Future of The Greenbacks: Are the Dollar Days Over?

The US Dollar has enjoyed global dominance since it overtook British Pound post World War II as the globally accepted currency for international trade. While USD may not be the only global reserve currency, it does stand robustly against its competitors (Euro, Yuan, Yen and Pound Sterling) with a whopping 61% of all central bank foreign exchange reserves. It continues to retain this status as of now despite an increasingly shaky US economy. So much so that around 90% of forex trading still involves USD. Here’s why - 

• US markets provide the world with ample liquidity and safety for assets.
• USD acts as a reliable currency for nations facing political or fiscal instability.
• The other global reserve currencies are yet to catch up with the dollar in stability and demand.

Hence, the dollar continues its power play in global trade and it is even known to maintain a strategic trade deficit for the “sake” of it. But times change; sometimes gradually, sometimes all at once. With the current economic crisis trailing the COVID-19 pandemic, the chances of USD taking a deep, frightful plunge is coming to be more than just a bad dream. 

The Art of Throwing Oneself under the Bus: US Managing the Recession

The COVID-19 has brought along with it the recession that the whole world had been fearing since 2018 and the US is no exception. The US normally works well, due to its strong institutional and political system, in spite of whoever the ruling party / president in the white house is; across most situations including war and economic crises, as there are playbooks set from the past.

• But in the current unprecedented crisis, with Trump in power, US seems to be not in control.
• It is highly likely that the current economic crisis will be grossly mismanaged by the US government (as observed so far)
• US can come on the verge of losing its ‘exorbitant privilege’ that enables it to reduce borrowing costs
• In an attempt to revive the economy, US might try to borrow more money by issuing more treasury bonds and/or printing more dollars, and the other gimmicks including “quantitative easing” which just defer the current pain to the future.
• In extreme situation, it’s now a possibility that all these actions could lead to a failed recovery and even a possible USD default (although chances of the latter is less than 1%). 
• If not, then global countries will certainly start to diversify away from USD as a base/reserve currency, partially if not fully.

Overall, a global loss of trust in USD is likely to happen. And the US dollar could plummet, any holder (including foreign governments holding US Treasuries) of dollar-denominated assets may try to sell them at any cost, leading to virtuous tailspin. 

The Alternatives of USD

Currently, the IMF recognizes eight global reserve currencies including the USD. They are: Euro, Chinese Yuan, Japanese Yen, Pound Sterling, Swiss Franc, Canadian Dollar and Australian Dollar. While the Eurozone countries are more inclined to hold the Euro, the Asian economies are inclined towards the Yen and more towards Yuan. But the global economy has used USD as its base currency for around 70% of the global finances for the last 75 years. It would be intriguing to see how the world will realign its assets away from the USD. 

While both Euro and Chinese Yuan seem to have the strength to replace USD, most experts believe that the American dollar’s prominence may still remain unchallenged. The other major currencies have varied levels of potential of replacing USD.

Chinese Yuan: Least likely

- Lacks characteristics of a global currency including a deep, open capital markets, a trusted legal system, and market-determined currency and interest rates.

- Also, it’s not freely convertible making it less accepted across the globe.

- In international payments, Yuan lags far behind other currencies at the eighth position.

- China’s role in the Covid-19 control may lead to boycott by several countries against it.

• Japanese Yen: Less likely

- Despite the rise, Japan has not been ready to strengthen its currency as yet.

- Japan’s debt-deflation and lack of structural reforms have also affected the Yen.

• Euro: Less likely

- Chance of the euro becoming a world currency was damaged by the Eurozone debt crisis.

- Share of Euro in the global foreign exchange has declined over the years.

- Also, there are no Eurozone bonds, only national bonds of Eurozone countries.

- Europe has been struggling for years to decades, and the covid-19 will leave its rich/old countries (spain, italy, etc.) and the union weaker.

• Pound Sterling: Less likely

- Had lost its command to the USD in the international money market 75 years ago

- Accounts for very low percent of global reserves as compared to Dollar, Euro and Yuan

- Post Brexit, the pound has possibly lost more significance.

• Swiss Francs: No

- Too small in terms of trades done in swiss francs today.

- Swiss bond market is too small to accommodate central bank reserve flows.

• Gold: Possibly

- Gold has been the base of financial world for centuries, including for the fiat currencies backing today

- Despite being an ideal reserve of value, gold is not a practical alternative when it comes to transactions since it’s difficult to fractionalize

• Bitcoin: Small possibility

- The trust in bitcoin as a currency is yet very limited and young (12 years old).

- Bitcoin may gain trust in the next decade or so with increased automation, robots around us, and the automated world where digital decentralised currencies like bitcoin (or their newer next versions) will make more sense. This point is further elaborated in this book “Squaring the Blockchain Circle”.

- Its essential lack of central banking makes it highly volatile and hard to manage.

- It can help in preventing inflation and/or bypassing capital controls.

- Bitcoin has been helpful in countries like Venezuela, Cuba and Greece, both for day-to-day exchange and as a store-of-value.

• A new global currency: Less likely,

- In 2010, IMF recommended to adopt a global currency called ‘Bancor’ and a global central bank (to print and administer it).

- Such a global currency could make international trade easier without giving unfair power any one nation

- But it will be harder as usual to bring several global countries on a common base, which is new. - Nations like Russia and China that are trying to establish their respective dominance in trade may not readily accept it.

• A Basket of few currencies with as a base index: Less likely,

- What if we take a hand full of top trade currencies like yen, yuan, euro and add gold and bitcoin, and make a new base index as reserve? Its an interesting idea but less likely to work

• No global reserve currency for number of years, everyone on their own: Likely

- Trade partners (say importer exporter country) to negotiate the terms on their own currencies, which will make trade deals harder but over time could be standard templates 

- Example, India has done INR deal with Iran and Rouble deal with Russia. India needed Russian defense systems, Russia pushed India to pay in roubles. Iran wanted to sell India its oil, India pushed them to accept INR.

Will the world really witness a world where the dollar doesn’t rule? There may be time to that but no one can rule out the possibility (and the increasing probability) of it happening.