Doing without the dollar
Pessimism used to be for monetary cranks; now even Goldman Sachs warns the dollar will go the way of the pound
by David P. Goldman April 13, 2022
NEW YORK – The staggering sum of US$18 trillion – nearly equal to a year’s gross domestic product (GDP) – is the amount that the United States has taken in from foreigners since the Great Financial Crisis of 2008.
The notion that the dollar’s dominance in world finance might come to an end was a fringe view only five years ago when America’s net foreign investment position was a mere negative $8 trillion. Now one reads forecasts of the end of the dollar era in research reports by Goldman Sachs and Credit Suisse.
Washington’s seizure of Russian foreign exchange reserves seems like a self-defeating measure given America’s enormous and accelerating dependence on foreign borrowing. Paradoxically, America’s strength lies in its weakness: A sudden end to the dollar’s leading role in world finance would have devastating consequences for the US economy, as well as the economies of its trading partners.
In addition to the $18 trillion of net foreign investment in the US, foreigners keep about US $16 trillion in overseas bank deposits to finance international transactions. That’s $34 trillion of foreign financing against a US GDP of not quite $23 trillion. Foreigners also have enormous exposure to the US stock and real estate markets.
No one – least of all China with its $3 trillion in reserves– wants a run against the dollar and dollar assets. But the world’s central banks are reducing dollar exposure, cautiously but steadily.
The trickle of diversification out of dollars could turn into a flood. What the International Monetary Fund on March 22 called “the stealth erosion of dollar dominance” prefigures a not-so-stealthy exit from the dollar. Unlike Nebuchadnezzars’ handwriting on the wall, the king’s soothsayers can read the message as plain as day.
One used to read about the demise of the dollar in the newsletters of coin dealers and monetary cranks. But now the most conventional of all commentators, the research department of Goldman Sachs, warns that the dollar will go the way of the British pound. Economists Cristina Tessari and Zach Pandl wrote on March 30:
The Dollar today faces many of the same challenges as the British Pound in the early 20th century: a small share of global trade volumes relative to the currency’s dominance in international payments, a deteriorating net foreign asset position and potentially adverse geopolitical developments.
At the same time, there are important differences – especially less-severe domestic economic conditions in the US today than in the UK in the aftermath of WWII. If foreign investors were to become more reluctant to hold US liabilities – [for example] because of structural changes in world commodity trade – the result could be dollar depreciation and/or higher real interest rates in order to prevent or slow dollar depreciation.
Alternatively, US policymakers could take other steps to stabilize net foreign liabilities, including tightening fiscal policy.
The bottom line is that whether the dollar retains its dominant reserve currency status depends, first and foremost, on the United States’ own policies. Policies that allow unsustainable current account deficits to persist, lead to the accumulation of large external debts and/or result in high US inflation could contribute to substitution into other reserve currencies.
Credit Suisse analyst Zoltan Posznar wrote on March 7:
We are witnessing the birth of Bretton Woods III – a new world (monetary) order centered around commodity-based currencies in the East that will likely weaken the Eurodollar system and also contribute to inflationary forces in the West.
A crisis is unfolding. A crisis of commodities. Commodities are collateral, and collateral is money, and this crisis is about the rising allure of outside money over inside money. Bretton Woods II was built on inside money, and its foundations crumbled a week ago when the G7 seized Russia’s FX reserve.
What should investors do in this environment? One recalls the old Brezhnev era joke about the recommended procedure in case of nuclear war: “Put on a white sheet and walk to the nearest cemetery – slowly, so as not to cause panic.” The smart money is walking towards the exit, so as not to cause panic. At some point, the walk may turn into a run.