"Every perception is to some degree an act of creation, and every act of memory is to some degree an act of imagination."
-- Gerald Edelman, Second Nature: Brain Science and Human Knowledge
1 The Capital War3 The Capital WarThe Capital WarChapter 7: US-China Relations and Wars2020-10-18Journal
The United States’ greatest power comes from being able to print the world’s money (i.e., from having the world’s leading reserve currency) and all the operational powers (e.g., influences on the clearing system) that go along with that. The United States is at risk of losing some of this power while the Chinese are in the position of gaining some of it. That is because the desirability of buying and holding US dollar debt is being reduced because a) the amounts of dollar-denominated debt in foreigners’ portfolios (most importantly in government-controlled portfolios such as central bank reserves and sovereign wealth funds) are disproportionately large based on a number of good long-term measures of what the size of reserve currency holdings should be,\[8\] b) the US government and the US central bank are increasing the amounts of dollar-denominated debt and money at extraordinarily fast paces that are scary and the amounts will be hard to find adequate demand for without the Federal Reserve having to monetize a lot of it, c) the financial incentives to hold this debt are unattractive because the US government is paying a negligible nominal yield and a negative real yield on it, and d) holding debt as a medium of exchange or as a storehold of wealth during potential wartime is less desirable than during peacetime. Further, the roughly $1 trillion of debt that China holds (which, by the way, equals only around 4% of the roughly $27 trillion outstanding) is related risk. Also, because other countries realize that actions taken against China could be taken against them, any actions taken against Chinese holdings of dollar assets would likely increase the perceived risks of holding dollar debt assets by other holders of these assets, which would reduce the demand for them. Also, the dollar’s role as a reserve currency largely depends on its being able to be freely exchanged between and working well for most countries, so to the extent that the US puts controls on its flows and/or runs monetary policy in ways that are contrary to the world’s interests in pursuit of its own interests, that makes the dollar less desirable as the world’s leading reserve currency. As you can see these dollar-weakening influences are adding up. At the same time the dollar is in a uniquely strong position because it is so extensively used, which makes it more valuable and less easily replaced.