It is true: the U.S. dollar rules the financial universe. Even though the dollar's hold on the world’s financial markets and instruments has been getting weaker over the past few years, no other currency comes close. The Chinese renminbi isn't a good alternative – until China opens its financial markets and accepts the rule of law, no investor will really trust its currency.
Those baffled by the U.S. dollar’s rule of the financial
universe should listen to “It’s all about the Benjamins”, an ode to the 100-dollar
bill by Puff Daddy, an American rapper. Broadly, if there is one benefit that
can be attributed to hegemons, it is the stability that they bring to the
systems that they rule. The United States dollar has dominated the world's
financial and monetary system for the past seven decades. In spite of all the rhetoric
about the Chinese yuan's ascent, the dominance of the dollar remains
unshakeable. Nothing can compete with it in terms of being a method of payment,
a store of value, or a reserve asset. But, the dominance of the dollar is built
on shaky ground, and the system that it supports is inherently unstable. Even
worse, the alternative reserve currencies suffer from a number of fundamental
flaws. The shift to a more stable system will be so difficult that it could be
compared to setting a wet log ablaze with a lighter.
For several decades, the economic might of
the United States legitimized the claims of the dollar to be the world's reserve
currency. Yet, according to published evidence, there is now a schism between
the economic clout and the financial strength that the United States possesses.
The United States is responsible for around 15.47% of the world's GDP and 8.11%
of the entire export commerce in the world in 2021 and in 2020 respectively.
Nevertheless around 70% of the world's output as well as a comparable
portion of the world's population lies within a de facto dollar zone. This is a
zone in which the local currency is tied to the dollar or moves in some synchrony
with the dollar. Since 1999, when it was 39%, the percentage of American
companies in the stock of worldwide corporate investment has decreased to
around 24% of what it is today. Yet, Wall Street now more than ever determines
the pace at which markets around the world move. The percentage of the world's
assets that are managed by American fund managers has increased to
approximately 55% from 44% a decade ago.
The expanding difference in economic and financial power between the United States and other countries, both within and outside of the dollar zone, presents issues for those other countries. The reason for that is simple: the expenses associated with the supremacy of the dollar are beginning to outweigh its benefits. First, economies have to be resilient enough to weather wild gyrations. Throughout the past few months, the interest rate increase in the United States has driven money away from emerging countries, causing currency and share prices to suffer. The decisions made by the Federal Reserve have an impact on offshore dollar debts and deposits totaling at least $9 trillion. Because certain nations peg their currencies to the dollar, the central banks of those countries are required to respond to actions taken by the Federal Reserve. In countries such as Indonesia, Malaysia, Mexico, South Africa, and Turkey, foreign investors own between 20 and 50 percent of the local currency's issuance of government bonds. When interest rates in the United States rise, these investors are more inclined to exit developing economies.
At one point in the past, the Fed would have been able to offset the negative effects of capital outflows by pointing to the increased demand for goods and services, which would have included an increase in imports. Nonetheless, during the course of the last ten years, the United States saw its proportion of global merchandise imports fall from 16% to 13%. The number of countries for which the United States is the largest export market has decreased from 44 in 1994 to only 32 in 2015; in comparison, the number of countries for which China is the largest export market has increased from two to 43. Unstable is a system in which the Fed continues to print money as the rest of the world trembles.
A second issue is that there is no safety net in place in the event that the offshore dollar system experiences a crisis. During the financial crisis of 2008–2009, the Federal Reserve reluctantly intervened, playing the role of a lender of last resort by providing international banks and central banks with a total of one trillion dollars in liquidity. If there were to be another crisis, it would involve far larger quantities of money. Since 2007, the global dollar market in offshore locations has more than doubled in size. By the 2020s, its size rivaled that of the banking business in the United States. After 2008-2009, Congress has developed a healthy amount of skepticism regarding the Fed's emergency loans. In the event of the next crisis, the Federal Reserve's intentions to issue massive swap lines may run into opposition from regulatory agencies or members of Congress. How much longer are countries going to be willing to have their financial systems tied to the turbulent and ineffective politics of the United States?
This subject is brought to the forefront by a third cause for concern, which is the growing tendency of the United States to utilize its economic might as a political instrument. The dollar payment system is being used by policymakers and prosecutors to exert control not only over rogue bankers and corrupt football officials, but also over rogue countries such as Russia and Iran. This weakness in American foreign policy causes other states to clench their teeth.
People in America might wonder why this is important to them. They didn't make any country tie its currency to the dollar, and they didn't try to get foreign companies to issue dollar debt. But Americans are affected by the dollar's huge role. It has benefits, like making loans cheaper. But there are costs as well as the "exorbitant privilege" of having the reserve currency. If the Fed doesn't step in as the "lender of last resort" during a dollar liquidity crisis, the collapse of economies around the world will hurt the U.S. economy. Even if there isn't a crisis, the dominance of the dollar will put American leaders in a tough spot. Foreigners will control the Treasury market by the 2030s if they keep building up their reserves. To meet the growing demand from other countries for safe assets denominated in dollars, the U.S. government could issue more Treasuries, which would add to its debts. Or, it could let foreigners buy up other securities, which could lead to asset bubbles like what happened during the 2000s mortgage boom.
A Matter of History
A natural question to ask at this point is clear: how do currencies achieve reserve status? There is no formal way to become a reserve currency. Instead, it's like winning a popularity contest. The de facto reserve currency is the currency that is used most often for international trade and business. The "popularity" of a currency is just based on how safe and strong people think the country issuing the currency is. This is the asset or currency that most central banks around the world prefer to keep in reserve. This is why the dominant asset is called a "reserve currency."
There have been six major reserve currency periods since 1450. Portugal had the most money in the world until 1530, when Spain got stronger. During most of the 17th and 18th centuries, trade around the world was done with money from the Netherlands and France. But when the British empire grew, the Pound Sterling became the reserve currency and stayed that way until the end of World War I. The pound was replaced by the U.S. dollar at the same time that the U.S. became more economically powerful than Britain. Since 2008, more than 75% of all transactions around the world have been done in U.S. dollars. The dollar is also used to pay for more than 60% of foreign debt and 59% of central bank reserves around the world.
Even though the dollar's hold on all of these markets and instruments has been getting weaker over the past few years, no other currency comes close. The Chinese renminbi isn't a good alternative, but geopolitical and macroeconomic trends make it likely that it will become one of the popular currencies soon.
Playing to Win
In a perfect world, America would not be the only reserve currency. But if the dollar's position as the world's most important currency is unstable, other currencies can't take over either. As I said above, the role of financial superpower has changed hands before, when the U.S. took over from Britain from 1920 to 1945. But Britain and the United States were friends, so the transfer went smoothly. And America already had things going for it, like a strong economy and, like Britain, a stable government and the rule of law.
Compare that to the people who are trying to become reserves today. The euro is a currency that can't be taken for granted, even in its existence. These questions won't be completely answered until the euro area agrees to a full banking union and joint bond issuance. As for the yuan, China's government has set up a huge network of currency swaps with foreign central banks, which is like an eight-lane highway, but no one is on it (except, perhaps, Russia). The yuan won't be a big deal until China opens its financial markets. And until it accepts the rule of law, no investor will really trust its currency.
All of this shows that the world's monetary and financial system won't be able to stop using the dollar easily or quickly. America can take on more responsibility by, for example, setting up bigger emergency swap lines with more central banks. More likely is that the system will break up, as other countries adopt capital controls to protect themselves from Fed decisions. The dollar is unique. But the system it is part of is falling apart.
References
Chandler, M. (2023, March
31). The Dollar Rules the Financial Universe. China Can’t Change That. Retrieved
from Barron's:
https://www.barrons.com/articles/dollar-china-petro-yuan-saudi-b0b6e48f
Genius. (2023). It’s All
About the Benjamins (Remix). Retrieved from
https://genius.com/Diddy-its-all-about-the-benjamins-remix-lyrics
O'Neill, A. (2023, February
15). United States' Share of Global Gross Domestic Product (GDP) Adjusted
for Purchasing Power Parity (PPP) From 2017 to 2027. Retrieved from
Statista: https://www.statista.com/statistics/270267/united-states-share-of-global-gross-domestic-product-gdp/
Raisinghani, V. (2023,
February 23). Could China’s Yuan Replace the US Dollar as the World's
Dominant Currency? How the Asian Nation's Trade Supremacy is Quickly Boosting
its Reserve Status. Retrieved from Yahoo! Finance: https://finance.yahoo.com/news/could-china-yuan-replace-u-163600681.html?fr=sycsrp_catchall
The Economist. (2015,
October 3). Dominant and Dangerous. Retrieved from
https://www.economist.com/leaders/2015/10/03/dominant-and-dangerous
The Economist. (2020, August
6). Dollar Dominance is as Secure as American Global Leadership.
Retrieved from https://www.economist.com/finance-and-economics/2020/08/06/dollar-dominance-is-as-secure-as-american-global-leadership
No comments:
Post a Comment