Is the World's Reserve Currency In Trouble? To what extent will the global role of the U.S. dollar have changed a decade from now?

 
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True, America's deep and highly liquid financial markets, investment-quality dollar-denominated assets, and the rule of law make the dollar the preferred global currency for commerce and trade. There is no obvious contender.

But the dollar and the U.S. banking system have become major tools of U.S. foreign policy at a time of deep and growing geopolitical rifts.

Increasing efforts by other economies and organizations to circumvent U.S. dollar domination include the new Chinese digital currency, Facebook's Libra, the decentralized Bitcoin, Europe's INSTEX system for avoiding secondary sanctions for trading with Iran, and even calls for a global digital currency from the Bank of England's Mark Carney and a digital euro from the association representing commercial banks in Germany.

The Chinese state-run digital currency, for example, is highly unlikely to replace the dollar, but could it have the effect over time of trimming back the dollar's use, particularly in the developing world economies? Moreover, the crime syndicate-based segment of the global financial system, which today is said to exceed in size most developing-world GDPs, is likely to become more than familiar with the growing world of digitized artificial currencies.

How will the dollar, and thus America's financial flexibility, be affected by this coming brave new world of digital payments technology, if at all?

TIE asked more than two dozen distinguished thinkers.

WILLIAM H. OVERHOLT

Senior Research Fellow, Harvard Kennedy School, author, China's Crisis of Success (2018), and co-author, Renminbi Rising: A New Global Monetary System Emerges (2016)

The U.S. dollar's hegemonic position has been sustained by open financial markets, deep liquidity, the reliability of the U.S. Federal Reserve and Treasury, and a workable global consensus that the dollar system provided vital public goods. Its greatest strength is the weaknesses of its competitors. The euro is not a deep pool of liquidity but rather a collection of puddles. The Chinese RMB market is fragmented into multiple bond markets with different regulators and no coherent yield curve. When Chinese financial markets were steadily opening, through about 2015, international use of the RMB rose at spectacular rates, but recently capital controls have tightened and those trends have slowed or reversed. Blockchain alternatives remain primitive and untested.

In the future, the euro market could become more integrated and the European Central Bank could well acquire a reputation for reliability comparable to that of the Fed. Chinese financial markets will probably become more integrated, and China could shift massively from bank-based finance to bond and equity finance, creating a very deep market. However, capital controls will persist until China's fraught domestic political environment and anti-corruption regime provide fewer incentives for capital flight.

While developments in the euro, RMB, and block-chain are gradual, the big change is in the international prestige of the dollar system. The Global Financial Crisis of 2008-2009 led some countries, most notably China and Russia, to advocate a system where they would be less vulnerable to dollar fluctuations.

Since the U.S. Congress imposed constraints on helping troubled countries after the Mexican crisis of 1994, and the United States failed to help Thailand and Indonesia in 1997-1998, the Fed and Treasury have lost some of their reputation for reliably providing crisis liquidity to friendly countries. Frequent use of sanctions to impose U.S. foreign policy on anyone who does dollar transactions has culminated with European allies scrambling to find a non-dollar way to transact with Iran after the U.S. abandoned a hard-won collective non-proliferation deal with Iran. There have been moments of mass use of the Hong Kong dollar as a proxy for the U.S. dollar that does not entail vulnerability to U.S. sanctions.

After Trump's full or partial abandonment of the Iran deal, the Paris climate deal, traditional support for democracy, traditional open internationalism, and traditional support of allies, the strong association of the dollar with benevolent U.S. policies and vital public goods has greatly weakened.

In political science jargon, the dollar-based system remains effective but has lost much of its legitimacy. Many countries will continue to chip away at their reliance on dollar reserves and dollar-based transactions to whatever degree attractive alternatives emerge. Those changes will be incremental and could experience reverses. That trend will contract the dollar system at the margin but maintain its dominance. If some drastic global financial development changes the relative attractiveness of U.S. openness and liquidity, much of the world will abandon the dollar system with alacrity.

MARK SOBEL

U.S. Chair, Official Monetary and Financial Institutions Forum, and former Deputy Assistant Secretary for International Monetary and Financial Policy, U.S. Treasury

The dollar was not ordained as the world's reserve and financial currency or declared so by fiat. It happened in response to organic factors--a large vibrant economy, deep liquid capital markets, and strong property rights.

These characteristics will not be replicated elsewhere in the coming decade. The U.S. economy will outperform advanced economies. The euro area and Japan are anemic, the former beset by weak banks, over-reliance on the ECB, and an imperfect union. Britain is racked by Brexit. Australian and Canadian markets are too small.

China is still more pretender than contender. Yes, China has a massive, growing economy and its amazing transformation continues. But it also has an increasingly authoritarian government, huge amounts of non-performing loans, excessive leverage, an inconvertible currency, capital controls, opacity, and capricious respect for property rights.

Global network effects reinforce the U.S. financial system's clout, and inertia further backs the status quo.

There is much talk about China leading on central bank digital currencies; Mark Carney speaks about synthetic hegemonic currencies; Facebook touts Libra. Expunging RMB cash from the Chinese retail system with a CBDC won't change China's financial realities. A synthetic hegemonic currency will prove as attractive as the Special Drawing Rights. Libra faces humongous hurdles getting off the ground.

America shouldn't be complacent--while the dollar's role may only ebb in the coming decade, tipping points can be reached.

U.S. abuse of financial sanctions looms as a potential future challenge to dollar dominance.

Financial sanctions can be a powerful tool. They should be used prudently. As evident in the George W. Bush and Obama administrations, financial sanctions, supported by our allies and/or multilateral institutions, can help achieve broadly shared global aims. That is the case with UN financial sanctions on North Korea. It was also true of Iran on the Joint Comprehensive Plan of Action. Such multilateralization is unlikely to have a detrimental impact on the dollar's global role.

In contrast, the current administration has overly used unilateral financial sanctions. When not backed by our European allies and/or internationally, unilateral sanctions may have a corrosive impact on the dollar's future. It is remarkable that our European allies, angered by U.S. actions over Iran, are now seeking--even if ineffectively--to develop alternative payments systems that bypass the dollar.

America benefits from the dollar's global role--seignorage, lower borrowing costs, and less exchange risk. But that role is not without downsides. The United States runs current account deficits with implications for jobs and growth at home.

Rather than fixating on whether the dollar's global role will change over the next decade, let's refocus on soundly and wisely running the U.S. economy and financial system and returning America to the path of multilateralism.

ALEJANDRO DIAZ DE LEON

Governor, Bank of Mexico

For decades, the U.S. dollar has been the prime currency in international trade and financial transactions, performing the functions of medium of exchange, store of value, and unit of account worldwide. Its dominant role has been underpinned by the U.S. role in the global economy in terms of trade and financial flows, the size of its economy, its rule of law, and its deep and liquid financial markets. In addition, network externalities imply that the more the U.S. dollar is used in financial and trade transactions, the more liquid it becomes and further enhances its benefits relative to other global currency alternatives.

The status of the U.S. dollar as the dominant global currency is a recurring theme in the international financial arena. Back in 1999, the emergence of the euro was expected to increase competition to the dollar in trade and financial transactions and as a reserve currency. Also, some believed that the 2008-2009 global financial crisis could curb the dollar's status. Contrary to those views, the dollar has consolidated its dominance in global financial markets. According to the Bank for International Settlements, the global foreign exchange market's daily turnover reached US$6.6 trillion in April 2019, with the U.S. dollar on one side of 88 percent of all trades. Moreover, according to the International Monetary Fund, between 2008 and mid-2019, the share of worldwide reserves that central banks held in dollars remained roughly constant, representing 62 percent of the total, while reserves in euros dropped seven percentage points and now account for 20 percent of global reserves.

More recently, the arrival and rising interest in digital currencies has once again drawn attention in regard to the dollar's long-lasting leading position. Digital currencies are perceived by some as an opportunity to limit the dollar's global dominance. Nonetheless, there are very clear differences among potential digital...

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