Biden’s debt ceiling crisis threatens stark consequences for the dollar

“Every night I ask myself why all countries have to base their trade on the dollar,” the Brazilian President, Luiz Inacio Lula da Silva, said on a recent visit to China.

If this seems implausible – there are surely less arcane issues to dwell on as bedtime approaches – the observation nevertheless highlights growing concern in the developing world over continued dollar supremacy.

Despite the birth of the euro, and an increasingly assertive yuan, the dollar remains far and away the dominant currency for international trade and capital markets activity.

So much so that if, for instance, you buy goods from Rwanda, it is highly likely that your pounds would first be converted into dollars before conversion into Rwandan francs; there is little or no liquidity in pounds to francs, but there is plenty of it in pounds to dollars, and dollars to francs.

In any case, more than 70pc of global trade involved the US dollar last year, with even higher percentages ruling for settlement in global financial markets. These proportions have barely moved in more than three decades. Rumours of the dollar’s demise, in other words, are greatly exaggerated.

Trust is at the centre of this almost unassailable position. Credible alternatives simply don’t exist as things stand. If you believe the Chinese data, the yuan is making important inroads, and certainly there is no lack of ambition. Beijing is well aware of the economic advantages of a pre-eminent currency, and as on much else, is determined to claim the position as its own.

But progress is slow. According to recent data from the International Monetary Fund (IMF), the yuan remains firmly stuck in fifth place among the world’s leading reserve currencies, with just 2.69pc of foreign exchange reserves held in RMB. As such, it has yet to surpass even the pound.

The reason? The law in China is no more than an arm of the state, and as such, the currency is simply not trusted as an impartial international means of exchange.

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That’s why Beijing’s deliberate subversion of the common law in Hong Kong is such a disaster. Hong Kong will no doubt remain an important Chinese financial centre, and a useful gateway for the West into China, but as an independent international financial centre and entrepot for Asia as a whole, it is essentially finished.

That position now belongs to Singapore.

As for the euro, as long as lingering doubts about the currency’s sustainability remain, it will be no match for the dollar. And the less said about crypto, the better. Maybe one day, but after the recent meltdown it’s a long way off.

So for now, the dollar’s reign on the global stage remains essentially unchallenged. There are, however, two important caveats. One is the US’s growing propensity to use dollar hegemony as a form of economic warfare. No need for military intervention if the dollar’s pivotal role in the global economy can instead be used as a way of bringing countries that step out of line to their knees.

For companies such as HSBC that straddle the geopolitical divide, the effect has already been chilling. Threatened with the loss of its dollar clearing licence, without which it would have been out of business, the bank had no option but to hand over key evidence to the US authorities against Huawei’s finance director, Meng Wanzhou, for alleged sanctions busting.

HSBC then had to spend years smoothing things over with Beijing, a process which seemingly included the forced public denunciation of Hong Kong’s pro-democracy movement by way of penance.

In any case, the imposition of sanctions, first on Iran then last year on Russia, has seriously worried many developing countries, alerting them to the dangers of falling out with the US and galvanising attempts to find dollar alternatives.

The second caveat concerns doubts about the dollar’s long term viability as a sound currency. Years of quantitative easing and debt accumulation have taken their toll, with the growing impasse over the US debt ceiling being just the latest example of a country whose mountainous public borrowing shows every sign of getting completely out of control.

Once again, the US government is in danger of running out of money. Without Congress’s go-ahead for borrowing more, this is likely to happen by July at the latest. One way or another, US debt ceiling crises have in the past always been resolved, with outright default avoided. But just how many near scrapes can you survive before your luck runs out?

Ability to borrow with impunity from the rest of the world is of course the key advantage of having the world’s dominant reserve currency, and it is why China covets that position so cravenly. That and the geopolitical power and influence that go with it.

Yet even to be in with a chance, China has to comprehensively overtake the US as the world’s dominant economy. Will this happen? Sheer weight of population alone suggests it should as China plays catch up with the advanced economies of the West.

Yet it should be noted that right up until the early 1990s, similar predictions were made for the Japanese economy, whose regimented approach to economic advancement was widely perceived as superior to the freedom-loving ways of an increasingly degenerate West.

Since then, the US has continued to prosper, while Japan has become mired in 30 years of going nowhere.

In hankering after alternatives, Brazil’s Lula may wonder – every night, he claims – why international trade is so heavily based on the dollar, but he should be careful what he wishes for.

Being in hoc to China is, I imagine, an even less appealing prospect than subservience to the US. In any case, the answer really isn’t that complicated. If there were a better alternative, it would by now be in the ascendency.