Is the Dollar In Trouble? If the dollar continues to deteriorate, and as east Asian countries peg their currencies to the Chinese currency to maintain exchange rate stability, the greenback could lose its key currency status by the end of the 2020s, just as it did in Europe in the 1970s.

• Author: Schnabl, Gunther

In the wake of the coronavirus crisis, U.S. President Joe Biden aims to accelerate the economic recovery with another fiscal stimulus package. Given the package's large dimensions and the expectation that the U.S. Federal Reserve will continue to purchase large amounts of government bonds, "Bidenomics" are reminiscent of Japan's "Abenomics," which have been pursued since 2013. A main difference between the United States and Japan is, however, the international role of the currencies: whereas the dollar remains the leading international currency (including East Asia), the yen has in the past failed to take over this role in the region.

Now China may make an attempt to challenge the international role of the dollar in East Asia. The time may have come, as the large purchases of U.S. government bonds have inflated the balance sheet of the Federal Reserve, thereby eroding the trust in the dollar. At the same time, the Chinese economy is up and running again. Neither Chinese government debt nor the balance sheet of the People's Bank of China has grown to the same extent as in the United States. The Chinese government has signaled with the Regional Comprehensive Economic Partnership its economic leadership in East Asia.

History provides a blueprint of how de-dollarization in East Asia in favor of the Chinese renminbi could work. Beginning with the Bretton Woods system in 1944, the dollar became the foundation of the postwar monetary and economic order. The central banks at the periphery of the Bretton Woods system had to stabilize their exchange rates against the dollar as the anchor currency. This also brought the dollar into position as the international reserve currency. When the United States financed the Vietnam War with the help of the Fed, the dollar came under depreciation pressure and the peripheral central banks had to buy large amounts of dollars to keep their exchange rates stable.

As the periphery countries de facto co-financed U.S. government spending, then-French Finance Minister Valery Giscard d'Estaing complained about this "exorbitant privilege." Stanford University Professor Ronald McKinnon later dubbed this phenomenon a "quasi unlimited line of credit" within an "unloved dollar standard." In the early 1970s, the resulting fast accumulation of dollar reserves in the balance sheets of the central banks at the periphery of the Bretton Woods system came along with strong monetary expansions. The German central bank, which was...