Trade deficit of USA with China is not the real reason of trade war. To understand that consider this analogy – imagine having a magic tree in your backyard that yields currency notes and you freely use these notes to buy groceries, movie tickets, jewellery etc.! Now suppose if your grocery store is charging you higher in the name of better services, would you complain? Logically, no, because you get currency without any efforts!
USA is in similar situation, it is the only country in the world that can print any amount of dollars and can import anything using that because dollar is the reserve currency of the world!
So, it is not the deficit that is a serious threat to USA. Just like the grocery store charging a bit extra is not a concern to you but IMAGINE THE GROCER TRYING TO CUT YOUR MAGIC CURRENCY TREE!!!
You will fight tooth and nail to prevent anyone trying to cut that tree, SIMILARLY – anyone trying to undermine the status of dollar as world’s reserve currency will become the biggest threat to USA. And this is what China is intending to do and that is why USA is all out to weaken Chinese economy so that it fails in its attempt to undermine dollar hegemony.
It may come as a shock to many people but the dollar’s status as a reserve currency is the primary reason for the US economic supremacy. Other countries need to export something to earn dollars. Not the US, which can print as many as it wants and buy any property, technology or pay for its massive imports. Also, it can invest a large amount of venture capital to buy any firms anywhere.
The dollar has become the reserve currency because over 70 per cent of world trade happens in dollars. This may look strange as the US share in world trade is less than 15 per cent. The US manages this by ensuring that large trade contracts for commodities like crude oil are always denominated in dollars.
The Saudi royal family has since the 1970s ensured that all OPEC oil contracts are denominated in US dollars. In return, the US ensured the continuation of the royal rule and fought Saudi enemies in the Gulf region. And this explains Trump’s action of isolating Iran. Since Iran is an enemy of Saudi, Trump announced sanctions to cripple Iran. Anyone buying from Iran would also face sanction.
Dollar hegemony is also supported by ensuring that global banking takes place in dollars. Large US banks operating globally ensure that most export contracts are made in dollars even though neither the buyer nor the seller uses dollars.
Individual countries may face inflation if they print more local currency, not the US as the excess dollar is absorbed happily by the world.
The video below gives a good explaination of dollar hegemony and the current geopolitical issues.
Once one understands the power of dollar hegemony, he would be able to understand the real reasons behind many of the US policies. Whenever there was a threat to dollar, USA acted swiftly and brutally.
In 2003, the US army captured Iraq and hanged its President Saddam on allegations that Iraq had Weapons of Mass Destruction (WMD). No WMDs were ever found. Later on it was found that Saddam had started the process of denominating oil contracts in Euro and other currencies.
The dollar’s position as the reserve currency is under strain again. Many countries including China are taking steps to denominate their trade contracts in local currency and reduce dependence on the dollar. China plans to denominate all Belt and Road Initiative (BRI) contracts in local currencies. No wonder China is the primary target in the trade war.
China's 'petro-yuan': Challanging the dollar hegemony?
How big a threat is the petro-yuan to the petrodollar?
The petro-dollar came under attack in 2015, when Gazprom Neft, the third-largest oil producer in Russia, decided to move away from the dollar towards the yuan and other Asian currencies. Iran followed suit the same year accepting the yuan for payment for Iranian oil exports.
A death blow that began in 2015 hit again in 2017 when China became the world’s largest importer of crude oil (see Chart 2)
It is becoming clear, at least to independent monetary observers, that in 2018 the petrodollar’s primacy is being challenged by the petro-yuan as the pricing medium for oil and other key industrial commodities. After all, the dollar’s role as the legacy trade medium is no longer appropriate, given that China’s trade is now driving the global economy, not America’s.
Though China plans to establish an Asian benchmark that will reflect Chinese consumption and more broadly Asian demand patterns but it's highly unlikely that the yuan will challenge the dollar in the near future.
Chinese yuan would have to become freely convertible, we would need other countries to open up to settlement in the renminbi; but the primary issue will be currency convertibility. And for now, the Chinese government is very reluctant to loosen currency controls and to give it up to free trade.
What China aims may take years or decades, but its intentions are written all over the wall and US will try its best to suppress Chinese ambitions – the trade war is going to last long.
Some important points –
Dollar hegemony is USA’s prime edge and its second strength is its technology (including military tech). It fears that China is stealing its technology and aiming to grow as technology superpower. Both issues – dollar and tech, central to the US power and eminence, are now under serious challenge.
US lead in digital and high tech space is under threat from China which is going all-out to become a leader in Artificial Intelligence and high technology by 2025. Loss of US monopoly in digital space is a worry too.
Many Chinese firms are large unicorns ready for global operations in direct competition to the US firms. Worse, the China model of not allowing entry to Google and Facebook is being copied by Russia, Brazil, and many others. The EU is also thinking of creating an EU wide internet. All this would mean an end of the dominance of the US firms in digital space.
Washington had recently barred Chinese telecoms giant ZTE Corp. from buying U.S. components. ZTE’s chairman said the April ban over its exports to Iran and North Korea could destroy China’s No. 2 maker of network gear. To regain access, the company agreed to pay a $1 billion fine, replace its executive team and embed U.S.-chosen compliance officers in the company.
Chinese government does not like the fact that its banks, airlines, farms and other industries need U.S. technology from jetliners to drugs to software. A key Chinese weakness is in semiconductors, used in everything from smartphones to cars. High costs and research challenges mean
Beijing’s plans call for state-led development in fields from energy and robotics to artificial intelligence and biotechnology. Though China is very aggressive in developing new technology (see chart below) and has filed a lot of patents, but most of these are minor improvements over existing technologies.
Total patent applications 1985-2014
China still needs years to create its own technology – and the shortest route to success is to simply buy US technology companies, which US is worried about.
"Russia and China, both of which are keen to replace the dollar as the world's dominant reserve currency, signed two major 30-year natural gas supply agreements in 2014 involving payment in yuan and Russian rubles. China pays for some of its crude from Russia with yuan."
"Although it is hard to envision the unified dollar-based market giving way to alternatives any time soon, the pressure for change will not go away, especially from states with rising oil import needs and growing fiscal deficits, as well as those with difficult relations with Washington. The dollar's dominance is not about to collapse. But it has begun crumbling at the edges."
"In an attempt to reshape the global oil market, the Shanghai International Energy Exchange has launched the first crude futures contracts priced in Chinese renminbi, or yuan."
“A Chinese or Russian SWIFT alternative would be a backwater of terror financing, money laundering and illicit financial activity by rogue nations,” he told the Washington Examiner. “No reputable bank would engage with such an entity. Additionally, this theoretical SWIFT alternative would not have the ability to conduct business in dollars or to access U.S. institutions and the U.S. financial system as a whole — this would not be a successful or even viable system.”
"Regardless, the well from which US hegemony sustains itself, including militarily, is the position of the dollar at the apex of the global economy. Without the dollar as the world's primary international reserve currency, US hegemony is unsustainable, making it the soft underbelly of the Empire it has fashioned in its name and image.
Thus de-dollarization (amounting for all intents to de-Americanization) is an idea whose time has come, just as de-Romanization was in and around the 5th century."
Impact on markets
It may take years for China to overcome or even seriously threaten US supremacy in currency and technology. But it has trillions of dollars in reserves, has a fast growing economy, ability to build world class technology, has capable, ambitious and stable government – these factors will ensure that it will not abandon its plans for world supremacy.
US on the other hand is running out of money, but under Trump's leadership it will fight aggressively to maintain its number one position.
We can expect US – China tussle to go on for years. Impact on markets at-least for the next few years may not be good. There may be disruptive developments in oil supply, geopolitical issues, protectionism, nationalism, and war for tech supremacy.
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