EDMONTON — The U.S. debt ceiling debacle laid bare the inherent and true costs to international trade from the outdated world reserve currency system.
Virtually every international transaction that non-American businesses complete, from importing Chinese-made TV’s to the proposed selling of Canadian LNG to Malaysia, must be done in U.S. dollars. The Canadian loonie does not directly convert into the Chinese Renminbi or the Malaysian Ringgitand their currencies do not convert into the Canadian Dollar.
China and many other countries are moving away from this U.S.-dominated system to a basket of reserve currencies that includes the Chinese Renminbi (yuan). China is also making direct currency swaps with trading partners that supports and encourages their bilateral trade. If Canada does not adopt similar reserve currency reforms, its companies will be at a long-term competitive disadvantage in Asia and around the world.
The origin of the U.S. dollar as the world reserve currency was the 1944 Bretton Woods agreement. The greenback was guaranteed by gold and other currencies were made fiat ones (having no intrinsic value but declared legal tender by their governments) and pegged to the value of the dollar. This system initially worked quite well but became unsustainable as global trade grew and more dollars were required than could be guaranteed by gold reserves.
In the 1970’s, the U.S. reached an agreement with the House of Saud to accept only dollars for its oil, maintaining the U.S. dollar’s supremacy in trade and eliminating the need for it to be guaranteed by gold. Since then, the world has been on an informal Black Gold standard, known as the petrodollar. Trading oil in U.S. dollars made it the logical choice for countries and international business to use for other trade and firmly established it as the world reserve currency.
China understands and acknowledges the risk of a U.S.-dominated financial system on its stability and future growth. It is rapidly moving towards a more internationalized yuan and has made currency swaps with nearly 20 countries including Australia, Argentina, Brazil, Japan, Hong Kong, Indonesia, Malaysia, Russia, Singapore, South Korea, the EU, and the United Kingdom. But not with Canada.
These swaps are becoming increasingly important to China’s bilateral trade. By moving to a direct swap, it saves at least 1 per cent on transaction costs and reduces its U.S. political risk exposure. In the case of China/Japan bilateral trade, the saving is estimated to be US$3 billion per year. There are also spill-over effects including the simplification of bilateral investment and the creation of new opportunities for small- and medium-sized companies.
Currency swaps taken individually are not of great importance but the combined impact is resulting in a transformational change to the world financial system. In the first quarter of 2011, the Chinese Renminbi surpassed the Russian ruble in trading volume for the first time. This year, Britain became the first G-7 country to set up an official currency swap line with China. Venezuela, Sudan and Angola are expected in the near future to sell oil in the yuan. Both Russia and Iran are already using it for oil sales to China. This helped accelerate a new US$85 billion China-Russia oil and gas deal that will be transacted in rubles and yuan, not U.S. dollars.
Canada’s bilateral trade with China was nearly $70 billion in 2012. Without a direct currency swap it loses at a minimum $700 million a year in transaction costs and is adding a level of complexity that is harming investment. When China wants to buy resources from Canada it has to pay the transaction costs to convert its currency into U.S. dollars then U.S. dollars to Canadian dollars, something they are less willing to do every year and something they do not need to do with a growing number of other countries that directly compete with Canada in the resource sector.
It is not enough anymore to simply sign free trade agreements and blindly believe that trade will grow. Canada must become proactive in its approach to trade. It is time to move away from the antiquated U.S. reserve currency model and to think not only in terms of oil at $100 per barrel, but also in terms of it at 600 Yuan per barrel.
Doing so will create the conditions for a more successful trade relationship with China and other South East Asia countries that are quickly embracing a new basket of reserve currencies that includes the Renminbi and new multi-polar trade models.
Ryan Lijdsman is a Canadian-based international business consultant.