It would be very tough to argue against the fact that we’re living in changing times. The COVID-19 pandemic is forcing a global economic shutdown on par with the great depression. Unemployment is spiking. In the U.S., the temporary lift through federal fiscal stimulus payments is working but there is uncertainty regarding how long this can be sustained before the tide of credit issues overflows businesses. Through such uncertainty, one should attempt to separate the temporary changes from the overall structural shifts in economic, political, and social structures. One concerning theme I am overly focused on is the United State’s lack of global leadership which is risking our position as the dominant player in global finance.
For context, the United States has played a dominant role in economic development since the end of WW2. The US Dollar found its way into power as the world’s reserve currency by way of the Bretton Wood’s agreement of 1944. Now, roughly two-thirds of international foreign currency reserves are denominated in US Dollars.
Outside of currency transactions, the US also holds a disproportionate amount of influence over Swift. This system is the underlying backend network supporting financial transactions across international borders in a secure and standardized format. Paired with the ability to manipulate the dollar to push the agenda of our foreign relations, we’ve been known to push Swift to satisfy our own needs. For example, in 2012, the United States pushed for bans on Iranian banks from making any transactions on the system, resulting in almost a complete shutdown for their international oil exports.
Through these politically isolating actions along with other dominative stances of economic development, the global perspective of leadership for the US has been decreasing. In Gallop’s poll, Rating World Leaders for 2019, the US reached a new low of 31% approval, signaling the world’s dissent towards our decisions. Our inability to control the COVID pandemic, I fear, contributes to this sentiment.
Underlying these actions, China has been pushing initiatives to solidify their position to circumvent the current financial system driven by US motives. They are pushing two ambitions paired to increase their position as a player in the financial system.
Firstly, at only 2% of global reserves, the yuan has a long way to go to yield the same amount of influence provided by the US Dollar. To that end though, the Chinese bond market is sitting in a perfect position to push this initiative. In the wake of the COVID-19 pandemic, fear rippled throughout the global financial system. Searching for safety, investors commonly sell out of developing market investments and risky assets. Interestingly, standing out from it’s emerging market peers, Chinese government bonds returned +1.3% since January 2020, compared to the -15.5% decline in other emerging market bonds, signalling a sense of security from investors. With yields rounding out at 2.25%, compared to 0.25% on US-denominated government bonds, its not hard to rationalize the potential for capital inflows for investors attempting to seek higher yields.
Alternatively, what if China’s position isn’t to take over in the structure of the current financial system? Opposed to increasing influence over the fiat currencies or the SWIFT system as a whole which pipes the current financial system, China is leveraging digital wallets created by Tencent and Ant Financial. Their position in the global financial economy is rather low compared to their ranking in economic output, which poses a daunting uphill battle competing with the United State’s negative sentiment towards Chinese investment. These technologies could allow for payments to take place alongside the existing currency based trustless financial system.
It is difficult to predict when or if a digitally dominant financial system could take hold. View the pains of a cryptocurrency advocates for evidence. With all of the changes occurring in the wake of the pandemic though, several important themes are coming to light:
Importantly, there is also room for positives to be taken here. With a globally connected economy, I don’t view these shifts as entirely zero-sum. It could be possible for two financial systems to develop, either governed by economic bodies or underlying technologies. In the post-Bretton Woods era, a merely analog world necessitated a system governed by a single or several small entities. It could be the case that a digital dominant system increases the ability of other countries to have a voice in global trade.