Dedollarization

Obviously, there has been much talk about replacing the dollar as the preferred medium of international exchange. Countries around the world, countries like Brazil and Saudi Arabia have started doing business in Chinese currency. 

On the other hand, many serious thinkers have dismissed the notion, in part because there is no viable alternative. Niall Ferguson, a man who is long the dollar and who reminds us, in his latest Bloomberg column, that world leaders, including Charles de Gaulle decades ago, have declared the end of dollar hegemony-- to little avail.

Ferguson quotes Larry Summers:

Former Treasury Secretary Larry Summers had a good line about all this back in 2019. “You cannot replace something with nothing,” he said. What other currency is preferable to the dollar as a reserve and trade currency “when Europe’s a museum, Japan’s a nursing home, China’s a jail, and Bitcoin’s an experiment”?

One remarks that Ferguson and Summers are not merely academic commentators. Their views move markets. One suspects that they are more cautious than most, given that their remarks might precipitate a run on the dollar, a movement out of dollars and into Euros or Renminbi.

As for why it all matters, Ferguson explains, quoting himself:

“For the United States,” I wrote portentously, “the question is: How long can [the] dollar standard last? As long as the dollar is ascendant, the United States can continue to run huge trade deficits and budget deficits, without having to worry about serious economic fallout. But if the dollar were to lose its status as the world’s reserve currency, and suffer a more precipitous slide, that could have grave consequences. Unfortunately for Americans, the sheer magnitude of the imbalances, along with the emergence of suitable alternative — the Euro — have made this a distinct possibility.”

Many important commentators believe that the dollar’s glory days are over-- one reason being that American administrations have been confiscating dollar denominated assets from certain foreign countries:

According to Peter C. Earle of the American Institute for Economic Research, “the dollar’s fate as the lingua franca of world commerce over the long haul may already be sealed.”

For Earle, it is American overuse of financial sanctions that is to blame. The more the US exploits its power to shut adversaries’ economies out of the dollar payments system, the more other countries want to reduce their exposure to that risk. Hence recent agreements between China and Brazil, China and France, and India and Malaysia, to settle trades in one another’s currencies.

Some believe that the dollar is losing its status:

Because of such trends, according to Stephen Jen of Eurizon SLJ Capital, the dollar has already “suffered a stunning collapse.” “The USD is losing its market share as a reserve currency at a much faster rate than is commonly believed,” Jen wrote in a recent research note quoted at length by Robin Wrigglesworth in the FT. “The main driver of the collapse in USD’s reserve status in 2022 may have reflected a panicked reaction to property rights being jeopardized” by the freezing of Russia’s foreign currency reserves following its invasion of Ukraine.  “What we witnessed in 2022 was sort of a ‘defund-the-global-police’ moment.”

And, of course, as long as the American government continues to run exorbitant deficits, the value of the dollar must diminish:

Meanwhile, the US government is running significantly higher deficits than the ones I wrote about in 2004. And, unlike two decades ago, the Federal Reserve has been monetizing a large part of the deficits. Back then, the Fed balance sheet was 6% of GDP. Now, after successive rounds of quantitative easing and other interventions, it is up to 35%. The 2021-23 surge of US inflation cannot be explained without reference to major errors of fiscal and monetary policy. If the US intends to preserve its global monetary dominance, it is concealing that intention very well.

As it happens, the alternative to a dollar based currency system is a gold standard. That is, fiat currency that is convertible into gold. Ferguson dismisses the notion, but one Ruchir Sharma, writing in the Financial Times, is more optimistic.

As for Ferguson, here is his viewpoint:

John Maynard Keynes famously called the gold standard a “barbarous relic,” but there is nothing barbarous about a non-interest-bearing asset that outperforms an interest-bearing one. Data from the World Gold Council are revealing on this score. According to the most recent figures, the euro area holds 30% of total world official gold holdings, the US 23%, whereas Russia and China together hold just 12%.

And, here is Sharma:

Today com­ment­at­ors over­whelm­ingly agree that a weak­en­ing US dol­lar can­not pos­sibly lose its status as the world’s dom­in­ant cur­rency because there is “no altern­at­ive” on the vis­ible hori­zon. Per­haps, but don’t tell that to the many coun­tries racing to find an altern­at­ive, and such com­pla­cency will only accel­er­ate their search.

The prime example right now is gold, up 20 per cent in six months. Sur­ging demand is not led by the usual sus­pects — investors large and small, seek­ing a hedge against infla­tion and low real interest rates. Instead, the heavy buy­ers are cent­ral banks, which are sharply redu­cing their dol­lar hold­ings and seek­ing a safe altern­at­ive. Cent­ral banks are buy­ing more tonnes of gold now than at any time since data begins in 1950 and cur­rently account for a record 33 per cent of monthly global demand for gold. This buy­ing boom has helped push the price of gold to near-record levels and more than 50 per cent higher than what mod­els based on real interest rates would sug­gest. Clearly, something new is driv­ing gold prices.

Actually, most commentators do not believe that the dollar is in danger, we ought to look at the contrary opinion.

Moreover, for our edification, Sharma explains why it matters:

Though some doubt a dom­in­ant dol­lar mat­ters for the US eco­nomy, high demand for the cur­rency in gen­eral tends to lower the cost of bor­row­ing abroad, a priv­ilege Amer­ica sorely needs today. Among the top 20 developed eco­nom­ies, it now has the secondhighest fiscal and cur­rent account defi­cits after the UK and the secondhighest for­eign liab­il­it­ies (as reflec­ted in its net inter­na­tional invest­ment pos­i­tion) after Por­tugal.

Again, American policy makers believe that the dollar is impregnable and that American can do what it wants, especially in the matters of borrowing and spending money.

They theorized, as Larry Summers said, that there was no alternative to the dollar.

The risk for Amer­ica is that its over­con­fid­ence grows, fed by the “no altern­at­ive” story. That nar­rat­ive rests on global trust in US insti­tu­tions and rule of law, but this is exactly what weapon­ising the dol­lar has done so much to under­mine. It rests also on trust in the coun­try’s abil­ity to pay its debts, but that is also slip­ping, as its reli­ance on for­eign fund­ing keeps grow­ing. The last line of defence for the dol­lar is the state of China, which is the only eco­nomy suf­fi­ciently large and cent­ral­ised to chal­lenge US cur­rency suprem­acy — but even more deeply indebted and institu- tion­ally dys­func­tional.

When a giant comes to rely on the weak­ness of rivals, it’s time to look hard in the mir­ror. When it faces chal­lenges from a “bar­baric relic” such as gold and new con­tenders like digital cur­rency, it should be look­ing for ways to strengthen trust in its fin­ances, not tak­ing its finan- cial super­power status for gran­ted.

For his part Sharma has been watching the rally in gold and believes that the gold market is telling us something about the dollar. If countries want to challenge dollar hegemony, backing their currency with gold would be a good place to start. But for that they need to accumulate large amounts of the barbarous relic. Is that what is happening today?

Subscribe to my Substack, for free or for a fee.