Ours is an era of dollar domination.
If there can be said to be a world currency, the US dollar is undoubtedly it.
The vast majority of international trade is done in dollars. And it’s the
currency of choice of central banks hoping to save up for tough times.
So, in this video we’ll explain the dollar’s rise to power…
People use the dollar because they've always used the dollar.
We’ll find out what keeps it at the top of the money tree…
Where would you rather be and be invested right now? When you look
at the world as a whole? And I think for many people, the answer is the US.
And reveal whether the dollar’s supremacy can ever be challenged. If so, by what?
Some changes are coming. Even for a dominant currency such as a dollar,
it could become a less important payment currency in international transactions,
thanks to the rise of other currencies.
Are the dollar’s days as the king of currencies numbered? Or has it achieved an unassailable edge?
Find out on this edition of Business Beyond.
1944. A war that has brought misery to millions is entering its endgame. Meanwhile the dollar is
being set on a course for world domination. Meeting at Bretton Woods in New Hampshire,
representatives of 44 countries agreed to a new world monetary order,
with the US currency at the centre of it.
The US emerged from World War Two as the world's dominant leading economy.
And the Bretton Wood system that was created after World War Two had embedded within it a
particular role for the dollar. The dollar had a link to gold, but other currencies were all linked
to the dollar. So the post war monetary system embedded within it the centrality of the dollar.
In the 70s, US President Richard Nixon ditched the dollar’s convertibility to gold. But by
then it had already been firmly installed as the central currency for global trade.
Because of the United States size, the dollar in a sense was a natural currency for most
international transactions. And there's the added advantage that because the dollar was
the central currency of the system, if two countries wanted to trade with each other,
the easiest currency to use was generally the dollar.
And so it continues to be. If entities in two different countries,
with two different currencies want to trade with one another, they’ll almost certainly
do so in dollars. The US currency is involved in 88 percent of international transactions.
What’s more, the dollar is the currency of choice for trading in all manner of
globally important commodities, like oil, coffee and gold. But as well as
sitting at the centre of global trade, the dollar dominates in another key field.
The dollar is the world's most important reserve currency. That is,
it is a currency in which foreign central banks hold their rainy day funds, so to speak
When it comes to having money set aside for hard times, to fund exports, service debt or balance
their own currency, central banks and treasuries more often than not put their faith in the dollar.
According to the International Monetary Fund, of all the foreign exchange reserves held by
countries around the world, over 60% of them are in dollars. No other currency comes even close.
The reality is that there aren't any serious rivals to the dollar as a reserve currency.
When a country wants to make its currency a reserve currency, it needs to issue a lot of
what they consider safe assets by the rest of the world and much of the rest of the world. And much
of the rest of the world - foreign investors, both private and official - seem to view US
government securities as a very good place to park their money during times of economic turmoil.
What does the dollar environment provide for investors? Deep and liquid capital,
private capital markets, a legal system that protects property rights and free flow
of capital. The US has also been more willing than other countries to be the lender of last
resort. So I think all these factors create this environment whereby - and I think this
is important to underline as well, we're not saying these factors are perfect, but on a
relative basis - they seem to be more favorable for the US dollar to be a global reserve currency.
We’ll talk about whether any other currency can ever rival the dollar in the world’s reserves
shortly. But first let’s look at what the existent dollar supremacy means for the United States.
There’s a term that often gets used when discussing this very subject, originally
coined in the 60s by French Finance Minister - and later, president - Valéry Giscard d’Estaign. He
described dollar dominance as “America’s exorbitant privilege.
He was making a specific point about the use of dollars by central banks in Europe,
but that core idea that the US benefits greatly from its currency’s power is still often cited.
The privilege is generally thought to be that the US, in particular the US government,
can borrow internationally at a slightly lower rate than would otherwise be the case. The
US can finance current accounts, mostly trade deficits, more readily and more easily and with
fewer risks than other economies. And certainly, there's an element of truth to that. Although
all the major advanced economies finance themselves in their own currency without
any real difficulty and often can finance themselves at lower rates than the US does.
So, the constant global demand brings advantages to the United States itself.
However, what some describe as America’s privilege can sometimes also be its burden.
One of the criticism is there is a lot of demand for the US dollar. What does this
do to the currency? It leads to appreciate and to be stronger than other currencies. And the
repercussions for the US economy is that it makes US exports less competitive. A stronger currency
will make US manufacturing, for instance, less competitive. And some associate the long-term
decline in US manufacturing sector, in part, to the role of the US dollar as a reserve currency.
It also creates a burden on the Fed. The Fed has to in certain cases act as
the dollar lender of last resort to the world and it did take up that role in
the global financial crisis during the Covid shock through those swap lines.
That's in some sense a burden but it's also in some sense a necessity because the offshore
dollar market is actually an important market for funding US companies. And so,
instability in the offshore dollar market would clearly reverberate back into the US.
That’s what it means for the US. But what are
the costs and benefits of global dollar supremacy for the rest of the world? Is
the lack of competition at the monetary top-table a positive or a negative?
Certainly, there's sort of a network efficiency that comes from having a dominant currency so
that two countries in Africa that want to trade with each other know that they can
settle that trade in dollars, and if they have dollars, they can conduct that trade
and they don't have to worry about negotiating a settlement currency for every transaction.
So, everyone using the dollar is - basically - convenient. Everyone knows where they stand,
and there’s no messy bartering over which of two parties has the most desirable currency to hold.
But the involvement of dollars in so much of world trade leaves economies
far away from the United States subject to the effects of decisions taken there.
US monetary policy, which is directed at domestic US conditions ends up having an outsized impact on
global financial conditions and that can at times contribute to financial economic difficulties
around the world. Everybody in the past year has faced pressure on their currency in part
because the US is a big economy and any shift in US monetary policy would have an impact globally,
but also in part because the dollar is used around the world and dollar interest rates have gone up
around the world. And so, the impact of dollar strength and Fed tightening gets magnified.
So that’s the double-edged sword of dollar dominance. But could it actually be any other way?
Let’s get down to that question of whether the
US currency’s supremacy could ever be challenged. And if so, by what?
So, let's go back to
the fundamentals. Why is the dollar the preferred or dominant global reserve currency? Deep liquid
capital markets, protection of property rights, capital flows that are free? How are they likely
to change in five to ten years? And where will these factors be more favorable than in the US?
Can we look at another country that is as willing as the US to be the lender of last
resort? So, when you look at the global foreign reserves dollars dominant, next is the euro.
So, when the Euro was created, it was believed that the Euro area could
end up with this currency becoming a serious competitor with the dollar as a reserve currency,
as a payment currency and so on. And it is true that the Euro economy stock put together had a
size that was roughly equivalent to that of the US, although that has shifted a bit over time.
Now, Euros on financial markets are quite large, but certainly not as large as those in the US.
We saw earlier that the Euro is number two when it comes to global foreign currency
reserves - albeit by some difference. So, what would have to happen for it to close the gap?
Well one key thing holding the Euro back comes down to the very essence of the Eurozone. It’s
a monetary union, made up of countries using the same currency… but with very different economies.
As we went through the Eurozone debt crisis and other problems in Europe,
it appears that foreign investors don't quite see, for instance, a Greek government bond the
same way they would a German bond, which has seen as a lot safer and more liquid.
So, if you take the size of Eurozone financial markets concentrated in
the core part of the Euro zone, it looks much smaller than the US.
Can the European Union move to a credible fiscal union in the next five to ten
years? And I think that could chip away a little bit from the US dollars role.
The dollar’s strength just recently has partly come as a result of the US economy
being resilient to current world events. That’s something that sets it apart from the Eurozone.
War on the EU’s doorstep and the economic hardship it’s wrought on
many European citizens has laid bare how vulnerable the Eurozone is to geopolitics.
Europe has been dealing with centrifugal fuse forces that threaten to pull the zone apart. So,
there is a fair degree of political instability within the Eurozone and that,
of course, waxes and wains. But if you think about foreign investors
trying to find a place to put their money for the long term, there might be some concerns
about Europe. The fragmentation that we've seen in Europe, despite the currency union, I think,
has kept the Euro from becoming a currency that could compete toe-to-toe with the US dollar.
So, it seems we’re not about to enter the Euro era just yet. But if not the Euro,
can any other fiat currency ever rise to compete with the dollar?
Could the world’s second biggest economy - behind
the US - provide the breeding ground for another truly global currency?
So, the Chinese renminbi, or yuan, is an interesting currency because it was only about
a decade ago that the Chinese government seemed willing to allow the renminbi to be more widely
used around the world and seemed to be desirous of making the renminbi an international currency.
And Beijing scored a big win in its efforts to establish the
Renminbi as a major reserve currency back in 2016.
The Yuan joined the ranks of the Dollar, the Japanese Yen,
the British pound and the Euro when the International Monetary Fund added it to
the basket of currencies that make up its Special Drawing Rights - or SDR. That’s
the IMF’s own reserve asset that countries can use to top up their foreign reserves.
But since then, the Chinese currency has lost momentum.
The renminbi has essentially flatlined. And that's because the Chinese economy, first of all,
was not doing so well and foreign investors were a little wary of putting their money in China's
financial markets. But more importantly, I think foreign investors don't have as much trust in the
renminbi because China does not boast of many of these institutional framework elements that
virtually every other reserve currency economy enjoys, such as the rule of law,
where even the government has to play by the rules of the game once they are determined.”
China has the additional limitation that China cannot put its international reserves in itself.
And so, until there's an offshore yuan market of enormous size,
China's reserves… their choices are more limited.
It’s possible to imagine a world where more countries
would want to hold their reserves in Yuan.
The US and the EU were able to hit Russia in the pocket after its
invasion of Ukraine by freezing Moscow’s access to its dollar and euro reserves.
The current system means the West has
an overwhelming stranglehold on the world’s money stores.
No doubt some smaller countries could consider whether or not they wanted to take the risk
associated with putting more of their reserves in yuan, whether as an alternative to the dollar or
as a hedge against the risk that your relationship with the United States might deteriorate.
But would that be enough to enable the Chinese currency to compete with the dollar?
I don't think the Renminbi has the potential to become a serious rival to the dollar, especially
as a reserve currency. Although as China becomes more important in the global economy,
the global trading system, and if China plays its cards right with certain reforms
to maintain the free flow of capital across its borders, I could see that it would be becoming
a more important payment currency, but still not one that really seriously threatens the dollar.
Okay, so that’s basically the euro and the yuan out. What about other
national currencies. How about the British pound, or the Japanese Yen?
Well despite having a couple of centuries of global domination itself,
the UK currency is showing no signs of returning to past glories. And the share
of global reserves denominated in Yen has actually declined in recent years.
Though the US dollar’s share has been falling a little,
it hasn’t been because of the behavior of other major currencies.
This entire decline in the dollar share has been taken up by the smaller reserve currencies such
as the Canadian dollar, the Australian dollar, and a smattering of other currencies. [...] So at
most I see some of the shares of these second and third year currencies rising marginally,
the dollar share perhaps dropping a little bit. But the gulf between the
dollar and all the other currencies is, if anything, widening right now.
But could stiff competition come from a total newcomer? 2023 kicked off with Brazil and
Argentina saying they were beginning work on a shared currency, with the aim of eventually
allowing other South American countries to join. It would be the world’s second largest currency
union after the euro - but probably therefore, even less likely to challenge dollar dominance.
So if traditional, fiat currencies are showing no sign of unseating the dollar,
could competition come from elsewhere, and outside of the control of central banks?
Cryptocurrencies provide speculators with a place to park their money, AND a means by which to buy
products across borders. Could they ever perform the same functions for economies around the world?
We certainly seem to be entering a new era of competition and money with privately
issued currencies such as cryptocurrencies potentially taking on some of the functions
of money. But the reality we've seen is that decentralized cryptocurrencies such as Bitcoin,
which are basically issued and managed by computer algorithm rather than buying distribution agency,
they seem to have very volatile value and they're not working very well as mediums of exchange.
A look at Bitcoin’s performance over just the past two years shows you that that’s
all too true. Its value against the dollar has fluctuated wildly.
There are so-called “stablecoins” that aim to provide a less risky investment.
But they do so by pegging themselves to other assets - like, for example… fiat currencies.
I think compared to most cryptocurrencies, the dollar actually has a ton of advantages,
well-regulated certainly by comparison to crypto markets, financial institutions
that can act as intermediaries, a deep and liquid market for interest varying securities,
a counterparty if you buy US. Treasuries, that is the most credible counterparty
in the global financial system. I actually have a little bit of
difficulty believing that cryptocurrencies are a realistic alternative, to be honest.
We'll probably spend many years debating the relevance of cryptocurrencies
as a reserve currency for the world. Let's see what happens in the next five to ten
years. Are central banks going to move towards digital currencies that are less
speculative in nature and more stable in value? Then the answer could change.
So, no obvious signs of cryptos challenging the dollar either. But just because no challenger
among the digital or traditional currencies seems likely to emerge,
that doesn’t mean we won’t see the dollar’s power diminish.
New technologies plus financial development in emerging markets,
it's making it easier to trade pairs of emerging market currencies without an intermediate currency
such as the dollar. So, the dollar’s role as a vehicle currency in international payments,
I think is likely to decline.
But what’s our overall verdict? Are the days of dollar dominance showing any signs of ending?
I think we could live in a world where it
doesn't remain such a dominant global currency and reserve currency. But I
do not see these factors as playing out to unseat it completely as a reserve currency.
I think it is hard to see the dollar ever just
becoming another small currency that's not a big part of the global system.
Some changes are coming. Even for a dominant currency such as a dollar [...] However,
my view is that the dollar is likely to retain its dominance for a long time to come.
That’s all from this edition of Business Beyond. If you’ve made it this far,
we reckon you’d enjoy THIS video too. We’ll see you there.