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Are we entering a post-dollar world?
Are we entering a post-dollar world?
- Most commodities and internationally traded goods get priced in dollars
- About half of world trade is invoiced and settled in dollars, far beyond the U.S. economy’s role in global trade
- The dollar is part of nearly all foreign exchange transactions
- Non-U.S. banks lend and take deposits largely in dollars
- Non-U.S. firms predominantly borrow in dollars
- Central banks hold three-fifths of their foreign exchange reserves in dollar-denominated assets, and many choose to peg their own currencies to the dollar
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Whereas most currencies are only used domestically and in cross-border transactions that directly involve the currency’s issuer, only the dollar is widely used outside its issuing country. Its nearest competitor for global currency status, the euro, accounts for 20% of central bank reserves compared to the dollar’s 60%, followed by the Japanese yen at 4%. The Chinese yuan lags far behind at about 2% of foreign exchange reserves.
Share of international revenuesIMF COFER
The dollar’s special role did not originate by chance, force, or decree. For much of the 19th century through the early 20th century, it was the British pound sterling that was the dominant global currency. But after World War II, the American economy became dominant in global output, trade, and finance. At the time, U.S. GDP accounted for roughly half of world output, so it made economic sense for the dollar to be the principal global means of exchange, unit of accounting, and store of value.
America’s economic supremacy has since waned, its share of global output now a fraction of what it was in 1945. This trend has led many over the decades to warn about the imminent end of dollar primacy.
Doomsayers from Wall Street and Silicon Valley to Moscow and Beijing offer numerous reasons for the dollar’s allegedly inevitable demise: China’s meteoric rise to global superpower; America’s stagnant productivity growth, out-of-control fiscal spending, unprecedented monetary stimulus, growing debt burden, record-high inflation, protectionist trade policies, and imperial overreach; challenges from disruptive technologies like crypto-assets; and, most recently, Washington’s weaponization of the dollar against its geopolitical foes.
(To be clear, it’s not obvious that losing dollar dominance would be a bad thing for the United States. In the 1960s, former French president Valery Giscard d’Estaing claimed that being the issuer of the global reserve currency afforded America with an “exorbitant privilege,” allowing it to borrow cheaply from the rest of the world, run chronic trade and budget deficits, and live beyond its means. That’s true, but it’s only half of the story. The oft-neglected downside (or “exorbitant burden”) is that outsized foreign demand for dollars pushes up the currency’s value, making U.S. exports artificially more expensive, harming domestic manufacturers, increasing American unemployment, suppressing American wages, fueling speculative bubbles, and widening inequality. Dollar dominance is a boon for Wall Street. For Main Street, not so much.)
Rumors of the dollar’s death, however, are greatly exaggerated.
Going by most usage measures, the dollar remains incontrovertibly dominant, if a little less so than at its apex. Its share of the world’s $13 trillion currency reserves is nearly twice that of the euro, yen, pound, and yuan combined—the same as it was a decade ago. Even China, in an environment of intensifying geopolitical competition with the U.S. and having just witnessed Washington’s freezing of Russia’s international reserves, has no choice but to continue accumulating dollar-denominated assets.
If prognosticators are right that the dollar’s days are numbered, markets—the ultimate judge, jury, and executioner—have yet to find out. As we’ve seen repeatedly and are witnessing now, every time turmoil roils global markets the dollar strengthens, as investors flock to the most plentiful and liquid safe assets in existence. In fact, despite unprecedented sanctions on Russia and 40-year-high inflation prints, the dollar has strengthened more than 10% year-to-date relative to other major currencies and is currently trading at its highest levels in 20 years.
U.S. dollar strength against other major global currenciesBoard of Governors of the Federal Reserve System
Why has dollar dominance remained so sticky?
In large part, it’s because incumbency is self-reinforcing due to inertia and network effects. People use dollars because other people use dollars. The more the dollar is used, the more useful it becomes, and the more it is used in response. Dollar dominance begets continued dollar dominance.
But it’s not just turtles all the way down. The dollar has inherently desirable features: it is at once highly stable, liquid, safe, and convertible. And U.S. financial markets are by far the largest, deepest, and most liquid in the world, offering a plethora of attractive dollar-denominated assets foreign investors can trade. No other market comes remotely close.
Investors want to hold dollar assets because America’s economic, political, and institutional fundamentals inspire credibility and confidence. The U.S. has the world’s strongest military, the best research universities, the most dynamic and innovative private sector, a general openness to trade and capital flows, relatively stable governing institutions, an independent central bank, sound macroeconomic policies, strong property rights, and a robust rule of law. People all over the world trust the U.S. government to safeguard the value of their assets and honor their rights over them, making the dollar the ultimate safe-haven currency and U.S. government bonds the world’s most valued safe assets.
None of this means that the dollar’s advantage can’t slip. After all, the pound sterling and all the reserve currencies that came before it were dominant until the moment they ceased to be. Yet in all those cases, there was another currency on the sidelines ready to take their place. Today there’s no such challenger.
Of the serious candidates to dethrone “king dollar,” the euro is not a viable alternative because of Europe’s persistent fragmentation. Despite having a sizeable economy, well-developed and deep financial markets, decently free trade and capital openness, and generally robust institutions, Europe lacks a true capital markets, banking, fiscal, and political union.
Ever since the eurozone debt crisis in 2009, European bond markets have been much more fragmented and illiquid than America’s, leaving investors with a dearth of high-quality euro-denominated assets. While the pandemic did push the EU to finally issue common debt to fund recovery efforts, that move alone is not sufficient to boost the euro’s international role, as markets know that even if full fiscal and financial integration was on the horizon—a big if—political integration isn’t.
The Chinese yuan is not a viable alternative because of China’s autocratic and state capitalist proclivities. Xi Jinping’s and the Chinese Communist Party’s domestic policy priorities—economic self-reliance, financial stability, common prosperity, social harmony, and political control of the economy—run directly counter to their global-currency ambitions.
Despite its growing role in the global economy and its long-standing desire to unseat the dollar, China lacks the investor protections, institutional quality, and capital market openness required to internationalize a yuan that is still not even 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 will all continue to undermine Beijing’s efforts to elevate the yuan.
Last and most definitely least, so-called cryptocurrencies like Bitcoin are not a viable alternative because they are speculative assets with no intrinsic or legislated value. By contrast, as legal tender, the U.S. dollar is backed by America’s current and future wealth and by the U.S. government’s ability to tax it.
I say “so-called cryptocurrencies” because these digital tulips are not really currencies or money: they are expensive and slow to transact in, they can rarely be used to pay taxes or buy groceries, and they are far too volatile to be useful as means of payment, stores of value, or units of account. Just since the beginning of the year, the price of Bitcoin has fallen by 60% and the market value of all cryptocurrencies has shrunk from over $2 trillion to well under $1 trillion.
The main threat to dollar dominance might actually come not from abroad (Europe, China) or from beyond (the digital space) but from within. The United States is still the world’s superpower, and it will arguably emerge stronger from the pandemic than any other nation on earth. It’s also the most politically divided and dysfunctional of all the major industrial democracies. The single biggest risk to the dollar’s global status is that growing inequality, tribalism, polarization, and gridlock undermine trust in America’s stability and credibility.
But no matter how much the dollar seems to lose its shine, global currency status is about relative—not absolute—advantages. Without a viable challenger, it’s very unlikely that the dollar will lose its special role. You can’t replace something with nothing.
As Margaret Thatcher might have said, there is no alternative.
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Who’s to blame for inflation?
Who’s to blame for inflation?
But of course, that’s not how most Americans see it. If instead I had called the U.S. government a right-wing one, my post would no doubt have been met with more derision. Fox News and elected Republicans say Biden and the Democrats are a bunch of socialists, and even if they wouldn’t go that far, the majority of Americans broadly think of the Democratic Party as being on the left. As far as my argument is concerned, that’s the only thing that matters.
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So what is my argument?
That the multidecade-high inflation that we’re currently experiencing in the United States—and in the United Kingdom, Germany, Canada, Italy, Brazil, and so many others—is a global phenomenon with global, not domestic, origins. It has nothing to do with the specific political parties or leaders in government. It doesn’t matter whether it was Trump or Biden, Johnson or Starmer, Scholz or Laschet, or Bolsonaro or Haddad that got elected—we still would have gotten high inflation globally.
Don’t get me wrong: it's understandable that when something upsetting like high and persistent inflation happens in a country that’s so divided like the U.S., people are going to blame the government in charge. The buck, as they say, stops with the president. But just because the political reaction is understandable, it doesn’t mean that the government is actually to blame. And that’s a difference I want my readers to understand.
What did cause the global inflation shock?
First was the Covid-19 pandemic, which disrupted labor markets and global supply chains and prompted governments everywhere to try to cushion the fall in incomes by putting cash into people’s wallets. The policy response worked wonders, preventing millions from falling into unemployment, bankruptcy, and poverty. At a time when supply was constrained, though, the flipside of people having enough money to spend was a rise in goods inflation.
Then, just as the United States and Europe were coming out of the pandemic and supply and demand were starting to normalize, China doubled down on its zero-Covid policy in the face of the highly contagious Omicron variant, locking down some of the global economy’s most important manufacturing and shipping hubs and boosting goods inflation further.And then on February 24 Russian President Vladimir Putin decided to launch a war of aggression against Ukraine, triggering Western sanctions and leading to massive dislocations in the global supply of energy, food, and fertilizer. As a consequence, the prices of these critical commodities shot through the roof.
This unprecedented confluence of overlapping shocks naturally led to inflation almost everywhere (China and Japan being the notable exceptions). Frankly, you’d be surprised if it hadn’t.
In hindsight, it’s easy to criticize the U.S. government for doing too much fiscal stimulus—especially in 2020—and the Federal Reserve for failing to tighten monetary policy sooner. Heck, some commentators are making a living out of it.
But hindsight is 20/20 and policymaking is hard. Let’s not forget how much uncertainty and fear we all were shrouded in when the pandemic hit. There was no playbook for how to protect people and businesses from a once-in-a-century pandemic with the potential to cause mass unemployment and poverty (in addition to death).
Policymakers were never going to get it exactly right: really, they were just trying to feel their way in a dark room without breaking too much furniture. Scarred by the timidity of the response to the 2008 financial crisis, which the U.S. took nearly a decade to fully recover from, they erred on the side of too much rather than too little stimulus. Arguably, that was the right call to prevent the most suffering with the limited information they had at the time, leading to the strongest labor market in half a century.
We should also remember that fiscal and monetary relief was one of the very few things that both Democrats and Republicans over the last two administrations agreed on. By the time Biden signed the $1.9 trillion American Rescue Plan into law in March 2021, former President Trump had already approved a total of $3.1 trillion in pandemic-related economic stimulus. And Fed chair Jay Powell was originally nominated to his position by Donald Trump before he was re-appointed by Joe Biden, both times being confirmed in the Senate by a bipartisan vote. So if anything, the fault for overdoing it lies with both parties.
The good news is that inflation will come down, because none of these shocks are permanent in nature. Demand is stabilizing because households have already worked through most of their pandemic savings. Supply chains will become normalized, especially as more Chinese get vaccinated and China’s zero-Covid policy ebbs away over the coming year. Sanctions on Russia will remain for the foreseeable future, but the Europeans will diversify their energy supply sources and lessen their dependence on fossil fuels altogether. All of this means that inflation will prove temporary, even if not short-lived (no, they are not the same thing).
In the meantime, though, inflation poses at least as much of a political problem as it does an economic one. Just ask Jimmy Carter. Voters positively hate inflation and blame the president for it—regardless of what caused it, how long it lasts, or whether there’s anything he can do about it in the near term. They don’t care that there’s little the Fed can do to lower inflation without choking off the labor market (i.e., throwing people out of work), or that presidents have no control over gas and food prices.
source:j John Cole / The Scranton Times Tribune
President Biden can announce a gas tax holiday, lift tariffs on China, or enact new green energy subsidies to make life a little cheaper for the average American, but none of these measures are going to save him and Democrats from a sure defeat in November’s midterm elections.
The biggest danger is that this strong public aversion to inflation will pressure the Fed to induce a recession in order to tamp down inflationary expectations—as economists are now expecting—and leave the U.S. government with little fiscal firepower left to offset it. Given the widespread belief that the current inflation was fueled by excess spending, it’s unlikely that Congress would be able to find a politically palatable consensus on any significant relief policies, putting the U.S. economy at risk of a prolonged stagflation.
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Dispatch from Davos
Dispatch from Davos
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Me moderating a panel titled "Russia: What's Next?"Source: World Economic Forum/Sikarin Fon Thanachaiary.
Why are we seeing so many converging crises at the same time?
Largely, I think it’s because we are in a geopolitical recession—a moment in history when nobody (not the U.S., not the G7, not the G20) is driving the bus—where many of the reigning global institutions are increasingly not aligned with the geopolitical balance of power. The United Nations Security Council, NATO, the World Trade Organization, the World Bank, the International Monetary Fund—all of these institutions were the product of a bipolar world forged atop the ashes of World War II.
The balance of power has shifted since—from the collapse of the Soviet Union and the rise of China to the end of the U.S.-led order—but institutions haven’t adapted. That’s why Germany and Japan, two wealthy, dynamic, free-market democracies with governments strongly committed to multilateralism and the rule of law, don’t have seats at the UN Security Council...while Russia does.
As a result of this vacuum of leadership and growing misalignment, the global architecture is no longer fit for purpose, and instead of global cooperation, we get every nation for itself. That makes crises more likely to emerge and the world less capable of responding to them.
Of all the Davos gatherings I’ve attended—and I’ve been coming since 2008—this is by far the one that is most being driven by geopolitics. Helle Thorning-Schmidt, former Prime Minister of Denmark, echoed this feeling during a Global Stage livestream conversation hosted on Monday by GZERO Media and Microsoft. Business leaders are starting to realize that they have no choice but “to engage in geopolitics,” she rightly noted.
Back in 2009, the first or second time I came to Davos, there was a massive sense of crisis, too. But everyone attending at least felt like they understood the playbook, the tools we had to respond to it. This time is different. People know there are massive crises brewing, but they don’t really know what the second- and third-order consequences will be, and they sure don’t know how to deal with them.
At the top of the agenda this year is the war in Ukraine and its many cascading effects. Everyone at Davos is worried about it, and for once, most everyone at Davos (though certainly not globally) is on the same side of the conflict. There’s a lot of consensus around Putin needing to be stopped and Ukrainians deserving all the help we can give them. But that’s where the unity ends. How does the conflict end? Can the Ukrainians actually win? Does that require humiliating the Russians? Or does Putin need to be offered an off-ramp? On those questions, there’s no agreement whatsoever.
Ukrainian President Volodymyr Zelensky addresses Davos via video.Source: World Economic Forum/Sikarin Fon Thanachaiary.
As for the outlook for the conflict, the pessimists (like me, on this one) think the fighting will continue, albeit at lower levels of intensity than we’re seeing now. The optimists think the fighting can stop, albeit not definitively. Either way, everyone agrees on at least three things: (1) a negotiated settlement is a remote possibility, (2) there’s no stable equilibrium in sight, and (3) the United States and its advanced industrial allies are in a cold war with Russia (veering on hot, if you count cyber, disinformation, and espionage).
This decoupled environment is far from the globalist ideal the World Economic Forum has been committed to for 50 years. A case in point is the fact that there are no Russians in attendance at Davos: no business leaders, no delegates, no government officials. The “Russia House,” a building in this mountain town that used to serve as an outpost for Russian oligarchs and officials, has been turned into the “Russian War Crimes House,” an exhibit of images depicting the atrocities committed by Russian forces against Ukrainian civilians.
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