We have seen an interesting digression in world monetary trend. China and Japan have announced last month (26th December) that they are going to start trading with each other in their own currencies, OTHER THAN U.S. DOLLAR. So they have formed a powerful currency union.
Japan previously used its massive foreign currency reserve of U.S. dollar to artificially devalue its currency- by pegging its currency to USD and expanding its money supply- thus undervaluing its currency and boosting its exports. China presently is doing the same. They currently hold world’s largest foreign currency reserves- China has about $3.2 trillion, while Japan holds $ 1.3 trillion- and any move to reconstitute the makeup of those holdings could change the global currency map.
Over the short run, the agreement is likely to lead to continued weakening of the dollar against the yuan (on the contrary, strengthening the yuan). That should help the U.S. to lessen the trade deficit with China, increasing American exports while weakening imports from China. On the other hand, the strategic advantage that the U.S. used to enjoy through the world dominance of its own currency, like getting all the products and commodities (mostly OIL) by importing in its own currency, would surely diminish. The seemingly unending American prosperity manufactured by way of manipulating its currency and money supply has started showing its diminishing returns.
The present fate of the dollar can be compared with the waning of the British Pound a century ago as the most prominent currency for international trade. And in all likelihood, the Chinese yuan will increasingly play an important role in Asia. So that U.S. dollar would be less important as currency for transactions in Pacific Rim trade.
It would be interesting to observe the reaction of the U.S. It has so far opposed every effort to deveiate away from dollar as world reserve and trading currency. Now that world's top 2 economic superpowers are going their own way, what the U.S. is going to do about it? It is already beleaguered with its own debt and other economic problems, and it counts so much on the economic strengths of these two giants! The global economy is taking on its inevitable course, with new players dominating the arena.
