Like Mark Twain said about himself, the report of the dollar’s death is exaggerated—though its health problems are multiplying.
About 60 percent of international and foreign currency claims (primarily loans) and liabilities (primarily deposits) are in US dollars. Its share of foreign exchange transactions is around 90 percent. US dollars constitute around 60 percent of global official foreign reserves. These shares are disproportionate to the size of the US economy (around a quarter of global GDP, or 15 percent adjusted for purchasing power).
The dollar’s difficulties are largely self-inflicted. Incontinent fiscal and monetary policy—with the US budget deficit and government debt at around 7 percent and over 100 per cent of GDP, respectively—has diminished long-term purchasing power of the dollar. Since 1972, it has fallen by 99 percent against gold and lost 90 percent of purchasing power of real goods and services.
In the wake of the Ukraine war, the US and its allies have frozen $300 billion of Russian central bank dollar holdings. The Biden administration passed the REPO Act authorising the confiscation of about $20 billion worth of Russian assets held by US banks, primarily government securities that were legitimately purchased, and transferring it to Ukraine. Selective cancellation of US government obligations held by a foreign power is now a policy option, despite its doubtful legal basis. It would represent a selective US government default.
These factors are driving foreign public and private institutions’ increasing reluctance to transact in dollars or hold dollar assets. But American authorities assume continuation of the dollar hegemony because of limited alternatives.
Two principles lie at its heart. The first is the ‘policy trilemma’ or ‘impossible trinity’ proposition of economists Robert Mundell and Marcus Fleming. It argues an economy cannot simultaneously maintain the following—a fixed exchange rate, free capital movement and an independent monetary policy. The second is the paradox named after economist Robert Triffin. This states that where its money functions as the global reserve currency, a nation must run large trade deficits to meet the demand for reserves. Any aspirant to a new global reserve currency status faces an unacceptable loss of economic control and must run large current account deficits.
Russia’s MIR and China’s Cross-Border Interbank Payment System offer alternative fund transfer arrangements. Nations are denominating trade in different currencies. China has reduced its US Treasury holdings to below $800 billion, down 40 percent from a decade earlier. Foreign investors have moved into real assets, primarily business and commodities. The Chinese Belt and Road Initiative is one example. Central bank purchases of gold and other currencies reflect these pressures. But the biggest change may be fundamental.
A trading and reserve currency is needed due to imbalances. Where India imports more than it exports to China, if denominated in rupees, would leave the Chinese with surplus Indian currency. Alternatively, if denominated in Chinese yuan, India would have to finance the deficit. This requires unfettered access to investments or funding in respective currencies. If trade is more bilaterally balanced over time, then there would be no surpluses to invest or deficits to finance, reducing the need for a reserve currency such as dollars.
The structure can be extended to encompass trading blocs, where imbalances net out between members when aggregated. It implies a world of multiple trading and reserve currencies, which has existed at various times in history.
A world based around bilateral or multilateral autarky has implications for growth and development. Trade and capital flow volumes would fall. It would diminish the ability to trade freely as well as sourcing investment capital for growing economies. Comparative advantages would be lost. But this approach is implicit in the evolving industrial structure driven by sovereignty and economic independence concerns.
The diminution of the dollar’s status would affect the US’s ability to fund its continuing budget and trade deficits. Dollar interest rates may have to rise and the currency devalue. The role of its capital markets and financial institutions would decline. American political prestige and power would suffer.
For the moment, America believes the dollar’s reserve currency status is secure. Given its economic, political and social problems, this belief will be tested. All major economic shifts go through phases—impossible, unlikely, plausible, likely and finally, inevitable. The dollar is progressing through these stages.
One young man of my acquaintance, who has inherited some acres, told me that he thought he should live as I did, if he had the means. I would not have any one adopt my mode of living on any account; for, besides that before he has fairly learned it I may have found out another for myself, I desire that there may be as many different persons in the world as possible; but I would have each one be very careful to find out and pursue his own way, and not his father’s or his mother’s or his neighbor’s instead. The youth may build or plant or sail, only let him not be hindered from doing that which he tells me he would like to do. It is by a mathematical point only that we are wise, as the sailor or the fugitive slave keeps the polestar in his eye; but that is sufficient guidance for all our life. We may not arrive at our port within a calculable period, but we would preserve the true course.
(...)
I read in the Gulistan, or Flower Garden, of Sheik Sadi of Shiraz, that “They asked a wise man, saying: Of the many celebrated trees which the Most High God has created lofty and umbrageous, they call none azad, or free, excepting the cypress, which bears no fruit; what mystery is there in this? He replied; Each has its appropriate produce, and appointed season, during the continuance of which it is fresh and blooming, and during their absence dry and withered; to neither of which states is the cypress exposed, being always flourishing; and of this nature are the azads, or religious independents.—Fix not thy heart on that which is transitory; for the Dijlah, or Tigris, will continue to flow through Bagdad after the race of caliphs is extinct: if thy hand has plenty, be liberal as the date tree; but if it affords nothing to give away, be an azad, or free man, like the cypress.”
(HDT.Walden, Economy)
@WendellDaily
— Guillermo Ruiz Zapatero (@ruiz_zapatero) July 12, 2024
let this day begin again the change of hogs into people,
not the other way around,
for today we celebrate again our lives’ wedding with the world https://t.co/KDZzoEy8kc
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