Does Ukraine mark the end of US dollar dominance? Yeah, heard that before…
Is it ‘times up’ for America?
America has sat at the top of the geo-political food chain since the end of the second World War.
But, as every pundit likes to remind us, no empire lasts forever. And maybe America’s time is up. They’re done and dusted.
Maybe. I’ve been hearing something along these lines for 40 years now. Maybe one day it will be true.
And right now people are saying that America has pushed things too far with the sanctions on Russia.
A big part of that story is the way that America coordinated with other Western nations and effectively locked Russia out of the global financial system.
The argument goes that other countries will be watching closely, and will be even more inspired now to end ‘dollar dominance’.
I’m not just talking about hack academics in China either. Just last week, Gita Gopinath, first deputy managing director of the International Monetary Fund said that the US risked fracturing the economic order it sits at the top of:
“The dollar would remain the major global currency even in that landscape, but fragmentation at a smaller level is certainly quite possible,” she told the Financial Times.
And Saudi Arabia is now in talks with China about receiving payment for oil in Yuan directly. (Currently 80% of oil transactions occur in USD).
But what are we actually talking about here?
Lets unpack dollar dominance and geo-political dominance. This is something I see people confuse all the time.
Yes, the US dollar is the world’s reserve currency. It’s the currency the world sets international prices in, and it’s the go-to currency for international reserves.
And it provides the world with liquidity. If I want to exchange Argentinian pesos for Malaysian Ringgit, I’m going to struggle to find someone to get on the other side of that trade.
But if I’m willing to turn those pesos into USD first, then I’ll find a lot of people willing to swap Ringgit for dollars.
This liquidity helps the gears of international finance turn and keep turning.
And what does the US get for the privilege of owning the world’s reserve currency?
Not much.
The usual argument is that because foreigners are buying up US treasuries to hold in reserve, that lowers US government borrowing costs.
Well, if that were true, the rates on US Treasuries would be degrees cheaper than any other countries debt. That’s not true. Japanese bonds pay less than treasuries.
The second supposed benefit is that it allows US consumers to live beyond their means. And maybe that’s true.
But the price they pay for the privilege is a higher US exchange rate and the hollowing out of the domestic economy (as productive assets are sold to balance out the capital account.)
Some privilege.
And if it were a privilege, other countries would be competing for it. But they’re not. In 2011, a bunch of Latin American nations decided to diversify their reserves into Japanese Yen.
Japan was horrified. They quickly took the money they got and converted it into US dollars in order to make it America’s problem.
So let’s get clear about the causation.
Owning the world’s reserve currency is a pain in the bum.
The USD is the world’s reserve currency because the US is powerful. Not the other way round.
And if other countries want to step up and take on reserve currency status, I’m not really sure the US would fight them all that hard on it.
But who’s going to do it?
Europe? – doesn’t have the bond market deep enough after the sovereign debt crises over the past decade.
China? They don’t even have an open capital account. You can’t move Yuan.
No, no one’s going to do it because, for the moment, America is the only country in the world powerful enough to shoulder the burden of being responsible for the world’s reserve currency.
And that’s a reality that’s just not changing any time soon.
JG.
Very interesting analysis.