"You have the global hegemon, the United States, which will provide a series of global public goods: free trade, capital mobility, lender of last resort, security and defense to Europe, to Japan, Korea, to the Middle East, you name it."
-Nouriel Roubini, aka "Doctor Doom"
6 MIN READ - The Cautious Correspondent for Economic Affairs and Other Egghead Stuff follows up future prospects for the dollar’s reserve currency status with a look at implications for the petrodollar and the role of military power.
If you haven’t already read the CO primer on what makes a leading global reserve currency, the Economics Correspondent recommends taking a few minutes to read at:
It’s no coincidence that before World War I the global reserve dollar’s unambiguous predecessor was the British pound.
Unlike the US dollar, which obtained global reserve status de jure during the 1944 Bretton Woods conference, it’s not easy to pin a precise date on the British pound’s adoption.
But 1815 is a pretty good estimate, the year Napoleon was permanently vanquished at Waterloo and many historians regard as the beginning of the century-long era of Pax Britannica.
Although many believe military power allows a global hegemon to “force” other countries to use its currency the primary relevance of military power is the ability to guarantee the security of the currency regime itself and maintain open trade routes.
19th century British military might guaranteed the security of the pound. After 1815 few could envision a foreign army invading England, marching into London, and taking over the Bank of England and its gold reserves.
Likewise after 1944, and particularly after the invention of atomic weapons, few could envision a foreign army invading the USA, marching into Washington, DC and taking over both the Federal Reserve System and the USA’s official gold reserve holdings at Fort Knox, West Point, and the Denver Mint.
However the pound’s 19th century dominance was reinforced by British military power another way: If the world was going to rely on the pound to trade between nations then the Royal Navy would ensure the sea lanes stayed open to conduct business in pounds.
The U.S. Navy plays a similar role today, using its leading maritime power status to keep goods moving freely between nations—even non-American states, e.g. Japanese cars headed for Latin America or Saudi oil heading for Europe.
After all, what good is using the dollar to trade with other countries if your products can’t get there?
Hence today we see the U.S. Navy keeping sea lanes open that don’t even carry much product to the United States itself.
For example, although the U.S. has strategic interests in the South China Sea with allies like Taiwan, Singapore, Thailand, and a slightly more indecisive Philippines, not that much of the USA’s own merchandise navigates through that body of water.
But the U.S. feels committed to keep the South China Sea open for other countries to ship their cargo since they overwhelmingly use the dollar.
And America has been a pretty good steward of open maritime trade. The U.S. Navy, for example, doesn’t block oil shipments between Venezuela and China, or merchant shipping between Cuba and Russia, or even cargo between Venezuela and Iran (despite sanctions from other countries) even though U.S. relations with every one of those countries is strained.
Even during the Cuban Missile Crisis the American naval blockade only stopped and turned away ships carrying materials for the deployment of nuclear missiles. Soviet freighters carrying any other cargo—even defensive-only conventional weapons like tanks, MiG fighter aircraft, SAM missiles, and artillery—were allowed to pass and dock at Cuban ports just as they had for the previous sixteen months that Cuba and the USSR had cooperated in a military alliance.
Now let’s consider what happens if the world adopts the Chinese RMB as the global reserve currency. If China builds a sufficiently powerful navy to patrol the world’s seas, do international governments trust Beijing to keep sea lanes open for commerce the same way the United States has?
If China doesn’t approve of how Japan is behaving, or the Philippines, or Malaysia or Australia, does anyone think the CCP will work 24/7 to keep all their sea lanes open? Or will the Chinese Navy neglect their trade routes or worse yet become the instigator of naval obstruction themselves?
And as Nouriel Roubini mentions, military sea power is a public good that the global hegemon provides in exchange for the world using its reserve currency. “Do business with our currency and we’ll keep the world open for business” is the unspoken agreement.
During Pax Britannica the Royal Navy provided that public good and during Pax Americana the U.S. Navy has provided it.
But when considering the prospects for a Pax China century the world’s governments may think twice about their reliance on the Chinese Navy to keep the world’s waterways open—particularly how fairly and evenly Beijing will police global sea lanes.
The Economics Correspondent hears a lot of talk about the petrodollar being the linchpin that keeps the entire crooked house of cards—the global reserve dollar—holding up.
Predictions are everywhere that if OPEC, or really just Saudi Arabia, abandons its pledge to accept payment for oil exclusively in dollars then it’s instant game over for the dollar's global reserve status.
The Economics Correspondent believes that, while a potential Saudi rejection of the dollar could only be harmful–both politically and economically—to the dollar’s world reserve status, predictions surrounding the degree of rejection are overblown and simple math says the same about any economic effects.
The recent story driving all this discussion is talks between Saudi Arabia—whose government is turned off by the Biden administration’s constant criticism and henpecking—and China about accepting some measure of RMB payment for its oil exports.
If such a deal went through then no doubt it would have a significant symbolic impact as the Saudis have insisted exclusively on dollars for half a century.
However, as covered in the previous post, no country trusts China enough to hold large reserve balances in RMB. The reasons are many including immaturity and untrustworthiness of Chinese securities markets, China’s continued use of capital controls, China’s continued manipulation of exchange rates, China’s insistence on trade surpluses (the opposite of what a reserve currency issuer needs to do), and the arbitrary power of an autocratic regime that has already shown no hesitation to abuse that power for even the tiniest perceived sleight.
So in the Economics Correspondent’s opinion, if Saudi Arabia did agree to accept some RMB payments for oil exports, the degree would be limited and mostly symbolic—probably enough to meet the kingdom’s most immediate import needs back from China itself and then perhaps a small reserve balance to serve as a political statement reflecting Riyadh’s “confidence” in its trading partner—all while the bulk of its real foreign reserves remains in dollars, euros, pounds, Swiss francs, and Japanese yen.
The other sobering reality is simple math. If Saudi Arabia were foolish enough to go all-in and accepted RMB payments for the entire 100% of its China oil exports, what impact would that have on the dollar’s global position?
Total global trade reached $32 trillion in 2022 which happened to also be a good year for oil prices.
Saudi Arabia’s total oil exports in 2022 were $326 billion, and of that 26% was sold to China.
Therefore, if Saudi Arabia agreed to sell 100% of its future oil to China in exchange for RMB instead of dollars, the impact would be ($326B x 0.26)/$32T = 0.26% of global trade.
As the dollar enjoys a 79.5% share of international payments, a complete Sino-Saudi RMB-for-oil deal would reduce the dollar’s global share from 79.5% to 79.24%.
However such a defection, while small as a share of global payments, could be more significant for its symbolic importance. Other smaller OPEC countries might follow suit, particularly if the Biden White House insults them enough times
But the Economics Correspondent believes any Saudi-China RMB-for-oil deal would not govern 100% of Saudi oil exports but rather just enough to make news headlines. Riyadh knows the realpolitik of its own finances and would never be willing to hold sizable shares of its hard-earned foreign reserves in a currency that can be controlled by a regime like the CCP.