(ATF) Confidence in the dollar is crumbling, but doomsters are wrong to view its fall to a two-year low as presaging its swift demise as the world’s premier reserve currency. For all the pressure on the greenback, there is no credible pretender to its crown.
When a bank as illustrious as Goldman Sachs expresses “real concerns around the longevity of the US dollar as a reserve currency”, the foreign exchange market’s concerns deserve close examination.
Chief among these is frantic money-printing by the Federal Reserve, which has bloated its balance sheet by nearly $3 trillion this year as a result of asset purchases to cushion the economic damage of the Covid-19 pandemic.
“In an international monetary system dominated by the US dollar, the unprecedented, unlimited quantitative easing policy of the US actually consumes the creditworthiness of the dollar and erodes the foundation of global financial stability,” Guo Shuqing, chairman of the China Banking Regulatory Commission, wrote in the Communist Party’s Qiushi magazine.
But Guo’s criticism begs the question what state the international economy and financial markets would be in if the Fed had not flooded the banking system with dollars, established swap lines with central banks worldwide and set up a repo facility so they could turn their Treasury securities into urgently needed cash.
Seen in this light, the Fed was reinforcing, not eroding, global financial stability – and in doing so was discharging the responsibility that comes with the “exorbitant privilege” of issuing the main reserve currency.
Indeed, the US is the only country that is safely able to borrow heavily enough to supply the huge volumes of safe assets – principally dollar cash and government debt – that the world demands in times of crisis. The European Union is just taking the first steps towards commonly issued euro-denominated debt, while China is hamstrung by a host of factors, not least a currency that is not freely convertible.
“China doesn’t want to be the leader. China doesn’t want the responsibility, and most of all it doesn’t have the financial and monetary means to… provide the global public goods that the United States has been providing since the end of the Second World War,” said Paola Subacchi, professor of international economics at Queen Mary University of London and author of a new book “The Cost of Free Money”.
A second, more serious seam of concern about the dollar’s resilience is Donald Trump’s America First nationalism. Not only has the president nonchalantly undermined the international institutions that have amplified US power for the past 70 years, he has dismayed friends and foes alike by weaponising finance, trade and investment in his prosecution of a new cold war against China – epitomised by the tightening of sanctions against Huawei that could spell the end for the telecoms equipment maker.
Trump is calculating that a tough line against China will help him win re-election on November 3. As he is trailing in the polls, the risk is that he could further ratchet up tensions by in effect blocking Chinese banks and firms – and anyone who does business with them – from dealing in dollars.
Because such a step would wreck global markets, the economy and the reputation of the dollar, many regard it in the same way as they do nuclear weapons – a useful deterrent but one that could never be used.
Perhaps. But who would have thought that Trump would go so far as to condemn one of China’s leading companies to the scaffold?
Against this background, it’s no surprise that senior officials in Beijing have been demanding contingency plans for a financial decoupling from the dollar by making more use of the yuan in cross-border trade and banking.
This process is painfully slow, as the People’s Bank of China’s latest report on renminbi internationalisation makes clear. The yuan makes up little more than 2% of global foreign exchange reserves, for instance. Still, there are signs of progress. In the first quarter of 2020, the dollar’s share of trade between Russia and China fell below 50% for the first time on record.
“Confidence in the US dollar as the ultimate means of payment in all critical situations is not dependent on the US,” said Martin Wolf, chief economics commentator with the Financial Times. ”It is dependent on the confidence of everybody else in the US and their trust that this is the ultimate international means of payment,” Wolf told a recent webinar hosted by Subacchi.
Europe and China
If the US continues to wield the dollar as a diplomatic weapon, both Europe and China are big enough to be able ultimately to develop their own, alternative reserve assets. Wolf said: “I think there will simply be a natural evolution.”
Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley, agreed that there was a need to move away from the dollar-centric international monetary system.
But he ruled out a significant global role for the renminbi, arguing that every true international and reserve currency in history has been issued by a democracy or a republic, with checks and balances that instil confidence that the ‘rules of the game’ will not be changed.
“The problem with the dollar at the moment is that the rules are being arbitrarily changed, but people will have even less confidence that the Chinese political system will be able credibly to commit not to change the rules,” Eichengreen said.
Despite Trump’s bulldozing and the relative decline of the US share of global output, the dollar certainly retains formidable advantages. These include America’s deep, liquid financial markets and the comfort afforded by its military strength and diplomatic alliances.
Reflecting on the dollar’s role as a reserve currency, Mohamed El-Erian, chief economic adviser at Allianz, said he was reminded of the principle that it is hard to replace something with nothing.
“At this time, there simply is no other currency that can or will fill the dollar’s shoes. Instead, we will continue to see small pipes being built around the dollar. And, because none of these will be large enough to replace it, the eventual result will be a more fragmented international monetary system,” El-Erian concluded.
Just how much more fragmented should become clear after November’s election.