US dollar set to remain the world’s reserve currency

With the rise of China’s renminbi and its internationalisation, a question naturally arises as to whether the US dollar as the world’s reserve currency can still be sustained sometime in the future.Here in Malaysia, should the ringgit depreciate drastically against the USD, our headline inflation may hypothetically spike from the present figures of between -1.5% and 0.5% to beyond the projected figures of between 1% and 3%. This is because of our dependence on food imports.

Our currency’s value relative to the USD inevitably plays into the geoeconomics game that is all about entrenching the USD’s hegemonic status for a long time to come. The Triffin Paradox means that sustaining the USD as the world’s reserve currency requires the US to run external deficits against the rest of the world continuously. This tends to weaken confidence in the value of the USD which leads to increased demands for convertibility back into gold.

China’s holdings of US Treasury bills, therefore, do not affect the US’ ability to deficit finance. It simply means the less holdings China has, the less debt the US needs to issue to repay, which in turn reduces the capital account deficit. This means there’s less demand for USD to be converted into yuan and hence the argument that it maintains the USD as the world’s leading reserve currency.

Cheaper borrowings resulted in speculative activities in commodities, including staple food imports such as wheat, which fed into the escalating food inflation in the importing countries that ignited the Arab Spring in the aftermath of the 2008 GFC. However, China had begun concerted efforts aimed at the internationalisation of the RMB. Its entry into the World Trade Organisation in 2001 marked its maturing into a full-fledged member of the international economic order. This could be seen in the bilateral swap arrangements and cross-border settlements in RMB which, among other things, minimise transaction costs.

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