This is an interesting feature article from Al-Jazeera: China buys gold, challenges US dollar. It covers information released by Wikileaks over cable transmissions alleging that China is buying gold to weaken the US dollar’s position as the world’s reserve currency. Of interest is this particular passage:
Buying gold and allowing the yuan to be traded freely would weaken the US dollar’s dominance as the international reserve currency. The move would have major implications, making it more expensive for the US government to borrow money and to run perpetual trade and budget deficits.
“The US is used to having the position of having the key reserve currency, but others are eager to replace it,” said Josh Aizenman, a professor of economics at the University of California and president of the International Economics and Finance Society.
As a reserve currency, the US dollar is the default for international transactions. If, for example, a South Korean company wants to buy wine from Chile, chances are they will carry out the transaction in dollars. Both companies must then purchase dollars to conduct their business, leading to greater demand. The value of global commodities, such as oil, is also generally demarcated in US dollars.
Being a reserve currency allows the US to borrow at low interest rates, as central banks around the world are eager to buy US government debt. “Any country that can finance its expenditures by printing money or selling bonds is essentially getting a free lunch,” Aizenman told Al Jazeera.
With China’s apparent change of heart, that “free lunch” now might come with a hefty tab. Given the massive US trade deficit, average Americans might be sent to the restaurant’s kitchen to wash dishes if the dollar loses its status as the world’s reserve currency.
I believe that what China is doing is definitely a smart move. It is only a matter of time before fiat (paper) money loses its value and the world returns to the gold standard. With the US debt piling up as it is into trillions of dollars, financial markets will eventually stop relying on the US dollar as their mode of commerce. This will no doubt paralyse the US economy in the long run when it happens.