The ends of financial cycles are usually accompanied by several time-honoured traditions such as the implosion of fad investments, exposure of frauds, painful realisation that this time wasn’t different and – of course – predictions of the end of the US dollar.
The recent sanctions-driven weaponization of the dollar – following on from multiple massive bursts of quantitative easing since 2008 – has given fresh ammunition to those claiming that the end is nigh for the greenback’s time as the world’s reserve currency. Many have gone further and predicted that the renminbi will be its natural successor – adding China’s currency to a long list of contenders including the yen, euro, bitcoin (more recently) and the all-time favourite: gold. All have so far conspicuously failed to take King Dollar’s crown.
Why is this? First, dollar sceptics usually fail to understand the basic properties of money. It’s a unit of account, a store of value and a medium of exchange. Any viable successor needs to replicate these characteristics on a vast scale and make this work at an international level. This is hard to do and sceptics often lack the technical treasury experience to understand what it means in practice. Quite simply, only the dollar offers the liquidity and critical financial infrastructure to serve as truly global money.
If this wasn’t enough, then there is the vast pool of assets that US dollars can be recycled into, from US Treasury bonds and stock in some of the world’s most dynamic companies to property in Aspen or a Harvard education. No other bloc can offer such a deep pool of assets all secured by one of the world’s most robust legal systems.
The cost of being number one
This leadership comes at a cost, though. The US has to export vast amounts of dollars via ever-expanding deficits to lubricate the system. This effectively overvalues the currency and damages the US’s industrial competitiveness. It also leads to the US facing a conflict between achieving domestic monetary policy goals and meeting other countries’ demand for reserve currencies – what’s often referred to as the Triffin dilemma.
Dollar doomsayers often overlook key factors in their analyses, such as the nature of trade balances. The vast dollar reserve balances built up by China, Germany and Japan should be seen as a by-product of exporting their massive excesses of goods and services. None of these countries are forced to trade with the United States; they are free to invoice in whatever currencies they wish. But their huge surpluses can only be absorbed by the US economy, which runs in dollars.
Should these countries wish to reduce the amount of dollars they receive, a simple solution is to better balance their trade by reducing exports and boosting domestic demand. Of course, this would result in a sizeable reduction of their industrial capacity and large-scale restructuring of their economies. These are consequences they seem unsurprisingly unwilling to accept.
Then there is the problem of viable competitors. Once again: a country cannot run a current account surplus while operating as the world’s reserve currency. This is the biggest structural barrier that both the renminbi and the euro would have to overcome even before each confronts its own idiosyncratic challenges.
In the case of the euro, these are the lack of fiscal union and fragmented nature of its underlying economies, which creates inherent credit and political risk. For the renminbi, there are China’s capital controls as well as a more limited pool of assets and a legal system that is less familiar to many international market participants.
Problems with the dollar – or indeed any reserve currency – have been long known. Indeed, the famous economist J.M Keynes pointed out many of these issues to the American delegation at the Bretton Woods conference in 1944, when the dollar was crowned as the world’s official reserve currency.
Despite all the recent rhetoric, the high point of predictions about the dollar’s demise came in the 1970s, when President Nixon took the dollar off the gold standard as part of a series of economic measures dubbed the ‘Nixon shock’ in response to deteriorating domestic economic conditions.
Is it even worth it?
Rather than asking whether the dollar’s dominance will continue, perhaps a better question is whether the US even wants to own the world’s reserve currency? As Keynes observed, ‘dollar hegemony’ comes with its own set of problems too such as a need to export its currency and loss of competitiveness leading to the hollowing out of its industrial base and increased financialisaton of its economy.
The long-term desirability of maintaining the status quo of Wall Street over Main Street is debatable, and it is not clear whether the US will be willing to run gigantic deficits to its own detriment in perpetuity. The dollar’s long-term status may well rest on a future American administration that chooses to abandon its role in maintaining the world’s reserve currency for domestic political reasons. Indeed, we have already seen the early signs of this in the Trump administration’s imposition of tariffs, renegotiation of NAFTA and disregard for the WTO.
What then would replace it? Before Bretton Woods, Keynes had suggested an alternative in the form of a supranational currency called the Bancor – which ultimately watered-down into the IMF’s Special Drawing Rights. It’s possible that a modern version of Bancor, based around some sort of crypto-derived stablecoin, might offer a solution. That is, assuming various key countries wish to adopt it – a key issue in itself.
Until then, the dollar’s dominance may well decline, but this would be relative at most, and reports of its imminent demise are likely premature. Though the dollar may be flawed, to paraphrase Churchill, it’s the worst system we have, except for all the others.
China’s rise and the relative decline of the US may cause the financial system to become increasingly fragmented, but it’s highly unlikely the system will be replaced in its entirety. And, as the US works to rein in domestic inflation, the overriding concern could shift from having too many dollars in international trade to not having enough. Or, as a former US Treasury secretary put it, the dollar “is our currency, but it’s your problem”.