China and Russia have sent a shockwave through the financial world, as they announced that they would no longer use the American dollar when trading with each other. Though this may seem like a rather innocuous announcement, it could be the first step in the decline of the U.S. dollar as the world’s trading currency.
Why is the U.S. dollar apparently losing the trust of some of the world’s biggest economies? Perhaps America’s massive US$ 13 trillion debt has something to do with it, along with the perception that America has no plan for balancing their budget and reducing this debt.
Imagine if you were a lender and you had a customer who kept coming back to you over and over again to borrow more money. Imaging that every year they demanded more and more, but kept telling you: “Don’t worry buddy, I’m good for it.” After years of hearing this, you might be forgiven for getting a bit sceptical that you would ever get your money back.
Since money is sustained by the consent and agreement of individuals and nations, when trust in a currency declines the results can be quite drastic. By deciding to use each other’s currencies in trade between each other, China and Russia are also showing that they no longer have the same faith in the U.S. dollar as they once did.
This is especially troubling for the U.S. because they are able to get away with huge budget deficits because of the fact that they are the world’s reserve currency. The world doesn’t want to call in the debt of the U.S. because that would damage the American dollar, and thereby damage the world economy as well. But if the U.S. loses their status as the world’s reserve currency, there will be nothing standing in the way of America’s debts being called in, with possibly disastrous results.
So, what can America do to maintain their monetary dominance? It’s all about trust, so America has to give the world a reason to trust them. It is no longer enough for America to talk about their history of economic success; the nations of the world need to know that America will eventually pay back the money they have lent them.
Though from an outside look the issue of world currencies may seem far removed from America’s budget woes, it really all fits together. If America does not fix their budget at home, they will continue to bleed away the trust that the world has in the greenback, and when that happens it will make it tougher for America to fix their budget problems at home, since their deficits will no longer be just a domestic problem, but an international problem.
China is an economy on the rise, and Russia wants to go along for the ride, as does much of the rest of the world. Right now, America looks like a nation whose best days are behind her, and China looks like they could inherit the future. This is not inevitable, as the world of economics is notoriously unpredictable, but this move by China and Russia is a shot across America’s economic bow, one that must serve as a wake-up call to the economy that is still the strongest in the world.