the g20's coming currency challenge: do we need heirs to the u.s. dollar -- and are there any?

8/6/2019 The G20's Coming Currency Challenge: Do We Need Heirs to the U.S. Dollar -- and Are There Any?

http://slidepdf.com/reader/full/the-g20s-coming-currency-challenge-do-we-need-heirs-to-the-us-dollar 1/6

Summary: It is commonplace to speak of the U.S. dollar’sdemise as the world’s reservecurrency. Along these lines, theU.S.-led nancial crisis of 2008is widely considered a tipping point and the death kneel of thegreenback’s global supremacy.

The general consensus today is that a tri-polar currency world isin the making, with the dollar,

the renminbi, and euro set toemerge as the world’s mostdominant currencies. According

to this narrative, the era of a uni-polar currency world is over. Thisshift is inevitable, but the dollar-centric global monetary order of

the past half century will not beupended any time soon. In theyears ahead, the dollar is likely

to remain rst among equals in amore multicurrency world. There-fore, the most signi cant ques -

tion is this: at what speed will the global economy shift awayfrom the dollar-centric world of

today and move towards a moremultilateral currency world?The answer to this questiondepends on a number of factors.Ultimately, however, the more

the nancial health of Americadeclines, the faster the world willshift away from the dollar-centricglobal economy of the past 60years. These transformationspose new policy challenges for

the G20.

1744 R Street NWWashington, DC 20009T 1 202 683 2650F 1 202 265 1662E [email protected]

Economic Policy Program

The G20’s Coming CurrencyChallenge: Do We Need Heirs to theU.S. Dollar — and Are There Any?by Joe Quinlan

June 15, 2011

Introduction

“Te dollar’s singular status is indoubt” 1—Barry Eichengreen, Exorbitant Privilege

It is commonplace to speak o the U.S.dollar’s demise as the world’s reservecurrency. Te U.S.-led nancial crisiso 2008 is widely considered a tippingpoint and the death kneel o the green-

back’s global supremacy. Te crisis notonly severely damaged the economiccredibility o the United States but alsoshattered the con dence in the dollar-centric global economy. In the yearssince the crisis, a debate has ensuedabout the need or a new internationalmonetary system, one not restingsquarely on the shoulders o the U.S.dollar.

Te general consensus today is that

a tri-polar currency world is in themaking, with the greenback, theredback (the renminbi), and euro setto emerge as the world’s most domi-nant currencies. Te era o a uni-polarcurrency world is over, according tothis narrative, with the United States1 Barry Eichengreen, Exorbitant Privilege: The Rise andFall of the Dollar and the Future of the InternationalMonetary System , New York: Oxford University Press,2011, page 6.

no longer deserving o its “exorbitantprivilege.” Te latter term, o course,comes rom the French who werecritical o the Bretton Wood system

or allowing the United States to printmoney to pay or imports and to undU.S. military ventures overseas. oday,many believe the United States isundeserving o this privilege. Rather,America’s battered scal position andEurope’s simmering sovereign debt

crisis juxtaposed against the capital-rich Chinese economy has set theworld on the path towards a tri-polarcurrency order. Or has it?

Not or the rst time, the generalconsensus about the uture o the U.S.dollar could be wide o the mark. Itis ar too early to write the dollar’sobituary. Granted, countries in theWest — namely the United States,developed Europe, and Japan — are

severely in debt and in the midst o a multi-year period o austerity. Tedeveloping nations, meanwhile, are

ush with capital and desire changesto the existing global monetary order.But the dollar-centric global monetary order o the past hal century will notbe upended anytime soon. Te dollaris likely to remain rst among equalsin a more multicurrency world.




2

The Buck’s Staying Power

A number o actors will underpin the dollar’s world reservecurrency status over the medium-term. One such actor isAmerica’s capital markets, among the deepest, largest, andmost innovative in the world. Tis gives the dollar a built-incompetitive advantage relative to other currencies — or assome say, the power o incumbency.

Notwithstanding the “Made in America” nancial crisis,the United States remains at the core o the global capitalmarkets. America is not only a global titan when it comes tototal bank deposits, government debt securities, corporatedebt, and equities, but is also at the ore ront o nancial

innovation and expanding nancial services.Another support o the dollar: global trade remainspredominantly denominated in U.S. dollars, with more than80 percent o world trade estimated to be invoiced in U.S.

dollars. Tis is despite America’s declining share o globaltrade over the hal century. As noted by Barry Eichengreen,more than 80 percent o South Korea’s and Tailand’s tradeare priced in dollars — notwithstanding the act that only 20 percent o their exports are destined or the UnitedStates.2 In the aggregate, the U.S. dollar is used in 85 percento all oreign exchange transactions.

It is the widespread global use o the dollar that givesthe greenback more staying power than most observers

2 Ibid, page 2.

recognized. o this point, key commodities like petroleum

continue to be invoiced in dollars despite grumblings romsome Middle East states over the steady decline in the value o their petrodollars. Tere has been increasing talk o creating petroeuros, but just talk. Te status quo in theMiddle East pivots around oil being priced in dollars anddollar-pegged currencies — a decades-old arrangement inthe Middle East that continues in exchange or U.S. military protection.

In addition to the above, there are a host o other variablesthat continue to underwrite the global supremacy o theU.S. dollar. Notably, the dollar’s dominance re ects the act

the U.S. economy is the largest, most productive, and resil-ient economy in the world. While much has been made o the rise o China in recent years, total U.S. economic output($14.7 trillion) was more than twice China’s $5.8 trillion.Granted, based on purchasing power parity metrics, the gapis not that wide. But this still does not subtract rom the actthat the U.S. economy remains one o the most dynamic inthe world.

Te dollar’s supremacy mirrors other unappreciated attri-butes o the U.S. economy. For instance, the United Statesremains among the top manu actures o goods in the world,

with a global share o roughly 17-18 percent in 2010.3

TeUnited States is the world’s largest exporter o goods andservices, and reins as the world’s most avored destination

or oreign direct investment (FDI) and port olio ows. TeUnited States is a magnet or oreign port olio thanks to itslarge and transparent capital markets; meanwhile, America’swealthy consumer base, skilled labor pool, world-class tech-nology capabilities, and protection o intellectual property rights support the United States as a prime destination o FDI. Last decade, or every $1 China attracted in oreigndirect investment, the United States attracted $3. Te moretrade and FDI conducted with the United States, the more

the demand and stature o the U.S. dollar.Te buck is also supported by the act that when it comes totechnological innovation, the United States ranks numberone in the world. Te United States is also home to nine outo the top ten consumer brands in the world (so power)

3 Data on global manufacturing comes from the United Nations

Table 1: Key Dollar Supports• Largest, most productive economy in the world• Large, deep capital markets• op exporter in the world• Number one destination or oreign direct

investment• op-ranked manu acturer• Global technology leader• op global brands (so power)• Sole military superpower (hard power)• Global trade invoiced in dollars• Few alternatives to dollar




3

and the number one military power in the world

(hard power).Considering all o the above, it is little wonder theU.S. dollar remains the world’s primary reservecurrency, the world’s only true internationalcurrency. Tis does not preclude other currencies

rom gaining importance in the years ahead, but atworse, the dollar will remain rst among equals orthe next decade or so. A snapshot o the holdings o central banks speaks to the staying power o the U.S.dollar.

The Future Has Yet to ArriveTe U.S. dollar remains the currency o choiceamong central banks. Based on data rom the IMF,o allocated global reserve holdings o central banksin the ourth quarter o 2010 — approximately $5trillion — 61.4 percent were held in dollars. Tat share wasroughly unchanged rom the prior quarter, although down

rom 62.1 percent in Q4 2009 and 64.1 percent in Q4 2008.4

Since the third quarter o 2008 — or the onset o the globalnancial crisis — central bank holdings o U.S. dollars have

increased on an absolute basis rom $2.7 trillion at the endo 2008, to $2.8 trillion at the end o 2009, to over $3.1 tril-lion at the end o 2010. Tat said, however, the dollar’s shareo central bank holdings on a relative basis has dropped by over three percentage points since late 2008 and by morethan 10 percentage points since 2000.

Which currency has gained at the dollar’s expense over thepast decade? Answer: the euro, whose share o total centralbank holdings rose rom 18.3 percent at the end o 2000to roughly 26 percent in the ourth quarter o 2010. Tatrepresents a sizable jump and supports the claim that theeuro is a credible challenger to the U.S. dollar. Yet there stillexists a a sizable gap between the U.S. dollar and its nextclosest rival.

As or the yen and pound, the ormer’s share o centralbank reserves declined rom 6 percent in 2000 to 3.8percent in the ourth quarter o 2010. Te pound’s share4 The gures are sourced from the IMF’s Currency Composition of Of cial Foreign Ex -change Reserves, which shows central bank holdings by major currency.

o total reserves has averaged roughly 3-4 percent over thepast decade, a ar cry rom the time when sterling was theworld’s premier currency.

All told, world central banks have made it a strategic pointto diversi y their holdings over the past decade. Yet theevidence still points to a world that is still dollar-centric,re ecting 1) the underlying attributes o the U.S. economy and 2) the act that there are ew legitimate alternatives tothe greenback.

Alternatives to the Dollar?

Substitutes or the U.S. dollar are ew. Yes, the euro hasgrown in importance during the past decade, and yes,the European Union rivals the United States in terms o economic output and global trade.

But while Europe has a single currency, it structurally lacksa pan-European capital market that would pool and allo-

cate capital more e ciently and efectively. Europe has onecurrency, but not one single capital market, and the region’snancial sectors are small, ragmented, and lacking econo-

mies o scale. In addition, the region’s simmering sovereigndebt crisis — and the muddled way Europe’s policy eliteshave handled the crisis — has done little to engender con -dence in neither the near-term nor long-term uture o the

0% 10% 20% 30% 40% 50% 60% 70%

U.S. Dollar

Euro

Sterling

Yen

Other

Figure1: World's Apart: Central Bank Holdings of Dollar vs. Others

(For Q4 2010; Percent of Allocated Holdings)

Source: International Monetary FundData through: December 2010




4

euro. As Eichengreen notes, the euro is a currency without

a state; there is no euro-government backing the currency,rather 17 diferent national governments with diferentgoals and objectives.5 I nothing else, the Greek debt crisishas been a per ect example o Europe lacking an efectivecross-border policy mechanism or handling acute periodso intra-Europe nancial stress.

As or the pound and the yen, the sun has already set onthese two currencies. Japan has neither the interest nor theeconomic means to nurture a true global currency. Whilethe U.K. pines or a strong pound, the sterling is an obvioushas-been when it comes to being a world currency. Swit-

zerland has little interest in seeing the Swiss ranc become aworld reserve currency.

China: Not Ready for Prime Time

What about the renminbi — or the prospect o Chinaemerging with the world’s number-one currency? Te shortanswer: although Beijing has accelerated the pace by whichits currency is used in international transactions, it is goingto be some time be ore the Middle Kingdom’s currency challenges the greenback.

During President Hu Jintao’s visit to the United States inJanuary 2011, the Chinese leader proclaimed that “thecurrent international currency system is a product o thepast.” Tat was code or the ollowing: that China, astbecoming a global economic power in its own right, wasnot com ortable with dollar-centric world o today; thestatus quo was unacceptable and that China’s own currency,renminbi, was primed to become more globalized.

o this end, Beijing has set up an ofshore market orrenminbi transactions in Hong Kong, with sales o renminbi-denominated bonds in Hong Kong climbing to40 billion renminbi thus ar this year, versus 36 billion lastyear. In March 2011, renminbi deposits in Hong Kong roseto a record 451 billion and are expected to approach 1 tril-lion by year-end. In promoting greater use o the renminbi,Beijing regulators broadened the scope o trading in HongKong in late 2010 by increasing the number o exporters

5 Barry Eichengreen, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, New York: Oxford University Press, Page 7.

that can use renminbi to trade their goods. Meanwhile,

China has entered into a number o currency swaps with anumber o nations and has agreed to price bilateral tradewith Brazil and Argentina in local currency, moves that will

urther underpin the globalization o the renminbi. Finally,in a historic rst, McDonald’s and Caterpillar became the

rst U.S. non nancial corporations to sell debt priced inrenminbi last year.

Looking orward, in order or China’s currency to remotely challenge the rein o the greenback, China has to rstmodernize and open its nancial sector, allowing orthe build-out o e cient money and capital markets. At

the moment, China’s banking sector is more closed thanopened. While the Chinese nancial sector weathered thenancial crisis rather well, that was due less to any inherent

strength o Chinese banks and more to the act that China’sbanks remain relatively walled of rom the rest o the world— circumstances that hardly auger well or the convert-ibility o the renminbi.

China remains nancially underdeveloped at the moment,a suitable strategy or a government that believes control o one’s nancial system remains paramount or growth andstability. Te nancial crisis o 2008 only con rmed in the

minds o Chinese policymakers that it is best to go slowwhen opening its capital markets. Against this backdrop,China’s banking sector basically begins and ends with ourlarge banks; in 2009, state-controlled banks held over $11trillion in assets, with the big our controlling 43 percent o China’s total nancial assets. 6

Not until the mainland orti es and opens its capitalaccount, strengthens its nancial sector, resists currency intervention, and establishes ull convertibility o therenminbi will the Chinese currency even have the slightestchance o being a world reserve currency. China is not

ready or prime time — ull- edged nancial re orm will ban evolutionary process, not revolutionary.

6 See Carl E. Walter and Fraser J. T. Howie, Red Capitalism: The Fragile Financial Founda - tion of China’s Extraordinary Rise, Singapore: John Wiley & Sons, 2011.




5

SDR’s Rise?

What about the attraction o special drawing rights (SDRs)as a world’s reserve currency — a prospect bandied aboutby some policymakers, notably the Chinese? Answer: theodds o SDRs becoming a reserve currency are slim giventhat very ew SDRs are in circulation and that very ewcountries, notably the United States, are likely to agree to anSDR-driven world o global nance.

Might the gold standard return? While widely discussed o late among policymakers, a return to the gold standard isan unrealistic option in a world economy that is greased by some $4 trillion in daily global oreign exchange transac-

tions. Pegging a currency to the xed stock o a real assetwould dramatically slow the volume and velocity o globalcapital ows, and result in a much slower speed limit o theglobal economy. Gold is just too illiquid to be considered aworld reserve currency.

The Road Ahead

Te dollar’s reign is set to continue over the next decade,although beyond the medium-term, the world is movingtoward a multilateral currency system, with the dollar atthe head o the pack. Te euro and renminbi will ollow,while hard assets like gold, timber, and oil are expected to

remain viable alternatives to the dollar as a store o value.

Te Russian ruble and Brazilian real could also emergeas signi cant regional currencies in the decades ahead. Amore multi-polar world entails a more multilateral currency regime, a scenario that will gradually erode the dollar’sglobal monopoly.

Te most signi cant known unknown is this: at what speedwill the global economy shi away rom the dollar-centricworld o today and move towards a more multilateralcurrency world? Another unknown: will the shi be orderly or disorderly?

Te answers depend on events overseas and in the UnitedStates, and on the ability o the G20 and its key members toadjust to the shi ing sands o the global monetary order. oensure an orderly transition towards a multilateral currency architect, the G20 must avoid “currency wars” and the toxictemptations o trade and investment protectionism. Telatter could become a more attractive option i unemploy-ment remains stubbornly high in the developed nations,notably the United States.

A less dollar-centric world entails a weaker dollar relative toother currencies, a transition that needs to be handled withcare since the stronger currencies o the developing nationswill impinge on their export-led growth strategies. It is crit-ical or the G20 to champion a more multilateral currency world in the content o global rebalancing, whereby saving-short nations like the United States consume less and exportmore, while capital-rich nations like Russia, China, andBrazil opt or more spending and less savings. Adjustmentsin currencies can acilitate such a shi , and needs to be astated policy objective o the G20.

G20 members should also avert using and excusing capitalcontrols and avoid blatant investment protectionism. Telatter is key since a more multicurrency world entails Chinaand other surplus developing nations diversi ying out o dollar-based securities or hard assets like plants, equip-ment, and companies. However, emerging market acquisi-tions o developed nations corporations and physical assetsremains a sensitive topic and one that needs to be managed very care ully by the G20. Te G20 should also work toensure that as a new multicurrency world takes shape,

58%

60%

62%

64%

66%

68%

70%

72%

2 0 1 0

2 0 0 9

2 0 0 8

2 0 0 7

2 0 0 6

2 0 0 5

2 0 0 4

2 0 0 3

2 0 0 2

2 0 0 1

2 0 0 0

1 9 9 9

1 9 9 8

1 9 9 7

1 9 9 6

1 9 9 5

Figure 2: Shifting Towards a Multi-Lateral Currency World(U.S. Dollar Holdings as Percent of Total)

Source: International Monetary FundData through: December 2010




6

world would help sustain global growth, promote global

rebalancing, and urther integrate the global economy.Conversely, a sudden and disorderly turn away rom thedollar-based global economy would be hugely disruptiveand bene t no one, notably the United States. For the G20,managing the tectonic shi towards a multi-currency worldis one o the most important and pressing challenges be orethe young organization.

nancial deglobalization — or the risk o over-regulated

global capital markets — is avoided at all costs.At the regional level, the speed at which the world becomesless dollar-centric will depend on how the eurozone debtcrisis is resolved. Te euro could still emerge stronger romthe crisis i the nations o the eurozone band together andsuccess ully navigate the treacherous waters o today.

Meanwhile, the pace at which China allows its currency tobecome more global will also determine the pace at whichthe world moves towards a more multicurrency world. Teprocess is expected to be gradual as China slowly shi s

rom export-led growth to more consumption-led growth.With the leadership o the Communist Party slated to bechanged next year, moves on the currency ront will benominal at best over the near term. It is in China’s owninterests not to see the dollar dethrone in a sudden andunexpected ashion, since the Middle Kingdom is one o thelargest holders o U.S. dollars. A sharp decline in the dollarwould cost the Chinese dearly.

Finally, no other variable will in uence the uture o theU.S. dollar, and its role as the world’s reserve currency, morethan policies in the United States. Te cost o two wars, andthe tab associated with one o the largest nancial crises inU.S. history and soaring entitlements threaten to turn theUnited States into a nancial cripple. Uncle Sam still enjoysa triple A credit rating — although America’s pristine creditrating is increasingly being called into question given theinexorable rise in U.S. debt.

Against this backdrop, the more the nancial health o America declines, the aster the world will shi away romthe dollar-centric global economy o the past 60 years.Tis shi is inevitable, but expected to play out over yearsand decades. An orderly passage to a multilateral currency

About the Author

Joseph Quinlan, a non-resident ransatlantic Fellow with GMFsince 2003, is the Chie Market Strategist o Bank o AmericaCapital Management, where he is charged with the development andimplementation o domestic and global investment strategies.

About GMFTe German Marshall Fund o the United States (GMF) is a non-partisan American public policy and grantmaking institution dedi-cated to promoting better understanding and cooperation betweenNorth America and Europe on transatlantic and global issues.GMF does this by supporting individuals and institutions workingin the transatlantic sphere, by convening leaders and members o

the policy and business communities, by contributing researchand analysis on transatlantic topics, and by providing exchangeopportunities to oster renewed commitment to the transatlanticrelationship. In addition, GMF supports a number o initiativesto strengthen democracies. Founded in 1972 through a gi romGermany as a permanent memorial to Marshall Plan assistance,GMF maintains a strong presence on both sides o the Atlantic.In addition to its headquarters in Washington, DC, GMF hasseven o ces in Europe: Berlin, Paris, Brussels, Belgrade, Ankara,Bucharest, and Warsaw. GMF also has smaller representations inBratislava, urin, and Stockholm.

the g20's coming currency challenge: do we need heirs to the u.s. dollar -- and are there any?

Documents