The dollar’s rise to become the dominant currency started after World War I, but it was only definitively confirmed by the Bretton Woods accord reached in 1944. President Trump has accelerated America’s turn away from some of the post-World War II global architecture that reinforced the U.S. currency’s place at the heart of international systems.
His tendency to pursue a unilateral approach could reduce the dollar’s appeal.
When previous leaders moved to weaken the dollar, they did so as part of a consensus shift aimed at redressing global imbalances—most notably with the 1985 Plaza Accord.
Last year, global reserve managers cut their U.S. currency holdings as a percentage of their total stockpiles close to the lowest level since the 1990s, International Monetary Fund data show.
That may have helped fuel the rush into dollars that occurred as the coronavirus pandemic spread in March, so the next IMF release could reveal a rebound in dollar holdings. But the severity of that dash into the U.S. currency helped drive up volatility in currencies such as the Australian dollar, Korean won, and Mexican peso when the Federal Reserve waited four days after taking emergency liquidity actions on March 15 to extend swap lines to those nations.
The Fed has added almost US$3 trillion to its balance sheet since February. Traders have bet Chair Jerome Powell would follow the central bank’s prolific quantitative easing program by cutting benchmark rates below zero. Though he has said that’s not appropriate for the U.S., he’s declined to specifically rule it out. Add a federal budget deficit that’s set to triple to US$3.7 trillion, and you have reason to doubt the dollar as a long-term store of value—a crucial factor for any currency, let alone a global reserve currency.
“The fact that the global financial system runs on dollars and that the Fed is central to its operation—those things haven’t changed, and those facts have been underscored and reinforced in the early stages of the crisis,” says Barry Eichengreen, a professor of economics and political science at the University of California at Berkeley. “At the same time, I think what the crisis and those dollar-related facts have raised are renewed concerns about the mismatch between the dollar-centric international financial system on the one hand and a multipolar world on the other. That’s an uncomfortable situation.”
While it seems hard to imagine the dollar losing its place as the world’s reserve currency, a glance at history tells us it’s far from impossible. The Dutch guilder filled the role in the 17th and 18th centuries, before the Spanish dollar took over, followed by the pound sterling from 1860 until at least 1914. In each case, the nation’s domination of global trade and finance was key to the currency’s status, though central banks and regulatory maneuvers played a role.
The dollar still dominates currency reserves and transactions, but its power is weakening. In global trade, the U.S. lags behind the euro zone and China in overall volume of exports and imports, IMF data show. So it seems like a good time to review the leading alternatives to the dollar, even if none appears ready to knock it off its perch just yet.
“Money is gold, and nothing else,” John Pierpont Morgan testified to the U.S. House of Representatives’ Bank and Currency Committee in 1912.
PROS: Gold’s allure as a global reserve currency is that it can’t be written into existence. That removes the risk that the government rolls its printing presses to fund spending, a practice that’s brought on hyperinflation and destroyed currencies throughout history.
The only way to increase the global supply of gold is to dig up more. That’s difficult and expensive, leading to remarkably stable long-term inflation rates. A favored anecdote is that an ounce of gold bought the same amount of bread (350 loaves) in the Babylon of 562 B.C. as it did in 1998, when economist Stephen Harmston took a look into the metal’s properties as an inflation hedge.
Gold is also free of counterparty risk. Fiat currencies derive their value from the creditworthiness of the issuer. That means their value can be eroded by economic or political policies pursued by the country or group of countries that backs the currency. Gold, by contrast, has an intrinsic value. Not only is it a sought-after ornament, but it’s also useful as an inert, pliable electric conductor. These attributes prevent its value from falling to zero.
CONS: Gold’s scarcity removes a key central bank policy tool. If central banks can’t control the money supply, they can’t respond to changes in aggregate demand. Adherence to the gold standard has been blamed for exacerbating deflation and causing the Great Depression. Most of the world’s governments abandoned gold-based money systems over the past century to gain flexibility in managing economic difficulties.
In the modern world, where money moves at the speed of light, sending shipments of gold to settle sovereign debt has become impractical. —Eddie van der Walt
The Japanese Yen
PROS: The yen has ranked among the world’s top reserve currencies for decades. It made up almost 6 per cent of official foreign exchange reserves last year. Japan’s US$9.5 trillion sovereign debt market trails only the U.S., data from the Bank for International Settlements show, providing investors with access to a deep liquidity pool.
Japan’s self-reliance is also a draw. The country has persistent current-account surpluses and the world’s largest savings pool. Japanese households held 1,903 trillion yen (more than US$17.5 trillion) of assets at the end of 2019.
CONS: The Bank of Japan’s massive asset purchases—the central bank owns almost 44 per cent of the nation’s debt, far outweighing the Fed’s or the European Central Bank’s bond buying—have distorted markets. Negative interest rates have failed to overcome persistent deflation, damping the appeal of Japanese assets. The yen slid as a proportion of global reserves after the BOJ introduced quantitative and qualitative monetary easing in 2013, though it has clawed back some market share.
Japanese policymakers may resist anything that causes strong currency appreciation, preferring to keep its exporters—the backbone of its economy—competitive in world markets.
THE BIGGER PICTURE: The nation’s economy has been eclipsed in the past decade by China. Japan’s rapidly aging and shrinking population has contributed to an economic slowdown, and even negative interest rates haven’t shaken its tendency toward high savings and low investment. Prime Minister Shinzo Abe has pursued reforms designed to restore growth, known as Abenomics. To make up for the labor shortage created by the shrinking workforce, the government has welcomed foreign workers. Still, cumbersome immigration policies have kept their numbers limited to 1.5 million in 2019.
Japan’s wariness about yen strength could be the biggest obstacle for the currency. In 2011 the country sold more than 14 trillion yen (worth about $185 billion at the end of that year) to halt a surge to a post-World War II record of 75 yen per dollar. —Ruth Carson and Chikako Mogi
Special Drawing Rights
PROS: The appeal of Special Drawing Rights, or SDRs, lies in their international pedigree. They were created—and are backed—by the International Monetary Fund.
In that sense they match the multipolar nature of the world economy. They’re accessible to almost all nations and are based on an adjustable basket of key currencies. Wider use of SDRs as a reserve currency would reduce developing economies’ need for foreign exchange reserves as “self-insurance.”
SDRs became a go-to reserve asset when the dollar fell 34 per cent vs. the yen and 23 per cent against the deutsche mark in the two years ended Dec. 31, 1978. And from 2009 through 2011, the IMF boosted the SDRs available to member nations to ensure adequate global liquidity.
CONS: In their current form, Special Drawing Rights can’t be used as a direct medium of exchange. Countries receive allotments from the fund, but they need to sell the SDRs to another country, or the IMF, to obtain actual currency. Outstanding SDRs were worth only US$281 billion as of March 2020, a fraction of the US$11.8 trillion of total central bank reserves.
The IMF’s role gives the U.S. effective veto power over SDR allocations. And there’s no central bank to redress imbalances. Suspicion of the IMF has increased around the world amid a growing awareness of the downsides of globalism. So a currency explicitly backed by the institution could be a political nonstarter.
THE BIGGER PICTURE: SDRs were set up in 1969 as a reserve asset that could act as a substitute in case of a shortfall of dollars. Unlike most dollar rivals, the SDR was explicitly designed as an alternative to the U.S. currency.
“The SDR—created 50 years ago to supplement IMF member countries’ official reserves—is the only true global money, backed by all IMF members,” Jose Antonio Ocampo, a professor at Columbia University who previously served as finance minister and central bank board member in Colombia, wrote on the fund’s website last year. “A more active use of this tool would significantly strengthen the IMF’s role as the center of the global financial safety net.” —Garfield Reynolds
PROS: From its birth at the dawn of the millennium, the euro inherited the deutsche mark’s position as a key rival of the dollar. Its standing has grown with the expansion of the euro zone to 19 countries.
Today the euro is used in a third of all foreign exchange transactions, behind only the dollar. The bloc accounts for almost half of global trade, and its economy is tied for second place with China at about US$13 trillion. (The U.S.’s economy is worth US$20 trillion.) The euro is the second-most-widely held currency in foreign exchange reserves, and the euro zone has the third-largest sovereign debt market, behind the U.S. and Japan.
The euro has its own central bank, and as a currency used by a diverse set of sovereign nations, it’s a more multilateral medium of exchange than the dollar.
CONS: The euro is still recovering from a near-death experience. In 2011 to 2013, policymakers in Greece and Italy came close to exiting the shared currency rather than accepting the austerity measures attached to bailout packages.
That highlighted a flaw in the euro: the lack of a shared fiscal policy to match the European Central Bank’s monetary powers. Richer countries in the north didn’t want to subsidize the poorer nations in the south. Until there’s a solution to that, the currency will struggle to challenge the dollar’s credibility among world markets.
The region’s relatively weak economic performance, often blamed on bureaucracy and a lack of innovation, also limits the currency’s appeal.
THE BIGGER PICTURE: Europe has a habit of taking key steps only when on the brink of collapse. The European Union in July agreed on a €750 billion (US$857 billion) recovery fund, to be paid for by selling debt on behalf of the 27 member states. That debt could one day rival U.S. Treasuries, boosting demand for the euro and fulfilling the long-held dreams of policymakers who want a more integrated Europe. The U.S. bond market, which has long seemed impervious to growing government deficits, could be punished by investors known as bond vigilantes if they felt they had another option.
“The only thing that can make U.S. bond vigilantes return is a viable alternative to Treasuries or the dollar, and the EU just took a major first step toward producing one,” Tom Essaye, president of Kinsale Trading, wrote in a note to clients. It’s not a problem for now, he said, but “the euro could challenge the dollar.” —John Ainger
The Chinese Yuan
The yuan’s rise is all about the way China has transformed itself into an economic superpower to rival the U.S.
PROS: China has overtaken the U.S. to become the single largest trading nation, while the IMF estimates China’s gross domestic product overtook the U.S.’s weight in the world economy in 2014, based on purchasing power parity.
The nation’s policymakers are determined to raise the currency’s profile, promoting direct trade settlements with Russia and other nations and pushing to add yuan-denominated bonds to major debt benchmarks (including the Bloomberg Barclays indexes). Stock market links with Hong Kong and the Bond Connect program make it possible for global investors to purchase yuan-denominated assets. In March foreign holdings of debt and equities denominated in yuan rose to a record 4.2 trillion yuan (US$600 billion).
In 2016 the yuan was added to the basket that underlies the IMF’s Special Drawing Rights, an official recognition of its use as a reserve currency. Crude and iron ore futures also now trade in yuan, boosting its value on world markets.
CONS: China’s capital controls present a hurdle. Officials tightened their grip when a shock currency devaluation in 2015 led to an accelerating exodus of funds. The yuan’s value is still closely managed by Beijing, primarily through the central bank’s daily reference rate. The People’s Bank of China’s use of a wide range of monetary policy tools makes the money markets opaque and alienating to outsiders.
As a result, the yuan’s global footprint remains tiny relative to China’s economic power. The currency’s share of global payments has stagnated at about 1.8 per cent, according to the Society for Worldwide Interbank Financial Telecommunication (Swift). The yuan makes up about 2 per cent of global FX reserves and accounts for just 4 per cent of foreign exchange transactions.
THE BIGGER PICTURE: The government is signaling change as it seeks to open China’s financial markets. The PBOC issues an annual report on the internationalization of the yuan, and the government is eager to showcase international cooperation, including its “Belt and Road” investment initiatives. While the yuan has a very long way to go to compete with the dollar, the way the nation surged in the 2000s to become the world’s largest consumer of raw materials shows its capacity for transformation. —Tian Chen
The newest dollar rivals are a bewildering array of decentralized digital tokens, which include Bitcoin, Ether, Tether, Bitcoin Cash, and others. Notoriously volatile and prone to manipulation, they have become infamous for their use in illicit transactions. But the technology behind them—and its potential ability to reorder global finance—has gained influential proponents, including former Bank of England Governor Mark Carney, Fidelity Investments Chief Executive Officer Abby Johnson, and Facebook Inc. CEO Mark Zuckerberg.
PROS: Like gold, cryptocurrencies aren’t fiat currencies, so there’s no government with the power to print them. Unlike gold, there’s no need for physical storage, electronic transfers are easy, and encryption offers relative anonymity.
CONS: Cryptocurrencies have proliferated into myriad coins and permutations of those coins created by splits and forks, meaning that relatively few are being widely adopted as a means of exchange.
The best known, Bitcoin, has been particularly volatile. It spiked to almost US$20,000 in late 2017, only to plummet to just above US$3,000 about a year later, undermining digital currencies’ claims to being a reliable store of value. Crypto’s role in criminal enterprise, where it’s prized for the anonymity it offers users, has hurt its reputation. So have hacking incidents that cost investors their digital fortunes.
THE BIGGER PICTURE: Digital assets have captured the attention of policymakers around the world because of the threat they pose to governments’ power over money. Regulators fret that tokens could move a large swath of economic activity out of their view. The Chinese government, which was early to ban cryptocurrencies, now has a pilot program for an official digital version of its own currency.
There are more than 5,000 tradable cryptocurrencies on Coinmarketcap.com. The largest and eldest, Bitcoin, was invented in 2008 and now has a market capitalization of more than US$150 billion. Proponents say the technology has staying power, despite the volatility that plagues the currencies.
“At the end of the day, trust is really getting broken in the traditional financial system—that’s the theme. The less trust you have in the dollar, the more you want alternatives,” says Tom Lee, co-founder and head of research at Fundstrat Global Advisors. “More and more people are saying, ‘You know what? It’s not such a bad idea to be decentralized.’ ” —Vildana Hajric
Reynolds is Asia Markets Live team leader in Sydney. Van der Walt is an editor on the Markets Live Europe team in London. Carson is a senior FX/rates reporter in Singapore, and Mogi reports on FX and bond markets in Tokyo. Ainger covers bonds in Brussels. Chen covers China markets in Hong Kong. Hajric covers cross-asset markets in New York.