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Guest Post by Jeremiah Jackson, Ph.D.
The U.S. dollar will someday lose its status as the global reserve currency, but it is delusional to think that this will happen on a timescale short enough to affect domestic politics.
Those who anticipate a collapse of the dollar often subscribe to an “imperial” theory of currency zones. They argue that the U.S. dollar is held by other countries because the U.S. military implicitly (and perhaps occasionally explicitly) threatens foreign banks or governments: “If you don’t use our currency, we will give you the Qaddafi treatment.” The people who hold this view essentially believe that military power underlies U.S. dollar (USD) hegemony and that our allegedly deteriorating military capabilities and recent losses portend a wider depreciation of the dollar.
As the conflict in Ukraine suggests, this view is obviously false on a short time horizon. First, the premise is probably false: the U.S. remains the world’s preeminent military hyperpower. Russia cannot project power more than a few hundred kilometers outside of its borders. China’s ongoing demographic crisis rules out a military reconquest of Taiwan in the foreseeable future. Second, for the sake of argument, let us concede that the U.S. military capacity is on a relative decline: the dollar has continued to rise relative to the Euro and the Chinese renminbi even after the U.S.’s ignominious withdrawal from Afghanistan. The U.S.’s attempts to remake the Middle East are a clear signal of imperial insanity if ever there was one, but the USD has continued to appreciate against its competitor currencies. But how does this argument hold up when projected into the longer time horizon, to, say, 2030 or 2050?
If history is any guide, a country can continue to maintain its status as the global reserve currency long after its economic and military power has diminished relative to peer nations. Consider the previous global reserve currency, the U.K.’s gold-backed pound sterling. Even as the U.K.’s relative economic and military power declined, it took World War II and a complete restructuring of the financial system (orchestrated by the U.S.) to displace the pound as the top foreign currency holding. This historical perspective seems to suggest an alternative perspective to the “imperial view” described above. The more likely possibility is that foreign nations do not hold dollars principally due to some immediate or implicit threat of military force, but simply because it is most convenient to hold dollars. It is convenient to hold dollars, in turn, because they can be used for a variety of international financial and trading activities, because most countries held dollars yesterday, and are expected to do so tomorrow, especially when the alternative is holding crappier local non-USD currencies.
From the fall of the Soviet Union until recently, the global financial order has presented the U.S. with a falling real interest rate. Combined with a currency that is accepted globally, the truly massive demographic and financial debts of the U.S., can be refinanced indefinitely. The U.S. simply issues larger Treasury bond holdings at lower real interest rates, knowing that foreign governments are willing to hold them for their utility as an “approximately” risk-free source store of value and for these instruments’ utility in international finance and trading. It is the empirical fact of apparently lucrative borrowing in one’s own currency over the last thirty years that underlies the Biden administration’s confident experiments in fiscal irresponsibility. If you talk to intelligent economists who endorse “Modern Monetary Theory,” you often find that it boils down to the above fact and does not contribute a single new insight that would justify the Biden administration’s recent fiscal choices. Nonetheless, unemployment is falling, real wages are only falling slowly, and the U.S. appears in no risk of a depreciation-driven debt crisis). What could threaten this sweet state of affairs?
First, very high levels of inflation would make dollars far less useful for trade and exchange. “High” is obviously in the eye of the beholder, but the 10% levels we are currently facing in the Biden regime does not cut it, particularly with the EU facing similar inflation levels. Even dubious Biden Fed confirmations have not yet triggered the type of price-wage-deficit spiral that would mechanically threaten USD hegemony by eroding the real value of dollars held by foreign banks and governments relative to other exchangeable assets.
A 2022 report by the U.S. Federal Reserve Bank of NY finds that:
Approximately half of all cross-border loans, international debt securities, and trade invoices are denominated in U.S. dollars, while roughly 40 percent of SWIFT messages and 60 percent of global foreign exchange reserves are in dollars.
If we think of the global reserve currency as emerging from an equilibrium in which most countries hold dollars because the alternatives are worse, then one can see why more inflation would be needed than you think to dislodge the U.S. as the global reserve currency. The insane energy prices you see in Europe, the disastrous experiments in 21st century socialism in Latin America, and hyperinflation in Zimbabwe support an equilibrium in which the dollar and short-term Treasury holdings are the single best liquidity instrument for someone with a global investment outlook. Of course, one should never hold only U.S. dollars, but it would be bizarre to imagine a portfolio without them. Indeed, Ecuador, El Salvador, Zimbabwe, Timor-Leste, Panama, and numerous other third-world countries presently use the U.S. dollar as their primary unit of domestic exchange for its relative stability compared to the (sometimes hypothetical) local currency issued by their (sometimes hypothetical) central bank.
Still, extended periods of inflation are possible. The lush benefits granted the baby boomers under Medicare and the poors under Medicaid represent massive and growing unfunded liabilities, as do state-level pensions. It is possible to imagine a retirement-driven fiscal crisis becoming a monetary crisis. The problem for those who fantasize about global collapse this way is that it is extremely easy in principle for a government to solve it: simply raise the eligibility age for benefits. It turns out small increases in the eligibility age (say, 1 – 3 years) are sufficient to massively reduce the debt burden. A larger (5 – 6 year) increase in the eligibility age is sufficient to eliminate shortfalls in toto. The challenges associated with strategy are essentially political and not a matter of technical economics, which is clear on the matter.
A second threat to USD supremacy could emerge in the form of an alternative, more convenient global currency regime maintained by a foreign or private power. This is a more serious threat. Consideration of it requires a macroeconomic discussion of what global currency regimes actually do as well as the U.S.’s global payments system, SWIFT.
Although the U.S.’s global reserve currency status creates longer-term benefits in the form of subsidized borrowing rates and consumption of foreign goods, it creates short-run costs for important domestic players. It was not uncommon in the 1980s through the 2000s to hear manufacturers and those aligned with the U.S. manufacturing system complaining about how the relative strength of the U.S. dollar disadvantaged them in their negotiations with Chinese, Japanese, and European purchasers. Other contenders for the status of global reserve currency may worry that, in having their currency adopted as a global reserve, they will lose control over the relative prices of their exports in the short-term.
Because Chinese and especially European countries rely on manufacturing exports to boost (short-term) domestic employment, conventional wisdom holds that these countries are especially hesitant to push for international financial regime change compared to the status quo, which historically privileged Chinese and European industrialists via the relative weakness of their currency. Local governments, major purchasers like Walmart, the education and health industry, and intermediate purchases in the global supply chain benefit from the USD as a global reserve currency and are unlikely to benefit from a move to a more complex or multipolar regime. On the other hand, the vanishing of non-defense manufacturing exporters as major independent interests in the U.S. reinforces the current political equilibrium within the U.S. In this equilibrium, the U.S. dollar is valued by citizens primarily for its purchasing potential.
The SWIFT system is the premiere system for international exchange in the USD and most compatible with large USD holdings. It is essentially a telecommunication system between banks that allows for easy and quick exchanges in dollars and euros and other secondary currencies. Over the last few decades, the U.S. government has weaponized the SWIFT system, banning individuals and more recently entire countries from its use via the use of targeted sanctions. The widespread sanction policies, in turn, reduce the utility of dollars to these countries since they must then engage in more costly bilateral exchange for their day-to-day operations. Concretely, consider a company that owes a bank debt repayments. Under SWIFT, that company can work with any local bank in the local currency and be assured that its payment will be documented by the recipient bank. Without SWIFT, that company must find a way to ensure that its currency is exchanged at a favorable rate and that the bank receives the payment that the company has sent. When the bank and company are headquartered on different continents and time zones, this can be quite difficult. Given the politicization of the SWIFT system, unsurprisingly, numerous challengers to the SWIFT system have emerged in recent years. Russia has deployed the SPFS, an apparently cheap alternative to SWIFT. China has pushed forward development of CIPS, a native-Chinese alternative.
To stretch the military analogy, it is convenient to think of the global reserve currency as a defensive weapon enabling the U.S. government to borrow cheaply during times of trouble and one which basically strengthens the purchasing power of U.S. consumers. Under the current system, a general global panic actually strengthens the dollar, as global investors rush to purchase medium-term Treasuries absent a reliable “risk-free” alternative. On the other hand, SWIFT is an offensive weapon masquerading as a neutral transactions platform. They together support the current equilibrium, but affect the U.S.’s foreign-policy orientation in fundamentally different ways. It is possible to imagine a world in which transactions were painless because of continued advances in transaction technology. Indeed, the continued development of the SPFS and CIPS’ systems have the potential to severely limit the effectiveness of U.S. sanctions. Even in this world, the dollar could remain the global reserve currency simply because it was the global reserve currency yesterday, and will be expected to remain so in the future.
Another possibility is that, as transactions become easier in the SPFS and CIPS’ systems, central banks and private actors might find it more convenient to hold and transact in Russian rubles or Chinese Yuan supported by these systems. This remains a more distant possibility for several reasons. First, SPFS is simply not as fast as the SWIFT. Banks of all kinds prioritize speed for transactions because stale prices cost them money. The Chinese CIPS, which is faster than the SPFS, has about 1% of the dollar volume of the SWIFT and only began to significantly expand its international services last year. The mere existence of these alternatives, which were not possible prior to the global diffusion of financial technology innovation of the last decade, has altered history. For instance, although the SPFS is not widely used outside of Russia, its use within Russia has so far enabled the Russians to avoid an internal collapse under the weight of U.S. sanctions.
Indeed, on closer inspection, the major barrier to the displacement of the USD as a reserve currency is simply that other contenders have historically either not wanted or not been capable of managing the burdens associated with managing a global reserve currency. It is common to read stories about how two countries have adopted one of their own currencies for bilateral trade rather than trading in the U.S. dollar, but this is the exception rather than rule. The U.S. dollar remains the default. As a measure of the strength of the dollar, we might contrast the number of countries outside of the U.S. adopting the dollar for domestic transactions, listed above, with the number of countries adopting other potential global currencies.
Only a few small former colonies of Europe and aspirants to the Euro use the Euro as their primary domestic currency. Outside Russia, only Belarus uses the Ruble. The currency most likely to eventually displace the dollar, the Chinese Yuan, has no adopters outside China. Furthermore, the Chinese have passed up clear opportunities to ensure that its currency is more widely adopted. For instance, defaulting countries could be compelled to make payments in Yuan on the One-Belt-One-Road set of projects. Instead of collecting those payments or extracting concession that would privilege the Yuan, e.g. insisting on bilateral trade in Yuan, or pushing small countries to adopt the Yuan as a currency, China has simply written off the debt in several cases. Similarly, China has maintained high holdings of U.S. dollars, a stance inconsistent with a singular drive to replace the US as world reserve currency. From the perspective adopted here, the “late” expansion of CIPS, the Chinese write offs of debt owed and the Yuan remaining pegged (usually via U.S. dollar purchases) rather than floating all represent consistent components of China’s current monetary strategy.
The U.S. sanctions regime, if it continues to expand, may inadvertently push China into displacing the USD simply because China wishes to do business with individuals and countries on the longer-and-longer sanctions list. The level of incompetence required to bring about this outcome would surprise even me. China tends to telegraph its moves on international monetary and trade policy years in advance, making this the most easily-avoided outcome in the medium-run. The logic for the E.U. is essentially the same. Indeed, under its current energy policies, it is simply impossible to imagine a rapidly depreciating Euro replacing the USD as the most widely held global reserve even with the will and determination to do so.
Still, all central banks, including the U.S. Federal Reserve, see dark clouds on the horizon. The more competing currencies there are with the U.S. dollar, the more constrained central banks will be in their attempts to control the currency’s value. In the limit, economic theorists have worried that the Fed will lose the ability to affect domestic interest rates in the face of widespread cryptocurrency holdings. Although at current volumes neither cryptoassets nor Chinese Yuan threaten the USD’s status, it is a safe bet that central banks around the world will expand their holdings of both Chinese Yuan and cryptoassets going forward to attempt a hedge against the (slightly) increased possibility of a dollar collapse. These possibilities have pushed the US central bank to begin experimenting with digital currencies, which are publicly justified on their ability to reduce the risk associated with digital currencies and transaction costs. Central bank digital currencies (CBDCs) reduce risk by being backed in the same way that the USD is backed by the Fed. CBDCs can potentially reduce transaction costs by allowing all payments and exchanges within the Fed itself. Unfortunately, in the current political environment, CBDCs are overwhelmingly likely to be used for nefarious ends like terminating bank accounts, mass surveillance, and the fining of dissidents and their allies.
What are patriotic Americans to do? First of all, stop fantasizing about dollar collapse. It is not enough for the federal reserve or Treasury to screw up, it must screw up significantly worse than other countries’ governments for it to be displaced as the global reserve currency. This is a tall order. The U.S. is mostly a consumption economy and at this point lacks the type of strong manufacturing sector that would advocate domestically for a more “multipolar” currency regime. Absent unprecedented action by China or Russia, international monetary events will not disturb the domestic balance of power and these countries seem either incapable or uninterested in knocking the USD from its position of privilege. Given the dramatic decline in US standard of living, rampant corruption in government, and seemingly ubiquitous incompetence wherever one looks, it is incredibly tempting psychologically to infer from this an imminent apocalyptic scenario. As bad as the monetary apocalypse sounds, it has a certain appeal of restoration, of justice being done—a reckoning for a system that is fundamentally illogical, clownish, and evil. For better or worse, the conditions just aren’t there for an imminent apocalypse — at least a monetary apocalypse that would unseat the global preeminence of the US dollar anytime soon.
Instead of engaging in international monetary speculation, America First patriots should devote their limited political capital to banning the Fed’s CBDC experiments, terminating overzealous sanctions, and perhaps most importantly attempting to prevent politics-driven financial deplatforming. When it comes to finance, there are too many domestic policy problems and opportunities at home to justify much attention to potential black swans abroad.
Dr. Jeremiah Jackson is the pseudonym of a former U.S. Treasury official now working as an economist in the private sector.