What will replace the dollar? — Forecasting — Quartz
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What would it take for global trade to bypass the US financial system? Perhaps the shock of the Russian invasion of Ukraine.
It looks like this, according to Zoltan Pozsar, bond market strategist at Credit Suisse. Post-pandemic supply chains are tangled, powerful sanctions have cut off major exporters like Russia from the global economy, and commodity prices are rising amid high inflation. In this world, producers of key commodities simply have more bargaining power and will be able to demand payment in their own national currency – or in Chinese yuan, so they can buy more goods from the world’s largest exporter.
“Before, it was as simple as ‘our currency, your problem’. Now it’s “our goods, your problem”, Pozsar written in march. As countries focus on securing stocks of key commodities, dollar demand and dollar debt will fall, and the offshore yuan will begin to dominate global trade.
It’s a convincing picture, but in the short term, unlikely. So far, neither Russia nor China has managed to change the terms of payment for raw materials. And a global monetary system based on durable goods rather than a global currency would be more volatile than most investors would like. As analyst Joseph Politano writing“There’s a reason no major country uses the gold standard anymore.”
Again, no one eats gold or makes electricity with it. Pozsar’s thesis is that the scarcity of oil and wheat will change the dynamic. But oil and wheat remain cheaper than they were at the height of the last commodity boom, although fertilizer prices are signaling more concern. The dollar (and US high-tech exports) may prove more resilient than expected.
A brief history of threats to dollar dominance
Since before World War II, the US dollar has been the dominant global currency, even after the Bretton Woods system was abandoned in favor of floating exchange rates. The prices of most goods and services traded between countries (and their banking systems) are priced in dollars, and investors of all stripes accumulate financial assets in dollars, often US debt, to ensure that they have of foreign currency.
At the turn of the century, the creation of the European Union and China’s entry into the global economy pushed the euro and the yuan forward as potential successors. When these rival economies become larger than the United States, it is believed, their financial gravity will usurp the role of the American financial system. Overall, that hasn’t happened: in 2021, the dollar accounted for 59% of global foreign exchange reserves, while US GDP accounted for about 20% of global output.
Recent search shows that most of the currencies supplanting the dollar come from countries close to the United States, such as Canada, Australia and South Korea, with central banks that benefit from the United States Federal Reserve’s international dollar swap lines.
The euro and the yuan have their drawbacks, According to Federal Reserve economists: The first still sits uncomfortably atop a confederation of independent states, not a single fiscally integrated government, with unpredictable results, as Brexit has shown. China, on the other hand, does not allow its currency to be freely traded or managed independently.
Even if Beijing took the necessary steps to make the yuan widely attractive to investors, such as opening up its capital account, it would still be an autocratic government with all the risks that entails. The uncertainty surrounding the fate of a struggling company like Evergrande would not do well applied to a monetary scheme.
What about electronic money?
Bitcoin, Ethereum, and other crypto-based digital tokens are popular candidates to compete against the dollar (at least among people who have a lot of money invested in crypto). Besides slow transactions and questionable security, the big problem is simply liquidity: there is not enough to sustain global trade.
At press time, all cryptocurrencies in the world are worth around $1.8 trillion. That’s a lot of money…but in 2021, foreign investors alone held $7 trillion in tradable Treasury securities, only a third of total issuance. This suggests that it will take a lot more crypto-denominated assets before it plays a serious role in trading. On the other hand, there is $25 billion in Swiss Francs held as foreign exchange reserves, so perhaps the right cryptocurrency could end up in international wallets.
But central banks could get ahead of decentralized projects. Efforts to develop government-backed digital currency, such as the U.S. electronic dollar and Chinese e-CNYcould overcome the hurdles facing private digital currency.
There is no doubt that the extraordinary dominance of the dollar is likely to fade. But investors have expectations of a reserve currency: stability, security, value and liquidity. Until another currency can offer all four, it’s hard to see the dollar being supplanted. The question is which alternative can do this, or perhaps more realistically which of the multiple trading currencies will bridge the gap together.
Some observers, like Poszar, are convinced that China will continue to liberalize its financial institutions to truly internationalize the yuan, or that new Cold War dynamics will force countries to choose. Others believe that some combination of inertia and US institutions doing enough to respond to changing economic trends will keep the dollar at the forefront of world trade. Ultimately, the fate of the dollar will be decided by politics.
📣 Sound off
What will replace the dollar?
Have a good week,
—Tim Fernholz, senior reporter (which is dominated by the dollar)
A 💵 thing
Why do we value the dollar? Forget the full faith and credit of the US government – sometimes the bills look cool. the Del Mount $20so nicknamed because a banana sticker stuck to paper during printing, was discovered in an ATM in 2004 and sold at auction for almost $400,000 in 2021.
It’s nothing compared to the “Great Watermelon$1,000 Treasury note, printed in 1890, which collectors love for its rarity and huge stylized zeros that look like watermelons. One such ticket sold for $3.3 million at auction in 2014.