Tuesday begins a four-day state visit to America for China’s president, Hu Jintao. On the eve of his to Washington, Hu told the Wall Street Journal and Washington Post that the U.S. dollar is a “product of the past”. Hu predicts that the Chinese yuan will become the world’s new reserve currency. While Hu Jintao’s visit with Barack Obama and Hillary Clinton will focus on human rights, global warming and other mundane issues, the fate of the dollar hangs in the balance.

hu jintao barack obama
Presidents Obama and Jintao last met at the 2010 APEC Summit. Image Source: WhiteHouse.gov

Relations between the United States and China do seem to be getting more strained of late. While long term geo-political issues, such as North Korea and Taiwan always cause riffs between Washington and Beijing, the past two years have become a mudslinging contest between both countries financial ministers. Up until late last year, China artificially pegged their yuan at a very low exchange rate with the dollar, a move to keep China’s exports to America cheap.

Since the financial meltdown of 2008, the United States, and the rest of the world, has been busy printing, or digitally creating, money to add liquidity to their credit markets. The U.S. Federal Reserve has already launched a second wave of quantitative easing, known as QE2, mainly to purchase U.S. Treasury bonds and other America securities. Global interest in buying America’s debt has fallen off sharply since early 2010.

China owns close to a trillion dollars of U.S. debt, the largest single foreign holder of our securities. They have become more vocal about America’s budget and debt problems, and finally moved to float the yuan free of the dollar. China is worried about inflation caused by America monetizing our debt. In the past ten years, the dollar has lost about 40% of it’s value, and many suspect that the Fed’s quantitative easing could double or triple that very quickly.

The dollar has come under fire as the world’s reserve currency due to it’s declining value. All purchases of oil must be paid in U.S. dollars up until recently. Many countries, like Brazil, Russia and China are now moving away from the use of the dollar to settle international payments. Rumors of other nations following suit are abundant. Even officials of the World Bank and International Monetary Fund are considering a new global reserve currency.

The implications of the demise of the dollar are profound. Not only would dollars become less used around the world, which would help fuel domestic inflation as more dollars come ‘home’, but many predict that the dollar may even lose popularity inside American borders. Imagine going to stores or to the gas station which refuse to accept dollars. Sound ludicrous? It’s already beginning to happen. Over 150 communities now offer alternative currencies locally and more businesses are favoring customers who pay in yuans or Euros.

So when Chinese President Hu Jintao says that the dollar is a “product of the past”, he’s not whistling ‘Dixie’. He has fired a shot across the bow on the eve of his four-day state visit with Barack Obama and Hillary Clinton. Peripheral issues like human rights in Tibet or North Korea’s nuclear program might grab the headlines for the next few days from Washington. But the currency war between the dollar and the yuan will be where the money is made.

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