[Vantage Point] Is it the end for the mighty dollar?

Over the past few weeks there has been a flurry of headlines about the imminent demise of the US dollar as the world’s reserve currency. This is precipitated by the coordinated attacks of some countries to dethrone the dollar.

Several eulogies have been penned, epitaphs were chiseled on tombstones – all pointing to the death of the mighty dollar. Anti-dollar forces cite several factors: from China’s rapid rise to superpower status and the advancing multipolarity of the global system to America’s lethargic economic growth. They doomsayers also point to the habitual deficits of the US, monetary expansion, growing debt burden, trade wars, financial fragility, and imperial overreach, as well as challenges from disruptive technologies like the central bank digital currencies and crypto-assets.

The “revolt” is led by five leading economies – Brazil, Russia, India, China, and South Africa – collectively known as the BRICS. The first four countries were grouped as “BRIC” (or “the BRICs”) in 2001 by Goldman Sachs economist Jim O’Neill, who coined the term to describe fast-growing economies that could possibly dominate the global economy by 2050. In 2010, South Africa was added to the group.  

The BRICS are in a rush to cut their dependence on the dollar. Recently, China and Brazil decided to ditch the dollar for their own currencies in trade transactions. Also, some members of the Association of South East Asian Nations (ASEAN) have concurred with the BRICS to reduce their reliance on the dollar in exchange for trade settlements. 

In a meeting in Indonesia on March 28, ASEAN finance ministers and central bank governors discussed efforts to reduce dependence on the US dollar, euro, yen, and British pound from financial transactions; and move to settlements in local currencies through the Local Currency Transaction (LCT) scheme. This is an extension of the previous Local Currency Settlement (LCS) scheme being implemented among ASEAN members.

This means that an ASEAN cross-border digital payment system would be expanded further and allow ASEAN states to use local currencies for trade. An agreement on such cooperation was reached between Indonesia, Malaysia, Singapore, the Philippines, and Thailand in November 2022. This follows from Indonesia’s banking regulator, stating on March 27 that the Bank of Indonesia is preparing to introduce its own domestic payment system.

I believe that the most pressing reason for Russia, on the heels of its exclusion from global finance, is the need to adapt strategically. The sanctions imposed by the West have economically devastated the Kremlin so much so that it has to scramble to find a solution. China offers an alternative – the yuan. China’s currency in Russia has topped the dollar in trading volume, only a year after the Russia invaded Ukraine. 

White House economist Jared Bernstein, however, says that there is evidence that China wants to weaken the dollar. Bernstein, a member of the White House Council of Economic Advisers, addressed the situation last week in a meeting with the Senate banking committee. Additionally, Bernstein told the senators that a resolution to the debt ceiling issue could preserve the greenback’s value.

“One thing we could really do to help both the dollar maintain its reserve currency status, [and] protect the value of the dollar would be to raise the debt ceiling,” Bernstein said. 

Even as the White House has been deeply involved in the ongoing debt ceiling negotiations, there has yet to be traction on an agreed budget to incur a ceiling raise. Simultaneously, the international trade market is seeking ways to curb the use of the US dollar, which is further diminishing its value.

Speaker Kevin McCarthy (R-CA) on Wednesday, April 19, unveiled his party’s highly-anticipated debt ceiling proposal, saying he’s willing to lift the limit by $1.5 trillion or until March 31, 2024 – whichever comes first – but only if Democrats agree to a host of other measures.

“I urge all my colleagues on both sides of the aisle to support this plan to get our nation back on track,” McCarthy said on the floor of the US House after months of waiting to introduce a plan, claiming those measures will save taxpayers $4.5 trillion over the next decade.

But Democrats are vehemently opposed to many of the key GOP priorities in the 320-page bill – which includes things like a cap on government spending and a reversal of parts of President Joe Biden’s agenda. This makes it muddy on how the two sides could agree on a compromise before the debt limit is reached, possibly in June. The US government wouldn’t  want to see a default which would have far-reaching consequences for world markets and, many fear, immediately tip the US economy into a recession.

The dollar dominance

The US dollar has been the world’s only reserve currency since the 1930s. Before then, the global reserve currency was the pound sterling. But thanks to the world wars, the costs of a colonial empire, and an increasingly socialistic economy, the British currency was replaced by the dollar.

Britain has been increasingly turned toward an economy based on subsidies, price controls, and other regulations. Although the US economy has also become more regulated, it remained relatively free. In 1944, the Bretton Woods agreement finally sealed the deal: the dollar had dethroned the British pound. Under Bretton Woods, the dollar would remain tied to gold for international transactions among sovereign states, and other currencies were only pegged to gold via the dollar.

Bretton Woods did not make the dollar the global reserve currency by decree, however. The new agreement simply “made official” what was already clear about the dollar’s new status as the dominant reserve currency. Decades of war, instability, and monetary inflation had finally done in the currencies of Western Europe. Coupled with the US’ new status as a global industrial powerhouse, the stage was set for decades of dollar dominance.

If the choice of a reserve currency were based merely on the size of the economy and total use in international trade, one would expect the euro to be much more competitive.

In a 2009 study, however, the US Treasury suggested a reason to explain how the US dollar continued to surpass the euro.

The US government bond market is huge and allows a great deal of ease in buying and selling Treasury bills and bonds, which remain extremely liquid and are considered by many to be near dollar substitutes.

Moreover, the eurozone does not present much of an alternative to the US in terms of macroeconomic policies. Deficit spending in the eurozone is enormous, and even though the US dollar is continually subject to monetary inflation, the euro easily rivals the dollar in this respect too. Finally, sovereign debt in Europe doesn’t appear any more secure than sovereign debt in the US.

Another example of why having a large economy on its own isn’t enough for a country’s currency to seize global reserve status is the Chinese yuan. In recent years, China has overtaken the US economy in terms of sheer size. Yet, the yuan remains in fifth place in terms of global foreign exchange reserves and, as of late 2021, still ranked fourth in terms of its share of international transactions.

Even though the yuan is certainly experiencing high growth in international trade, it still has a lot of ground to cover. Recent deals with Russia, Saudi Arabia, Iran, and an increasing number of countries in the developing world will advance this trend, it will only help China meet some of the requirements for becoming a global reserve currency. 

Problems of openness and convertibility remain obstacles for China, despite the size and scope factors that are working in China’s favor. China still employs capital controls, which makes its economy relatively less open than Western ones. 

Coffee shop talks of the dollar’s demise are mostly hyperbolic. Based on most usage measures, the dollar remains irrefutably dominant in global trade and finance, despite its not being at the apex.

While most currencies are only used domestically or in cross-border transactions that directly involve the currency’s issuer, the dollar continues to be widely used for funding, pricing, trade invoicing and settlement, and cross-border borrowing and lending, with or without direct US involvement. 

It is true that dollar’s share of the central banks’ $12 trillion foreign exchange reserves has gone down since 1999, but it still is, nearly twice that of the euro, yen, pound, and yuan combined – the same as it was a decade ago. Its nearest competitor for global currency status – the euro – accounts for barely 20% of central bank reserves compared to the dollar’s 58%, followed by the Japanese yen at 5%. The much-touted Chinese yuan lags far behind at under 3% of foreign exchange reserves.

Even China, in an environment of intensifying geopolitical competition with the US and having just witnessed Washington’s weaponization of the dollar against Russia, has had no choice but to continue accumulating dollar-denominated assets.

Can the yuan topple the dollar?

According to Peter C. Earle of the American Institute for Economic Research, the likelihood of the yuan becoming the global reserve currency ranges between profoundly unlikely to essentially impossible: “It is pegged to the US dollar, and therefore does not float.” 

What Earle means is that yuan’s exchange value is not subject to market forces and if I may elaborate, that peg permits Chinese monetary authorities to adjust the currency value to benefit Chinese exports; and that the Chinese capital account is closed, which essentially means that capital does not flow out without approval.  Earle says that these (and a handful of other characteristics) are simply not conducive to the establishment of a currency that will be used as a unit of account, medium of exchange, and/or basis for settlement in countless international daily transactions.

Beijing’s authoritarian and statist bent prevent the Chinese yuan from being a viable alternative to the US dollar.  Xi Jinping’s policy preferences – economic self-reliance, financial stability, common prosperity, and political control of the economy – in fact run directly counter to his global-currency ambitions.

Despite its growing role in the global economy and long-standing desire to unseat the dollar, China lacks the required investor protections, institutional quality, and capital market openness to internationalize a yuan that is still not fully convertible overseas. Persistent currency and capital controls, an opaque banking system with too many non-performing loans, spotty contract enforcement, and often arbitrary and draconian regulations continue to undermine Beijing’s efforts to elevate the yuan.

So-called cryptocurrencies like Bitcoin are likewise not a viable alternative because they are speculative assets with no intrinsic or legislated value. By contrast, the US dollar as legal tender is backed by America’s current and future wealth, and by the US government’s ability to tax it.

Simply replacing the fiat currency of the largest economy in the world with the fiat currency of a smaller economy is hardly a viable replacement strategy. Due to historical, technological, financial, and habitual obstacles, moving away from the dollar brings substantial barriers to exit as well as network effects to overcome, For example, the US dollar is the de facto currency of East Timor, Ecuador, El Salvador, the Federated States of Micronesia, the Marshall Islands, Palau, Panama, and Zimbabwe. Moreover, the comparatively and relatively transparent conduct of monetary policy in the US has led to no less than 22 foreign central banks and currency boards to peg their currencies to it. The dollar is also the cheapest means to acquire nominally risk-free US Treasury instruments.

By one estimate, the dollar is a part of 88% of all international transactions. Some people fear this dominance cannot last, while others question whether it should: Doesn’t a stronger dollar hurt US exports, and thus US workers?

Despite what dollar bashers are saying, the US dollar is not likely to lose its reserve currency status any time soon. Independent financial advisors are confident that the dollar will continue its dominance because a good or viable alternative is nowhere on the horizon. 

The de-dollarization trend over the past 30-plus years is still not at an inflection point in economic history. Global trade (and trust) in the US dollar is still at about 60%. It may be lower than about 30+ years ago when it was about 75%, but for now, the world trusts the US dollar the most. The trend may or may not continue. Only God knows. De-dollarization, if it does happen, will be way beyond our lifetime. – Rappler.com

Val A. Villanueva is a veteran business journalist. He was a former business editor of the Philippine Star and the Gokongwei-owned Manila Times. For comments, suggestions email him at mvala.v@gmail.com.