The author is Professor Emeritus at the Stern School of Business, NYU and Chief Economist at Atlas Capital Team
The US dollar has been the predominant global reserve currency since the conception of the Bretton Woods system after World War II. Even the abandonment of fixed exchange rates in the early 1970s did not call into question the “exorbitant privilege” of the greenback.
But given the increased weaponization of the dollar for national security purposes and the growing geopolitical rivalry between the West and revisionist powers such as China, Russia, Iran and North Korea, some argue that dedollarization will accelerate. This process is also driven by the emergence of central bank digital currencies that could lead to an alternative multipolar currency and international payment regime.
Skeptics argue that the US dollar’s global share as a unit of account, means of payment and store of value hasn’t shrunk much, despite all the talk of a terminal decline. They also point out that you can’t replace something with nothing – as former US Treasury Secretary Lawrence Summers said: “Europe is a museum, Japan is a nursing home and China is a prison. “.
More nuanced arguments point out that there are economies of scale and network that lead to a relative monopoly of reserve currency status, and that the Chinese renminbi cannot become a true reserve currency unless currency controls capital is phased out and the exchange rate made more flexible.
Moreover, a reserve currency country must accept – as the United States has long done – permanent current account deficits in order to issue enough liabilities held by non-residents in return. Finally, these skeptics argue that all attempts to create a multipolar reserve currency regime — even a basket of IMF special drawing rights that includes the renminbi — have so far failed to replace the dollar.
These points may have had some validity in the past, but in a world that will be increasingly divided into two geopolitical spheres of influence – namely those surrounding the United States and China – it is likely that a regime bipolar currency, rather than multipolar, will eventually replace the unipolar one.
Full exchange rate flexibility and international capital mobility are not necessary for a country to achieve reserve currency status. After all, in the era of the gold exchange standard, the dollar dominated despite fixed exchange rates and widespread capital controls.
And while China may have capital controls, the United States has its own version that may reduce the appeal of dollar assets among relative enemies and friends. These include financial sanctions against rivals, restrictions on foreign investment in many sectors and companies sensitive to national security, and even secondary sanctions against friends who violate the main ones.
In December, China and Saudi Arabia made their first renminbi transaction. And it’s not far-fetched to think that Beijing could offer the Saudis and other oil states in the Gulf Cooperation Council the ability to trade oil in RMB and hold a larger share of their reserves in the Chinese currency.
It is likely that the GCC countries, as well as many other emerging market economies, will soon start accepting these Chinese offers given that they trade much more with China than with the United States. Furthermore, there is clearly a so-called Triffin’s dilemma in a monetary regime in which the reserve country runs permanent current account deficits that will eventually undermine its reserve status as the growth of its international liabilities becomes unsustainable.
Critics wonder if the currency of a country that runs a persistent current account surplus can ever achieve world reserve status. But China could in any case move towards a growth model less dependent on trade surpluses.
It is also an anachronism that the United States, whose share of global gross domestic product has halved to 20% since World War II, still accounts for at least two-thirds of all transactions in so-called vehicular currencies. The current system makes emerging market economies financially and economically vulnerable to changes in US monetary policy driven by domestic factors such as inflation.
Finally, new technologies, including CBDCs, payment systems such as WeChat Pay and Alipay, lines of exchange between China and other countries, and alternatives to Swift, will accelerate the advent of a monetary system and bipolar global financial. For all these reasons, the relative decline of the US dollar as the main reserve currency is expected to occur over the next decade. The intensification of the geopolitical struggle between Washington and Beijing will inevitably be felt in a bipolar global reserve currency regime as well.
