In the last post we discussed why Libra’s pretensions toward a new global reserve are facing many headwinds, to put it mildly. In this post, let us look at the current global reserve currency, the US dollar, and its status and role in the global economy.
THE RISE OF US DOLLAR AND ITS DOWNSIDE
After the proposal for an independent currency that would be managed by the IMF, Bancor, was rejected by the United States, the de facto world superpower after WWII, the US dollar supplanted the British sterling as the currency for international settlements. This placed the US in a unique position, creating an artificial demand for its currency as countries needed it not only for buying US goods, but to participate in international trade as well.
Given that the US was an industrial powerhouse at the time of this decision, it was difficult to imagine that the value of the US dollar against other currencies pushed up by its new global status would one day work against the industrial base of the country. When US companies started relocating their facilities abroad in the 1990s, the difference in wages between US and China or Mexico played a major role in their decisions.
Without its global reserve status, this difference would still exist, but on a smaller scale. One wonders if a narrower gap would have led to a relocation of industry to an extent as to produce a deindustrialized zone like the Rust Belt. It is worth noting that domestic industry would be in a better position with a weaker Dollar, as exported goods would be cheaper to the rest of the world.
Many commentators have been expecting the interest rates on US sovereign bonds to skyrocket due to the ever growing debt burden, currently around 12 trillion dollars. When this doesn’t happen they point at the privilege of its global reserve status as an explanation. However, this is not a complete picture. For example, look at Japan. With the largest government debt in the world, the interest rate has been close to zero for the last 15 years. It seems the relationship between debt and interest rates is not necessarily strictly an inverse one as we tend to believe.
The current US administration intends to keep interest rates low, so that the Dollar’s exchange rate declines, making exports cheaper. An outflow of capital from the US seeking higher yields in foreign assets should also help bring the exchange rate down.
While devaluing the dollar may bring about the above mentioned effects, one must also take into consideration that the standard of the working class may be affected by having to pay more for imported goods, not to mention the inflation of housing and asset markets as speculators invest cheap money into securities with higher yields, thus executing a sort of arbitrage provided by the Fed’s monetary policy.
If the US dollar suddenly lost its reserve status, we cannot be certain that the interest rate on government securities would shoot to unprecedented highs, but as the dollar fell against other currencies, the country’s ability to import would suffer. At the same time, this gap would not be adequately compensated by the rise in domestic production of goods due to the above mentioned erosion of the industrial base.
US DOLLAR’S GLOBAL DOMINATION UNDER SIEGE
The US dollar is facing an increasingly challenging environment. The UN’s call for a new global reserve currency might have been easy to disregard by the US, but the intent of China and Russia to lessen the strength of the US financial hegemony will be more difficult to dismiss.
More recently, Saudi Arabia has also issued threats to sell its oil in other currencies if the US should apply antitrust laws to OPEC. This threat will likely not be carried through due to tight economic and military ties between the two countries. But even the European Union was nonplussed when the US banned Iran from using the SWIFT payment system. The more the US uses its currency status for geopolitical pressure, the more incentive the rest of the world will have to flee from the US dollar.
CAN A FINTECH REVOLUTION PROVIDE AN ALTERNATIVE?
With the global financial system under strain from financial turmoil and trade wars, the flight from the US dollar hegemony is becoming more and more appealing. Historically, a reserve currency lasted anywhere from 80 to 110 years for different national currencies. But this time there is no super power on the horizon that could easily become a single hegemonic power in the current global system.
Fintech might provide a solution and the basic concept is already operational in Decentralized Distributed Ledger (DDL) technology. The world needs a global reserve currency and yet no country really trusts one another. With improvements in scalability and transaction speed, it will eventually be possible to apply this technology to a global currency where no country could claim jurisdictional authority over its transactions.
A governing body such as a consortium of central banks could govern such a currency, so that no country could use this currency to the detriment of another. A fintech alternative is present, but still in its infancy, and in the future we are likely to see that a step toward a new financial architecture of trust will depend more on political will than on technological know-how.