In 2010, China’s gross domestic product (GDP) was approximately one-fourth that of the U.S. Since then, China’s overall economy has advanced at an annual compound growth rate of 10% compared to the U.S.’s much slower expansion of 4.1%. Should this trend persist, China’s GDP will surpass the U.S.’s in 2027. Other than bragging rights, what are the impacts? Could the U.S. dollar lose its reserve status?
At the 1971 Bretton Woods Agreement, the U.S. dollar was officially crowned the world’s reserve currency. Even without this official designation, due to the size of the U.S. economy, and its debt markets, the U.S. dollar was, and is, the global reserve currency. As a result of this status, other countries accumulate reserves of U.S. dollars equivalents instead of gold. But rather than holding U.S. dollars, these nations purchase and hold interest earning U.S. Treasury bonds. These purchases have the impact of reducing U.S. interest rates. Furthermore, these bond purchases strengthen the U.S. dollar making purchases of foreign products such as Paris vacations and German automobiles cheaper in price for U.S. consumers.
However, in 2015, the IMF awarded the Chinese yuan status as one of four reserve currencies with the dollar supreme. The IMF basket of reserve currencies currently includes the euro, the Japanese yen, the British pound, and U.S. dollar. Should China’s GDP surpass that of the U.S., and they abandon currency manipulation, there will be pressure from global investors to abandon the dollar and crown the yuan as THE global reserve currency.
The yuan replacing the dollar as THE global reserve would push U.S. interest rate much higher, increase borrowing costs for U.S. firms engaged in international trade, and boost U.S. consumer/business borrowing costs.
At this time, China’s interest rates on government debt are approximately two percentage points higher than the U.S.’s. Thus, the dollar losing its status as the global reserve currency could increase U.S. federal debt service by as much as two percentage points and cost U.S. taxpayers as much as $600 billion per year in interest payments, other factors unchanged.