The US dollar, by historical norms, is living it large well into borrowed time.
Since 1450, only five other powers have enjoyed having a currency that dominated global trade and, in more recent centuries, the vaults of the world’s central banks: Portugal, Spain, the Netherlands (known as the Dutch Republic at the time), France and Britain. Each reign lasted an average of less than 95 years.
The dollar took over in the early 1920s, according to many academics, even if it would be the Bretton Woods conference in 1944 that established the postwar international financial system and cemented the greenback’s supremacy.
The demise of the dollar has been called many times in recent decades as persistent budget deficits have led to soaring US government debt. Borrowings have tripled over the past 15 years alone, to about $36 trillion (€31.6 trillion). But inertia and what economists call “network effects” – where governments, businesses and banks continue to use a currency because everybody else does – kept such predictions in check.
The dollar’s slump against most major currencies since Donald Trump announced his ‘Liberation Day’ raft of tariffs last week has reignited the debate. It has fallen by as much as 5.7 per cent against the euro, with most of the sell-off occurring since Trump paused most of the charges on Wednesday evening, spooked by volatility on the bond market.
Could this time be different?
“I think we are at the start of the end [of the dollar era], but only at a start,” Vincent Mortier, chief investment officer at Amundi, Europe’s largest asset manager, told The Irish Times on Friday. “But the issue, right now, is: what are the available alternatives?”
The benefits of being the reserve currency have been many. It’s given the US and its citizens greater buying power and access to lower borrowing rates – boosting economic growth – than they might otherwise enjoy. The dollar’s centrality to the global payments system has strengthened the US’s diplomatic power, making it easier to impose and enforce financial sanctions against countries, individuals and entities that it has problems with.
About a quarter of the US’s $36 trillion debt is owned by foreign investors. Mortier sees the percentage held by domestic players, including retail investors, increasing amid signals from Trump’s officials that they would like to ease bank capital reserves rules so they could hold more US bonds and potential incentives encourage retail investors to buy government debt.
This might allow a country – such as Japan, whose bonds are about 88 per cent owned by domestic investors – to run higher debt burdens than would otherwise be tolerated by the markets. “But the side effect is that the US dollar – and buying power – will continue to weaken,” says Mortier.
Some argue that bitcoin, the teenage granddaddy of cryptocurrencies, will be reserve currency of the future. Indeed, Larry Fink, chief executive of BlackRock, the world’s largest asset manager, posited in his annual letter to shareholders last week that this is a risk if the US doesn’t get its debt under control
The main driver of the renewed market pressure on the dollar in recent days has been the escalation of the US-China trade war, with the White House clarifying on Thursday that total tariffs on China would now be 145 per cent, even as it has reduced tariffs on the rest of the world to 10 per cent – for 90 days.
“The question of a potential dollar confidence crisis has now been definitively answered – we are experiencing one in full force,” said Francesco Pesole, a foreign exchange strategist at ING.
Large questions marks hang over whether the US can strike a flurry of trade agreements with other nations before the 90 days are out.
“There has been little respite for the dollar,” said Deutsche Bank strategists in a note on Friday, “as markets continue to reassess how much of the historical premium for US assets stemming from American exceptionalism is still justified under the radical vision and volatile policy of the new US administration.”
There are no obvious successors, however.
The euro may be the world’s second most traded currency and number two in the stockpiles of monetary authorities. But the euro zone doesn’t have a proper capital markets union – despite the European Commission’s best efforts over the past decade – let alone a fiscal union.
The euro-zone debt crisis hasn’t helped. The euro accounted for less than 20 per cent of global reserves last year, down from peak of almost 28 per cent in 2009, according to International Monetary Fund data. The dollar accounts for about 58 per cent of global reserves.
The big problem with adopting the renminbi, which makes up just 2.2 per cent of global reserves despite China being the world’s second-largest economy, is the country’s lack of rule of law and its one-party state.
Some argue that bitcoin, the teenage granddaddy of cryptocurrencies, will be reserve currency of the future. Indeed, Larry Fink, chief executive of BlackRock, the world’s largest asset manager, posited in his annual letter to shareholders last week that this is a risk if the US doesn’t get its debt under control.
But bitcoin has a long way to go to establish itself as a store of value. Over the past six months alone it has almost doubled in price to peak at more than $109,000 before falling back by a third.
“Instead of a radical transformation, we believe currency reserves are likely to go through an evolutionary process,” said Atul Bhatia, an investment strategist at RBC Wealth Management, in a report this week.
“Falling trade will lead to slower global growth and declining reserve needs, but the reduction will likely be done passively. Some countries may choose to rebalance part of their holdings away from the dollar, but the lack of ‘safe’ investment options for non-dollar currencies will act as a constraint, in our opinion.”
For Mortier at Amundi, too, there is unlikely to be one winner, but a broader spread of currencies in reserves, to include the euro, pound, Swiss franc, renminbi and Japanese yen – along with the dollar.
“We are at a pivotal moment of structural shift that is very important for the world, for the global economy,” he said. “And what is happening now is a kind of acceleration ... of the US losing its status as the only superpower.”
