From time to time appetites arise for an alternative reserve currency to the dollar, and in some market it is filled with predictions about the imminent demise of the greenback. For nearly three-quarters of a century, the dollar has dominated global trade, finance, and the emergency reserve portfolios of central banks. However, high inflation, geopolitical unrest and sanctions imposed by the United States and its allies on countries like Russia have made dollar skeptics speak up again.
Often these episodes are fueled by some world leader’s outburst of anger. In 1965, Valéry Giscard d’Estaing, then French Minister of Finance and Economic Affairs, lashed out at the “exorbitant privilege” that the greenback conferred on the United States. Now it has been Luiz Inácio Lula da Silva, president of Brazil, who on a recent visit to China has called for emerging markets to trade their own currencies. At the same time, the rise in the price of gold and the fall in the dollar’s share of world reserves have encouraged other skeptics, who can also allude to the admission made in April by Janet Yellen, US Treasury secretary, and according to the which, over time, the use of sanctions “could undermine the hegemony” of the currency. Also, it doesn’t help that the United States may soon face a fiscal crisis if Congress does not authorize raising the ceiling on domestic borrowing.
However, the enthusiasm of skeptics has turned away from reality. The greenback exerts an omnipotent gravitational pull on the world economy that has not materially weakened, despite the recent discovery by the United States that there are real obstacles to exploiting its currency’s pre-eminence.
The initial advantage of the dollar is immense. Between one third and one half of world trade is billed in dollars, a share that has remained relatively stable over the long term. The currency participates in almost 90% of foreign exchange transactions; Such is the liquidity of the greenback that if you want to exchange euros for Swiss francs, it may be cheaper to negotiate through dollars than to do it directly. About half of cross-border debt is denominated in dollars. And while central bank reserves have declined over the long term, the dollar share still makes up about 60% of them. There are no signs of a dramatic immediate change, other than mechanically caused by central banks revaluing their portfolios to account for exchange rate movements and rising US interest rates.
No other currency comes close to the size of that ecosystem, nor to its fundamental attraction: the supply of safe assets available to dollar investors. The eurozone is fragile and its sovereign debt market is highly fragmented among member states. It is not possible for China to meet the global demand for safe assets as long as it tightly controls capital flows and runs current account surpluses (meaning that, on net terms, it is accumulating financial claims on the rest of the world and not vice versa). And the dollar, as the dominant currency, benefits from network effects. People want to use the currency that others use.
Now, what is becoming increasingly clear is that individual countries can circumvent the dominant system if they really want to. Russia’s war economy has been affected by sanctions, but not crippled; in part, because 16% of its exports are now paid for in yuan, compared to almost zero before the invasion.
The Chinese alternative to the SWIFT interbank messaging system has grown at full speed. The country has also been increasingly shifting its bilateral trade towards settling in renminbi, an easier task than substituting for the dollar in trade flows between other countries. Even many Western companies now use the renminbi to trade with China. New digital payment technologies and central bank digital currencies could make it even easier for money to move around the world without US intervention.
On the other hand, Yellen is right that using the dollar to put pressure on countries is not a way to make or keep friends. The United States has not imposed secondary sanctions on countries like India, which still trade with Russia, because it fears a likely backlash. Although not imminent, the shift to a multipolar currency system could occur by the end of this century as the United States’ share of the world economy shrinks. Such a system would be inherently less stable than one centered on the dollar, so it is in neither the United States nor the world’s interest to accelerate change.
© 2023 The Economist Newspaper Limited. All rights reserved. Translation: Juan Gabriel López Guix