[Lee Jong-woo's Economic Reading] Considering Yuan for Oil Payments... Will the Dollar's Status Be Shaken?

Petrocurrency as a Criterion Dividing Key Currencies
Even with Trade Deficits,
Economic Strength to Endure Is Essential
China's Financial Assets at 20% of the US
No Immediate Currency to Replace the Dollar

Concerns about the changing status of the dollar have intensified as Saudi Arabia considers settling its oil imports from China in yuan. Unlike in the past when the key issue was whether a particular currency could be exchanged for gold, the currency used for oil settlements now serves as an important criterion for determining the global reserve currency. If the share of yuan settlements increases, the dollar's status will inevitably weaken. Currently, 80% of global oil transactions are settled in dollars.

Several conditions must be met for a currency to become a global reserve currency. First, the country issuing the currency must have significant influence in the global economy, politics, and military sectors. This ensures an increase in trading partners and widespread use of the currency in international settlements. The currency must also be highly liquid. Since people worldwide use the currency, its supply cannot be limited. To support this, the country must have the economic strength to withstand trade deficits and the ability to supply investment assets, including government bonds.

Since the 1980s, concerns have arisen that the dollar's status as the global reserve currency might weaken whenever the U.S. trade deficit grows, but the opposite has occurred. Even after the financial crisis and during the COVID-19 pandemic, when the U.S. trade deficit increased, the dollar remained strong. This is because the market realistically sees no alternative to the dollar. As a result, despite the U.S. running massive trade deficits, capital inflows continue to cover these deficits.

The unparalleled size of the U.S. financial industry also helps maintain the dollar's status. Currently, U.S. households hold about $90 trillion in financial assets, which is only about 20% of China's holdings. The U.S. financial industry is large enough to supply bonds worldwide, attracting global investment funds to the U.S.

However, the dollar is not without weaknesses. The U.S. accounts for less than 10% of global trade volume and only about 20% of global GDP. On the other hand, 60% of the world's foreign exchange reserves are held in dollars. The outstanding dollar-denominated debt held by non-U.S. companies amounts to $12.7 trillion, tens of times larger than that of other currencies. Given the disproportionate share of the dollar in settlements and financial transactions compared to the U.S.'s real economic share, concerns about the weakening status of the dollar persist.

Yet, there is currently no currency that can immediately replace the dollar. The yuan is likely to remain a regional currency used mainly for oil and mineral settlements with Middle Eastern and African countries rather than becoming a global reserve currency. Although Chinese authorities are considering issuing a digital yuan to enhance its status, it is uncertain whether this will yield satisfactory results.

For the yuan's status to rise, China's share in the global economy must increase, and its capital markets must develop further. Only then will more countries use the yuan. It is unclear whether China's financial industry can handle this expansion. Premature efforts to strengthen the yuan's status without a robust financial market could lead to a crisis.

The euro holds the second-largest share of global foreign exchange reserves after the dollar, but its influence is limited by inherent constraints. The euro is a currency that binds several member countries with different economic conditions. As seen during the 2011 European debt crisis, conflicts may arise between countries benefiting from the euro and those suffering from it.

It is also questionable whether the euro can be supplied at a level befitting a global reserve currency. Currently, no European country is willing to supply euros globally while accepting trade deficits. Germany has the capacity but has benefited from increased trade surpluses since joining the Eurozone, making it more likely to support maintaining the current system rather than strengthening the euro's status. Due to the euro's nature as a currency shared by multiple countries, there is no way to compel a specific country to supply liquidity.

The Japanese yen is currently struggling to manage depreciation. Since the outbreak of the Ukraine crisis, the yen has rapidly appreciated, reaching 124 yen per dollar, the highest level since the end of 2015, although it has depreciated nearly 10% compared to the end of last year. The yen's weakness stems from differences in monetary policies between the U.S. Federal Reserve and the Bank of Japan. The Fed plans to raise its benchmark interest rate to 2% by the end of this year, while the Bank of Japan has no plans to revise its accommodative monetary policy.

Bank of Japan Governor Kuroda stated that although Japan's consumer prices may exceed 2% after April, there is no reason to change the monetary easing policy since Japan is pursuing demand-driven inflation. As a result, the yield spread between 10-year U.S. and Japanese government bonds widened from 1.4 percentage points at the end of last year to 2.0 percentage points currently. Considering that capital flows from low to high interest rates, the yen's weakness is natural.

Concerns about the Japanese economy following the Ukraine crisis have also contributed to the yen's weakness. In the past, the yen's depreciation often coincided with improvements in the Japanese economy. This time is different. Despite the yen's weakness, the Japanese economy has not recovered from stagnation, primarily due to a rapidly increasing trade deficit caused by rising international oil and natural gas prices.

In February, Japan's corporate goods price index rose 9.3% year-on-year, marking the highest increase in 41 years, while consumer prices rose only 0.9%. Despite rising raw material prices, Japanese companies have been unable to pass these costs onto product prices. With high oil prices and a weak yen weakening household real purchasing power, corporate profitability has deteriorated, increasing the damage to the Japanese economy.

The dollar's status has strengthened through the COVID-19 pandemic and the Ukraine crisis. The dollar index, which measures the dollar's value against six major currencies, is approaching 100. Since it was 90 in June last year, the dollar has depreciated nearly 10% in nine months. Naturally, other currencies, including the Korean won, have weakened against the dollar. This trend is expected to continue for some time as the Federal Reserve is under greater pressure to raise interest rates than other advanced central banks. Changes in currency values significantly impact trade, the real economy, and financial transactions. It is time to pay close attention to international currency trends.

This content was produced with the assistance of AI translation services.