The End of the U.S. Dollar's Reign?
How likely is it that the dollar will be dumped as the world's reserve currency?
April 27, 2005
In light of the U.S. dollar's three-year swoon, many observers believe we are witnessing the beginning of the end of the dollar's role as the world's reserve currency.
A number of interrelated factors support this view, ranging from America's abysmal savings rate to the soaring U.S. trade deficit.
Unchecked, according to the consensus, current trends are putting the dollar's role as the world's dominant currency at risk.
I do agree, in general, with this assessment. Yet, I remain stumped by the following: If the dollar's 60-year reign is in its twilight, then what other currency is in position to supplant or usurp the dollar's role as the world's reserve currency? My answer: none.
Obtaining reserve currency status is not easy. The requirements include a large and open economy, a well-developed and highly liquid financial market and a convertible and widely accepted currency in which large volumes of trade and commerce are transacted.
Political stability, a history of stable economic growth and a country of global importance or stature are also prerequisites.
That said, in a world with more than 150 national currencies, viable candidates to supplant the U.S. dollar are slim, but I offer up a short list:
The euro is a serious contender to the dollar given the fact that Europe's financial markets are deep and liquid and that the euro is fully convertible.
What also helps is that the EU economy is about the size of the U.S. economy and is an essential component of global trade.
Now the bad news. Europe is increasingly viewed as a dithering dysfunctional family, unwilling and unable to make tough economic decisions regarding future economic growth.
In just the past few months, the Stability and Growth pact has been watered down. The Lisbon agenda — a blueprint to increase EU competitiveness on the global scale by 2010 — has all but been abandoned. And the European Services Directive was rejected thanks to opposition from France and Germany.
The latter would have enhanced the competitiveness of Europe's inefficient service sector and may have gone a long way in bolstering the attractiveness of the euro as a reserve currency.
Fiscal tensions in Europe, coupled with numerous structural deficiencies — labor market rigidities, for instance — hardly make the euro more appealing than the dollar.
Add to this the possibility of a French veto to Europe's impending constitutional vote, the effect of which would not doom the euro, but would likely hamper efforts in creating a more unified and dynamic European Union.
Without a ratified constitution, the EU forgoes the opportunity to have a new full-time president, a single EU foreign minister and other institutions supportive of a strong currency. In the end, the prospects for the euro upending the U.S. dollar as the world's reserve currency appear slim.
Japan's currency is not a serious contender to the U.S. dollar for several reasons.
Firstly, Japan has long been governed by a political elite that has embraced domestic concerns far more than it has its global ambitions.
In addition, the Japanese economy is highly export-dependent — and Japanese policymakers generally prefer a weak currency. Also, a great deal of Japan's trade is still denominated in dollars.
Add to the above sluggish economic growth and a resistance to shifting the status quo and the yen hardly appears as a formidable relative to the dollar.
Also working against the yen are regional hostilities toward Japan, negative sentiments that would run counter to any move towards making the yen a regional or global reserve currency.
China's currency is often mentioned as a candidate to dethrone the U.S. dollar, although it would take decades — rather than just a few years — for the yuan to present a serious challenge to the greenback.
Presently, China possesses very few attributes that are supportive of a reserve currency.
The country's capital account remains closed, the currency is non-convertible and the banking sector is fragile and in need of an overhaul.
China's trade, like Japan's, is largely denominated in U.S. dollars and exports are increasingly a key ingredient of growth. This portends a preference by China for a weaker — rather than a stronger — yuan.
Meanwhile, the recent diplomatic row between Japan and China, with bilateral relations hitting a multi-decade low, does nothing to engender added confidence in either the yen or yuan.
The Swiss franc is certainly a strong currency, but I do not think it is a contender for reserve currency status since Switzerland's financial system, in general, can be described as nothing short of opaque.
Transparency matters — and Switzerland fails on this score.
Call it a case of "been there, done that." There is little appetite among the world's major nations to revert back to a gold standard, given the limitations to monetary sovereignty that come with such an arrangement.
All the talk about the U.S. dollar losing its favor as the world's reserve currency is just that — talk. The dollar reigns by default.
Benign neglect on the part of the rest of the world has left few, if any, challengers demonstrating the core competencies required to underwrite the world's reserve currency.
Scanning the global horizon, I just can't spot a viable alternative to the dollar. That, of course, does not say much for Europe, Japan and Asia. That the dollar remains the best of the lot speaks volumes about the unbalanced and unsettled state of the global economy.