Way before the US dollar was around, the eight-reale (also known as the Spanish dollar), became the world’s first international currency.
The silver coin gained global popularity in the 16th century after the Spanish conquistadors found that Potosi and Mexico held a huge amount of silver.
But they needed a buyer for all that silver, and that became China.
China was quite eager to get their hands on silver back then.
You see, around the same time, China had also changed their tax system. The single-whip tax reform required the Chinese population to change the way they paid taxes from things like rice to silver.
But there wasn’t enough silver to go around, which pushed silver prices up.
So, they started importing it from Spain.
It worked well for both countries.
China got enough silver for its taxes.
On the other hand, for Spain it was cheap to mine silver in the colonies and could then sell it for a higher price to China. Spain could use that money to finance their ambitious expansion plans.
The Spanish galleons would leave the Americas full of silver and travel through the Pacific to Manila, in the Philippines, which was at the time a Spanish colony.
They would exchange their silver there for things like silk and ceramics with Chinese traders.
And soon enough trade between the East and the West flourished, with China — and silver — at the centre of it.
As you can see, during that time China increased its share of global GDP:
Source: Visual Capitalist
Eventually, with so much silver around, the metal’s price decreased. But China remained at the centre of global trade until the after the 1800s, as you can see in the chart above. The world craved their arts, silk, and later on, their tea.
China was the large exporter to the world, but, if you wanted to trade with them, they had a few norms.
The British East India company, who was looking to increase trade with China, complained about unfair trade conditions.
Anyway, long story short, this friction led up to a war —or two — and eventually to China’s decline.
This is the simplified version, but what’s that they say, that history often rhymes?
500 years on and there are a lot of similarities.
What happens when this trade connection breaks?
The US dollar and China have both become crucial to global trade.
China is once again the world’s manufacturer and a huge exporter. The US buys from them in US dollars. The People’s Bank of China then buys excess supply of US dollars from exporters and gives them yuans to pay for their expenses.
Then with those dollars China buys US treasuries. As of December 2019, China owned about US$1 trillion in US national debt.
Anyway, this increases the demand for the US dollar and keeps its value which the US uses to finance their deficit.
This also gives China a huge market for their stuff, it keeps their exports cheap, and keeps jobs in China.
But the system started to crack recently.
There were trade wars, concerns on security, and China’s advances in technology.
And then the pandemic expedited this trend.
With the world in lockdown countries are exporting less. It’s brought into light the need of bringing at least some of the supply chains back home, and diversifying.
It means that China’s source of US dollars is drying up.
There are already some indications of this.
In an article this week, Bloomberg says:
‘The increasing spillover of Sino-American tensions into the financial sphere has ignited a fresh push by China to promote the global use of the yuan. A growing number of government officials and influential market watchers have in recent weeks urged greater efforts on the endeavor, which gained renewed significance after China’s new Hong Kong security law triggered the threat of retaliation from Washington.
‘While such drastic action is far from being implemented by the U.S. — and could potentially do major damage to American interests and the entire global financial system — the risks alone have raised alarm bells. With almost a trillion dollars in offshore bonds and loans and $1.1 trillion in state-owned bank liabilities, access to the greenback is vital for Chinese companies and lenders.’
What will happen when this trade connection our world is built on breaks?
The coronavirus has brought even more geopolitical instability, and, as Jim has been saying, what happens next is what’s important. Jim has some ideas on how to prepare and protect yourself…and a prediction.
To read more on this, go here.
For The Daily Reckoning Australia