Does the Dollar Have an Achilles Heel?

It seems like a momentous event. Unfortunately, it’s so complicated and abstract that precious few media outlets are reporting it.

I will admit that I am not even remotely qualified to offer a sage commentary, so I will report the information as I read it.

Columnist Robert Morley tells us that the China is trying to make its currency, the yuan, a reserve currency. He then explains what that means and why it matters:

This year may go down as a turning point in United States economic history.

Reuters reports that three high-level Chinese officials have confirmed thatChina will launch its long-awaited international payment system in September or October. The system will allow foreign banks to conduct transactions in yuan instead of dollars and transfer funds across international borders without using America’s SWIFT payment system.

This latest move by China is an effort to make the yuan a reserve currency. If successful, the newly created China International Payment System (CIPS) will remove the biggest hurdles to internationalizing the yuan. It will cut costs, cut processing times, and simplify the transactions associated with obtaining and using yuans. Apparently 20 Chinese banks and 13 foreign banks are currently engaged in testing the system.

Purchasing goods in yuan will soon be as simple and inexpensive as using the dollar. Reuters compared the creation of CIPS to a “worldwide payments superhighway” for the yuan.

Geopolitical repercussions are inevitable. The dollar’s role as global reserve currency is being challenged.

Loss of reserve currency status would leave America without the freedom to create money out of thin air to finance government spending. All things being equal, interest rates would be higher, borrowing rates would fall, banking profitability would shrink, consumer spending would constrict, corporations would become less profitable, jobs would be cut, and stock prices would fall. Additionally, America’s large debt and retirement obligations would become even less likely to be paid.

In short, America’s standard of living would trend toward the typical Chinese person’s, while China’s would trend toward America’s.

If Morley is right our current prosperity is based largely on the fact that the dollar is a reserve currency. If you are looking for hegemony, that would be a good place to start.

If China can undermine the dollar’s status, we will have more difficulty borrowing money to pay our burgeoning debt. We will be forced to trim government spending drastically. We will have to pay off debt with earnings.

The good news is that this is not going to happen tomorrow.

Morley is hardly alone in being alarmed. Harvard professor Lawrence Summers has much the same view, and Summers is not some crank getting messages from a crystal ball:

It’s true that global yuan usage is still a fraction of the dollar’s, but China’s move to create its own competetive version of America’s SWIFT system is just one piece of infrastructure going into place to allow the yuan to grab global market share from the dollar.

Another even more significant piece of China’s attempt to dollarize the yuan is its new Asia Infrastructure Investment Bank (AIIB).

Former U.S. Treasury Secretary Larry Summers said the launch of this bank should be a “wake-up call” for America.

The U.S. has protested strongly against the creation of this bank—which China marketed as an alternative to the U.S.-controlled World Bank. Yet every single U.S. ally except Canada and Japan have defied America’s wishes to join China.

“I can think of no event since Bretton Woods comparable to the combination of China’s effort to establish a major new institution and the failure of the U.S. to persuade dozens of its traditional allies, starting with Britain, to stay out of it,” wrote Summers.

It says a lot about your standing when even your closest allies join your enemies.

Morley continues by quoting famed investor Jim Rogers:

The U.S. is the largest debtor nation in the history of the world. Never has a nation ever got into this much debt, and it’s getting higher and higher every day.

Washington is spending and borrowing even more and not doing anything about it. No nation would be able to get out of this without a crisis.

What will need to happen for the U.S. dollar to lose reserve status? More of what is already happening—debts going higher .…

Even our friends are starting to say it is out of control. The [South] Koreans do not have too much choice but are saying it is not going to work. … The Chinese and the Russians … are looking for something to use besides the U.S. dollar in their trades and in their reserves.

If you are looking for potential black swans, an international payment system in yuan seems clearly to fit the criteria.