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Is the U.S. dollar adrift?

Money | Other nations are starting to think so

Issue: "Into thin air," Aug. 23, 2014

“What you are watching is the demise of the U.S. dollar as global reserve currency,” wrote Dennis Bennett, managing director of The Altan Group, after a WORLD notation about the latest creation by the BRICS nations (Brazil, Russia, India, China, South Africa): a new $100 billion fund to help stabilize the finances of developing countries. “Too much debt, too many sanctions, too weak foreign policy,” he continued. “Just a matter of when, not if.”

Ominous words, but he’s probably right. 

“Global reserve currency” status means the U.S. dollar is the currency of choice for countries looking for a safe place to hold some of their funds, and for international transactions. Foreign countries buy and hold U.S. Treasury bills, which are paid in dollars. Participants in international transactions often snatch up actual dollars, which is why two-thirds of all $100 bills (the most popular denomination) are held by foreigners. 

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The dollar’s supremacy serves as a reminder that the United States is still the world’s only superpower, and thus makes our foreign policy more credible. It also is one reason the dollar hasn’t collapsed in the past six years, despite our miserable economic performance. The constant demand keeps the dollar’s value up and the interest we pay on U.S. Treasury bills down.

The U.S. dollar dislodged the British pound as the leading currency roughly a century ago, after World War I solidified America’s status as the world’s top economy. In July 1944 the representatives of 44 countries agreed at meetings in Bretton Woods, N.H., to link their countries’ currencies to the dollar. Even after President Nixon brought the Bretton Woods arrangement to an end in 1971 by suspending the convertibility of dollars into gold, the dollar retained its global reserve currency status.  

The dollar is still highly stable, and there are plenty of dollars to satisfy everyone’s needs, but the cracks in its foundation are growing. U.S. bank regulators have recently hammered foreign banks for allegedly violating U.S. law in transactions conducted in dollars. At some point, banks like BNP Paribas (recently fined $8.9 billion) will avoid the regulatory onslaught by using currencies other than the dollar. Russia and other bad actors richly deserve the economic sanctions imposed on them (almost our only discernible foreign policy at the moment), but they’ll also be looking for other places to park their money.  

The $100 billion fund created by the BRICS is China’s latest ploy to take advantage of the uncertainty. It is an alternative to the International Monetary Fund, which has been a symbol of U.S. financial leadership (the United States has the biggest vote) ever since its creation at Bretton Woods. If the BRICS fund grows, it could further shift the financial balance of power away from the U.S.—and the U.S. dollar.

The dollar does have one thing going for it: None of its competitors are ready for prime time. China’s economy could be twice as large as America’s in the next 20 years or so, but unless China radically liberalizes its political structure, other countries will be reluctant to hold renminbi (yuan). The euro currently is the second most popular reserve currency, but the eurozone—and even the future of the euro itself—is filled with uncertainty.

The U.S. dollar won’t be displaced tomorrow. But if our current economic and foreign policy tendencies continue, its days as the undisputed global reserve currency may be over soon.

—David Skeel teaches corporate law at the University of Pennsylvania


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