This is a question that flares up every so often—at least once a year, it seems. It revolves around whether the dollar may lose its role as the preferred go-to medium for global payments and beneficiary of asset flows under times of global financial stress. In short, according to opinions of a variety of economists and political strategists, the dollar may lose its prominence gradually perhaps (as all dominant currencies have in history), but not likely any time soon. This is due to a variety of unique American strengths, not to mention the lack of a clear up-and-coming alternative.
Recent worries stemmed from Brazilian president Lula da Silva’s lamenting the dollar’s outsized role in settling global commerce, shared publicly during a trip to China, which raised a new round of discussion on the topic. Interestingly, his comments were quite similar to those shared by French president de Gaulle in the 1960’s venting the same frustrations. While a few other currencies have gained ground since that time, the dollar remains the standard. Of course, such negative comments about the dollar have the tendency of being self-serving, especially if the observer’s own currency value is at a weak point, or if a nation is attempting to improve trade relations with another.
It might help to provide a reminder about what gives a currency worth. Traditionally, there have been three key factors: (1) medium of exchange, (2) unit of account, and (3) store of value. These represent practical considerations, such as the ability to use the currency in day-to-day transactions, and acceptance from a maximum number of trading partners. For instance, metal coins would be more convenient to use in settling transactions than would barrels of oil or tons of copper; paper notes are even more practical than coins (and weigh less). With most commercial transactions now being electronic, these physical characteristics are even less of a constraint. By unit of account, being divisible into pieces is important, which accommodates modern accounting. (There are practical considerations here, too, such as in the historical cases of currencies depreciating so rapidly that small denominations become no longer relevant, such as during hyperinflation in 1920’s Germany, and Zimbabwe in recent decades.) Store of value is a more intangible concept that gets to concepts such as trust in institutions, political and economic stability, military might, natural resource assets, and other economic capital backing the issuer. In the very short term, currencies are valued relative to each other based on relative outlooks for each issuer’s levels of inflation, interest rates (related to inflation), and economic growth prospects. With relative stability on key fronts, especially when compared to the costs/benefits of other competing foreign currencies. the U.S. dollar has continued to look attractive as a global reserve.
Removing the political discussion on the topic, this status is borne out in the data. In fact, as of 2022, per research from JPMorgan and the Bank of International Settlements, nearly 90% of all FX transactions have involved the dollar as one of the pairs, with turnover of nearly $7 tril. per day. In addition, the dollar accounts for 85% of activity on currency forward and swap markets, 80% of trade finance, and represents 60% of foreign currency reserves held worldwide (China’s ownership of U.S. dollar reserves are a similar 60% as well). For direct trade reasons, emerging market nations tend to hold larger reserves of countries from whom they import military equipment (also largely the U.S.). Several nations, including Hong Kong and Saudi Arabia, continue to peg their currency’s value to the dollar, requiring ample dollar reserves for such pegs to be sustainable via constant FX market tweaking.
The U.S. is trusted not only for its physical assets and geopolitical power projection, but even more fundamentally by its ‘rule of law’ and democratic institutions (despite the political bickering, which has always been a byproduct of democracy). There are few competitors on this front. The next closest contender at this point appears to be the euro, which ranks roughly number two on the list of global payment mediums. While currently trusted as a ‘law and order’ region, there do remain concerns over the long-term longevity of the eurozone, as the track record for multi-nation currency unions has not been great historically (they’ve all eventually failed). Also, occasional budgetary arguments pit member states against each other—at several times threatening to break the union apart in recent years. Every time this occurs, it appears to set the euro back a bit in terms of global trust. World War I, ‘the war to end all wars,’ was followed by World War II just 20 years later, so the precedent for competition and conflict isn’t unprecedented. In fact, the geographic isolation of the U.S. provides another subtle benefit geopolitically. The Chinese have taken a greater share in global transactions in recent decades and would prefer to see the yuan take on a larger role on the world stage. The reality at this time is that many trading partners don’t see it as a complete alternative, due to the lack of transparency into the nation’s economic and exchange rate operations. On the other hand, being heavily exposed to the U.S. dollar can expose a nation to the powerful negative financial impact of sanctions, should those ever be imposed. That concern is generally relegated to a certain sub-set of actors, such Russia, as well as Iran, Libya, and Venezuela, but nations seeking ‘sanction diversification’ have chosen to find alternative channels to the dollar to avoid being frozen out of world financial payment systems through a secondary safety valve, of sorts. China has offered to fill this this role recently, especially as it fits their interests in securing vital natural resources.
There are other currencies that often take on the role of ‘safe haven,’ especially during times of global stress. These include the Japanese yen, U.K. pound, Swiss franc, and Swedish krona. While these countries are valued for their consistent policies, several are far smaller, which restricts the ability to absorb large levels of trading liquidity. Gold is often considered a ‘currency’ of sorts, as it’s had that function for thousands of years, with some countries finding gold more desirable culturally than others (notably in South and East Asia). While gold is more cumbersome to trade (even small coins are expensive), it’s been seen more as a ‘store of value’ than ‘medium of exchange’ for routine transactions. Gold has tended to become more popular in heavily-sanctioned nations, such as Iran, and other countries where a local currency has sharply depreciated or is extremely volatile in exchange rate value.
Some of these complaints about the dollar are also related to its strength in recent years, although ‘strength’ is relative when dealing with currencies (quotes are always in pairs). The dollar rose in value by roughly 30% over the last decade, to a point where, at least in prior cycles, it reversed and began to normalize lower. The same pattern happened in the early 1980s and late 1990s. (That dollar strength was during times of rising U.S. interest rates was not a coincidence.) A stronger dollar benefits U.S. importers, by making foreign goods cheaper, and also makes tourism abroad more attractive. It also lowers imported inflation (like for petroleum), which has been a welcome offset to high domestic inflation generally. A weaker dollar, by contrast, raises imported inflation, but also acts as a tailwind to exporters, as goods become automatically cheaper for foreign purchasers. Foreign investments also become more attractive, as they’re priced in rising values for foreign currencies. Hence, both sides of the currency trade are a mixed bag.
In short, there seems to be agreement that the U.S. dollar’s status as global reserve currency is not under immediate threat at the moment, but there could be a push to broaden the trade basket to include other currencies to dilute this dominance. There is certainty motivation on the part of global politicians to throw stones at the dollar for their own aims, in attempts to raise interest in alternative transaction mediums (such as proposed currency union between Brazil and Argentina, the ‘sur’). Of course, in times of extreme stress, the knee-jerk market reaction over the past several decades has been consistent. It’s been a rush into U.S. dollars, and dollar-denominated debt, such as treasury bills and notes. Ironically, this flight to the dollar even occurred during 2011’s debt limit crisis when the U.S. was on the brink of default—an episode we hope to avoid a repeat of in 2023.
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