This is the text of a talk by AIER Research Faculty Peter C. Earle at the June 7, 2023 Meeting of Alder Unplugged.
Good afternoon and thank you for having me. I’ve planned for these remarks to take no more than ten minutes, but economists are about as good at forecasting as politicians are at budgeting. So, it may run a slight bit longer – apologies in advance if it does.
About two months ago, on April 4th, I wrote an article entitled “De-dollarization has Begun” which was published on the AIER, that’s the American institute for Economic Research, website. In it I discussed a few recent developments which show an acceleration of projects around the world seeking to reduce dependence upon the US dollar. In what was a complete surprise to me, that article wound up becoming the second most read in AIER’s digital history. (We are celebrating our 90th anniversary this year, but our internet history is decidedly shorter than that.) With that unexpected level of interest came a large number of inquiries, which resulted in my writing and publishing a follow-up article one week later. In “De-dollarization has Begun: Redux,” I addressed the most frequently asked questions and made my personal view on those recent developments and their significance clear. I hope.
In the first article, I commented on the recent trade deal between China and Brazil. Owing to that agreement, their sizable trading relationship will now be denominated and settled in the renminbi and real instead of, as it customarily has been, the US dollar. India and Malaysia recently began a pilot project to settle trades in rupees, instead of the dollar, and France has reported successfully executing a natural gas trade with China settled in renminbi. These are but a handful of developments which led me to surmise that long-discussed plans to create alternatives to the current global reserve currency, our US dollar, are picking up momentum.
Why would nations voluntarily seek to avoid, or at least explore workarounds, for the most liquid currency with the broadest and deepest sovereign debt complex in the world? My thesis focuses on two prevailing reasons, although there are certainly other explanations.
First, the recent experience of Russia. Shortly after its invasion of Ukraine Russia had most of its links to the dollar-based trading network SWIFT severed, as well as seeing some $300 billion in US dollar reserves frozen. Those sanctions–unwittingly, I believe–provided a cautionary tale even to current and long-time allies of the United States. The risk that getting on the wrong side of a US policy position could result in a nation’s being effectively shut out of global commerce. This may not have occurred to many nations previously. Clearly many are aware of it now.
In addition, the current decade has not been kind to the reputation of America’s central bank, the Federal Reserve. In the early phase of the COVID pandemic, the Fed unleashed a multi-trillion dollar deluge in which rates of money creation briefly exceeded 25 percent annualized at one point. They then watched as inflation broke out, wasting precious months on inaction while calling the rise in the general price level “transitory.” At AIER we were quite sure the rise in prices was in fact not a mere temporary blip, and wrote extensively about it at the time. In fact, prices had begun to rise as early as January 2021, and by the spring of 2022 were rising at their fastest clip in over 40 years. The Fed then changed gears, shifted into a panicked catch-up mode, and raised policy rates the most aggressively they have in decades. The combination of flooding banks with money and then hiking interest rates at an incredibly rapid pace generated some $640 billion in unrealized losses on bond positions held at depository institutions, and resulted in a handful of bank failures earlier this year. To add insult to injury, despite financial instability and a rise in both bankruptcies and credit card defaults, inflation has proven stubborn in the 5 to 6 percent range. It may very well be that the monetary policy playbook that worked in a goods-dominated late 1970s economy is less efficacious in today’s highly financialized service-dominated US economy.
Thus I see the weaponization of the dollar and an increasingly error-fraught monetary policy regime as providing incentives for nations to explore means of alleviating their dollar dependence.
Let’s briefly go back to the beginning. The dollar formally became the global reserve currency in the Bretton Woods Agreement in 1944. That placed the dollar at the center of international trade, and defined a US dollar in gold terms: $35 dollars would equal one troy ounce of fine gold.
The prominent role of the US dollar is neither an economic aberration nor a product of sheer luck. At least three constituent elements have fed into it: economic power, military power, and technological power. The third is perhaps the least appreciated, but includes the innovation of satellites in the 1960s, telex and fax communications in the 1970s, and increasing computational power starting in the 1980s. Container ships, fiber optics, inventory management systems, and financial engineering have played supporting roles. It didn’t hurt that many of the countries that would eventually become our major competitors were either being rebuilt or captive to ruinous economic systems for decades after the end of World War II.
Indeed, if all of this were not so, not only would the dollar not be as centrally positioned as it was, but America would not have been able to amass $31 Trillion dollars in public debt. Nor would the powers in Washington DC have been able to promise to backstop anywhere from $40 to well over $100 Trillion – no one really knows how much – in unfunded liabilities.
Moving on. The Bretton Woods agreement collapsed in 1971, yet despite being unmoored to gold the dollar remained the center of gravity of global commerce owing to a number of factors. The size of the US economy and its productive capacity are two, but also high barriers to exit, switching costs, and path dependence, the latter owing to a number of formal and informal institutions keeping the dollar in that role. Of course the benefits to being the issuer of the global reserve currency are considerable, not least among them, as mentioned previously, a high and fairly steady appetite for sovereign debt. Any firm or country holding dollars in their FX reserve wants to earn a return, and the US Treasury is more than happy to provide those securities.
In 1977 the US dollar reached a peak in its foreign reserves holdings, representing 85 percent of the currency held by foreign central banks and major corporations. By 2001 it was 73 percent, yet recently the number was estimated at 58 percent. The Euro has accounted for some of that loss of market share, as has the growing influence of a handful of other currencies.
So now, a few updates to my April 2023 articles.
Since then, some nineteen nations have agreed to settle trades with India in rupee. They include some unsurprising names, like Russia, some neighbors like Sri Lanka and Bangladesh, but also some surprising backers, including the United Kingdom, Germany, New Zealand, and Israel. Rupee-settled trading will likely start in textiles but expand over time.
Also, in a meeting between China’s Premier Xi Jingping and French President Emmanuel Macron last month, Macron publicly stated that the dependence on the dollar’s “extraterritoriality” should be reduced. Bangladesh, in an unusual transaction, received a $300 million yuan loan from Russia to build a nuclear reactor. That transaction was executed via CIPS, which is the Chinese Cross-Border Interbank Payment system, a direct competitor to SWIFT.
Two weeks ago the government of Iraq made use of the US dollar illegal. The United Arab Emirates currency, the durham, is seeing an increase in use throughout the Middle East.
Far more significantly, this past weekend (June 2nd and 3rd) a BRICS conference (that’s Brazil, Russia, India, China and South African) was held discussing a dollar alternative. Some thirteen nations additionally requested membership and others have expressed interest. Among those were Argentina, Iran, Egypt, Indonesia, and most troubling of all, Saudi Arabia. There were also a number of states which attended the conference anonymously. The “BRICS plus” coalition could be substantial, as those nations account for 42 percent of the world’s population and 23 percent of global output.
Independently, Brazil has decided to end its practice of using the US dollar for gasoline prices in a process they are referring to as ‘Brazilianation.’
The Chinese yuan’s use surged to a record amount in the first quarter of 2023. Foreign exchange swaps referencing the yuan, in fact, saw their second largest surge ever in March owing to growing use of the currency. The dollar’s share in Chinese trade fell from 83 percent to 47 percent between 2010 and this year.
Going back to 2009, there’s no other way to look at the innovation of cryptocurrencies, now in their second decade, than as an early plebiscite on US monetary and fiscal malpractice. Bitcoin is nothing if not a 24/7 tradable indictment of Federal Reserve, US Treasury, and congressional policies.
Yet perhaps the biggest sign that change is afoot in international currency dealings is the surge in gold purchases by central banks and global financial institutions. In 2022, central banks around the world went on their biggest gold buying binge since 1950. To some observers, the explosion of interest in physical gold is a referendum on either or both the status and health of the US dollar. It’s also a hedge against inflation. A handful of small countries, including Zimbabwe and Ghana, are moving toward backing their currencies with gold or using gold as a direct medium of exchange – in Ghana, in oil transactions.
But in a poll taken by the World Gold Council, 24 percent of the central banks surveyed intend to continue to purchase gold, and that in summary, “Central banks’ views toward the future role of the dollar were more pessimistic than in previous surveys.” Further, 46 percent believe the share of the dollar in foreign exchange reserves will fall.
The idea that the death of the dollar is either imminent or inevitable is highly unrealistic, however. None of the currently proposed replacements are viable for several reasons. The Chinese yuan or renminbi is, at present, completely inappropriate owing to its closed capital account (capital controls) and the fact that the yuan is pegged to the dollar and manipulated in value to positively impact its exports. The currencies of a handful of other nations, for example the South Korean won or the Swedish krona have many of the characteristics required, but are simply too small to meet global standards. Any nation or group of nations wanting to capture the role of global reserve currency would additionally have to be willing (and able) to run current account deficits and have a wide variety of debt issues outstanding. We Americans consume more than we produce, generating a current account deficit, the gap in which is met by IOUs that we call Treasury bills, notes, and bonds. Additionally, though infrequently discussed but of critical importance, the rule of law – and in particular private property rights – are imperative fixtures of a reserve currency issuer.
What is eroding the faith in the dollar and inspiring the slide in its use, as well as motivating programs and projects to explore substitutes are its recent weaponization, and the continuing abdication of sound money principles. The full realization of that transformation, if undertaken, would take years at the least, and more likely decades, but the consequences would be nontrivial.
I would add that the recent debt ceiling scare, which was mostly hype, was nevertheless damaging to America’s fiscal and monetary reputation.
There is much more to say about the possible consequences of reduced dollar influence for US citizens and the painful but imperative requirements to repair the dollar’s sliding reputation, which include buttressing the dollar’s value, but I’ll stop there for now.
