Usurping Dollar’s Dominance Over World Is a Near Impossible Task
- America’s deep capital markets, economy seen as unparalleled
- Yuan viewed as afterthought even with progress: PineBridge
Libby Cherry, and
21 March 2022, 5:55 am MYT Updated on 21 March 2022, 7:30 pm MYT
Dethroning the dollar is easier said than done.
That’s the conclusion of investors after Washington’s freeze of Russia’s dollar holdings created fresh impetus among central bankers to rethink the security of access to foreign-exchange reserves. The move fueled speculation that countries such as China could redouble efforts to unshackle itself from greenback-denominated financial systems and look for alternatives.
While Goldman Sachs Group Inc. and Credit Suisse Group AG have flagged threats to the dollar’s supremacy, finding a valid replacement is going to be extremely challenging, according to funds from Brandywine Global Investment Management to JPMorgan Asset Management. The size and strength of the world’s largest economy is unparalleled, Treasuries are still one of the safest ways to store money and the dollar remains a pre-eminent beneficiary of haven flows.
There are simply “no other options at this stage in the game” for currency alternatives to the greenback, said Mark Mobius, a four-decade markets veteran and founder of Mobius Capital Partners. “The dollar is still strong and will probably get stronger if tensions continue to escalate.”
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Memo 04.01.2022 10 minutes
Dethroning the Dollar￼
The yuan is a long way from becoming the world’s reserve currency.
For 50 years or more we have heard frequent forecasts of the dollar’s decline. Economists, political pundits, and newspaper commentators have drawn on bouts of inflation, geopolitical and military setbacks, or simply ebbs in public confidence to declare that the dollar will soon lose its status as the world’s reserve currency; that is, it will cease being the default denominator in world trade and the primary repository for the foreign reserves of the world’s central banks.
Yet through it all, the dollar has retained its status almost undisturbed. True, America during this time has lost relative economic and financial power as well as geopolitical stature. But the dollar persists as the globe’s reserve currency because no viable alternative has ever arisen, and despite recent enthusiasms about China’s yuan, that remains true. The dollar will continue as the world’s reserve currency for the foreseeable future.
The Ukraine crisis provides a recent sign of the dollar’s abiding status. The months prior to the invasion showed no special preference for the dollar over other currencies, but as soon as trouble started, the international community fled to its presumed safety as the world’s reserve. Against the euro, the dollar had fluctuated in a stable range for quite some time, but then rose 10 percent in a matter of days after the tanks rolled. The dollar’s value against the Japanese yen repeated this pattern. Relative to China’s yuan, the dollar had been in decline for the three months up to the Russian invasion, when a sudden movement toward the greenback allowed it to recoup all those losses in just days. These moves may fail as definitive proof of the dollar’s status, but they are certainly consistent with the way a reserve currency is sought in times of trouble.
The dollar has served as the world’s unchallenged reserve currency since the late 1940s, when this country’s economy dominated the world, accounting for no less than half of global gross domestic product (GDP). The United States possessed the most stable socio-political environment in the world and had overwhelming geopolitical and military prominence. The scale and ceaseless activity of its financial markets reinforced any preference for the dollar by allowing importers and exporters to trade the currency easily and at any time, and also by offering anyone who held dollars a wide array of investment options. Britain, it may be recalled, had currency control regulations until 1979, and France did not entirely liberalize its currency until 1989. What is more, America’s reputation for following the rule of law reassured dollar holders wherever they resided that they were safe from expropriation and would receive a fair hearing should any dispute arise.
Now the speculation about dollar dethroning revolves around the rise of China’s economy and the attendant prominence of its currency, the yuan or renminbi. The concern is certainly understandable. China’s economy and the breadth of its trade have risen at prodigious rates. China’s economy rivals America’s in size and scope, and its trade levels may have surpassed those of the United States. Beijing certainly has ambitions to make the yuan a global currency. Its so-called Belt and Road initiative has heightened China’s geopolitical profile and allowed Beijing to raise the yuan’s international stature by insisting that all nations involved in the initiative base their trade in yuan and not in dollars, at least in their negotiations with China. China has also insisted on a yuan base in several bilateral trade agreements with a wide range of countries, among them India, Saudi Arabia, the United Arab Emirates, Iran, South Korea, and Japan. Nor has Beijing hidden its intentions. Chinese representatives at the G-20 have repeatedly accused the United States of “abusing” the dollar’s reserve status and living off paper money with no real prosperity. An editorial in Xinhua, China’s official news service, mused that “it is perhaps a good time for the befuddled world to start building a de-Americanized world.”
Even if the yuan had all the necessary elements to support a reserve currency—which it currently lacks—it would take it a long time to unwind all the customs and practices that have grown up during the decades of dollar dominance. The Federal Reserve calculates, for instance, that the dollar is a part of some 85 percent of all the world’s currency exchanges. The next most significant is the euro at 35 percent, which includes euro-dollar transactions. For all Beijing’s pushing, the yuan at most constitutes 5 percent of these exchanges. About 80 percent of all trade contracts globally are denominated in dollars, whether an American is involved or not. The yuan barely exceeds 5 percent. According to the International Monetary Fund (IMF) some 60 percent of all central bank currency reserves are held in dollars, down from 70 percent at the turn of the century but still an overwhelming proportion. The next highest is the euro at 20 percent. China’s yuan amounts to a mere 2 percent.
China is not yet ready even to begin repainting this picture of dollar dominance. Its economy is certainly big enough, though its geopolitical and military profiles are largely regional and certainly do not compare with the global reach of the United States. The yuan’s real problems, however, are legal and financial. China, which pursues mercantilism and cronyism, can make no claim to operating a system under the impartial rule of law. Not only has the country violated patents and copyrights on every continent, but it has blatantly stolen technology and trade secrets from all its trading partners. It regularly alters rules with no recourse offered to either domestic or foreign interests, and Beijing threatens to expropriate assets from any who do not bow to its political demands. No one would want his or her international holdings subject to such behavior. Meanwhile, the yuan suffers from serious financial shortfalls. Trading in China’s markets is far from free; these markets cannot offer yuan holders the array of investments available in dollars and many other currencies; nor can they provide the easy trading into and out of the yuan that a reserve currency demands.
For all Beijing’s ambition, it may find itself disappointed should the yuan supplant the dollar. China has an export-oriented economy that runs a huge trade surplus and depends in part on a cheap yuan to make its goods attractively priced on global markets. A reserve currency demands a very different economy. Because so many must hold the reserve currency and the amounts must grow in tandem with world trade, the economy behind the reserve always imports more than it exports. The difference feeds this need for currency holdings. Markets bring this about because the demands from holders of the currency bid up its foreign exchange value above the level that would otherwise balance exports and imports. This fact has ensured that the United States has run a trade deficit just about every year since the dollar gained dominance. To replace the dollar with the yuan, China would have to give up on its export-led growth model. This reality was why Japan rejected reserve status for the yen when it was mooted in the 1980s. Making the change that Japan rejected may be a step too far for Beijing. It would certainly involve much painful dislocation.
The U.S. economy and the dollar may not be what they once were relative to other economies and currencies. The greenback nonetheless still stands as the world’s best option to fill the role of global reserve, and will for a considerable time to come. Those who point to inflation or this country’s relative economic and geopolitical decline may describe one reality, but they seem unwilling to recognize the lack of any alternative or the remaining relative strengths in the dollar’s favor.
Milton Ezrati is a contributing editor at The National Interest, an affiliate of the Center for the Study of Human Capital at the University at Buffalo (SUNY), and chief economist for Vested, the New York based communications firm. His latest book is Thirty Tomorrows: The Next Three Decades of Globalization, Demographics, and How We Will Live.