China's Yuan Won't Topple the Dollar After All

Milton Ezrati

Economics, Asia

Concerns that the dollar's days are numbered lack merit.

It was always a ridiculous contention, and it seems even less reasonable now. Not even a year ago, consensus thinking saw China’s yuan on the verge of replacing the dollar as the world’s premier reserve currency. Now the flood of funds out of China, and the yuan’s declining value, have stifled all such talk and even such thinking. No doubt circumstances will continue along current lines for a while to come. Still, today’s negative attitudes are setting the stage for a rebirth of pro-yuan speculation, perhaps pretty soon. It will be wrong again.

When the pro-yuan thinking was at its height last spring, it looked as though the currency had support from all quarters. China’s economy seemed to be doing reasonably well, though growing at a much slower pace than previously. Beijing was also making headlines with its efforts to give the yuan a more prominent international role. To argue the other side of the question, that the dollar was not quite so vulnerable, took a disciplined analysis of the fundamentals, historic and economic, as well as recognition that not all policy in Beijing supported the effort to substitute the yuan for the dollar. The National Interest offered just such an analysis.

The pro-yuan enthusiasm, nonetheless, dominated most decision making. Foreign companies, confident China was unstoppable and that the yuan’s value would continue to rise, invested heavily in the country. For the same reasons, foreigners bought Chinese stocks and bonds, while Chinese firms borrowed in dollars and other foreign currencies with the expectation that their appreciating yuan earnings would enable them to service this debt easily. All these huge capital inflows created an exaggerated feeling of prosperity in the Chinese economy and drove up the prices of Chinese stocks and other financial assets, a development that redoubled the supportive inflows.