see this slow decline in the U.S. dollar as a reserve currency is the loss of wealth against gold. Investors who are losing faith in the U.S. dollar over the past decade are looking for an alternative place to put their money and for now they’re placing it in gold. If the yuan becomes a viable alternative to the U.S. dollar, I think you will see some of these investors placing their funds in the yuan. Notice the decline in the U.S. dollar against gold over the last decade. This decline will only continue if American politicians don’t make substantial changes to the business environment to strengthen the economy and the U.S. dollar.
Of course, this is not the end of the U.S. dollar as a reserve currency; just a warning sign. If American politicians ignore what’s important to businesses and investors, the trading centers will move offshore. The most important thing when it comes to a reserve currency is the faith of investors in the government. If the government is being mismanaged and run poorly, if businesses are being overly taxed and prevented from operating at full capacity, they will move. It’s as simple as that. This is a wake-up call to Washington: do what you can to try to improve the environment for businesses here in America!