Bylines 13 Aug/14
New Challenges to the Old Currency
What do recent comments by the CEO of a large French oil company, European government discussions regarding U.S. extraterritoriality, the structuring of a new natural gas deal between Russia and China and the growth of Bitcoin all say about the possible future direction of global financial markets? The answer lies in an interest in promoting the idea that the 70-year reign of the U.S. dollar as the world’s preeminent reserve and trading currency should eventually come to an end.
Just since the start of 2014, disparate voices around the world—including banks, non-financial corporates and sovereigns—have called for renewed consideration of alternatives to the dollar as the currency of choice in conducting financial transactions and international trade. Challenges to the dollar’s status aren’t new in the post-Bretton Woods era (remember the forced abandonment of dollar-gold convertibility in the early 1970s), but the degree to which de-dollarization rhetoric has escalated over recent months deserves careful attention.
What are the shared concerns expressed by de-dollarization advocates? And how realistic, at least over the near term, is any effort to unseat the dollar as the world’s premier reserve currency?
The sources of frustration with dollar dominance are truly diverse. Motivations range from industry-specific questions like those raised by Total S.A.’s CEO in July over the perceived need for an alternative to the dollar-only oil trading system to new institutions being launched by the BRICS nations, establishing a multilateral lender and a non-dollar currency stabilization fund (much like the World Bank and IMF, on a small scale).
Geopolitical forces driving de-dollarization extend beyond the BRICS nations. For example, European concerns over extraterritoriality have grown in the wake of numerous fines levied by U.S. regulators against European banks, most recently a fine of $8.9 billion against France’s BNP for violation of U.S. sanctions laws.
Worries about the long reach of U.S. law, tied to the need for foreign banks to clear transactions in dollars, have driven governments to take more outspoken positions on dollar dominance. Skepticism about the dollar's role had already expanded over the last decade in response to rising U.S. government debt levels, fiscal deficits, the debt ceiling impasse, and widening concerns over currency depreciation and inflationary pressures resulting from aggressive Fed monetary stimulus.
Here is a list of other notable recent developments that may have been driven, at least in part, by an interest in weakening the dollar’s dominant position:
- Proposed establishment of a $100 billion Asian Infrastructure Investment Bank (AIIB) by China to compete with the World Bank. China is reportedly in discussions with India and South Korea regarding cooperation in this venture;
- Announcement by Russia’s central bank that it would seek to use a ruble-renminbi swap facility as a payment mechanism in a $400 billion multi-year Gazprom natural gas deal with China;
- Bilateral trade accord between China and South Korea calling for creation of won-renminbi clearing capability to facilitate trade without dollars;
- Growth of virtual currencies, including Bitcoin, whose daily transaction volume has increased from zero to about $50 million a day;
- Reported moves by Russian companies to transfer cash holdings into the Hong Kong dollar to limit the impact of U.S. and EU sanctions.
Yet, the obstacles to any near-term replacement of the dollar as the largest reserve and trading currency are enormous. Bank for International Settlements (BIS) data show that foreign exchange market turnover for the dollar was more than 2.5 times the level for the next-largest currency (the euro) in April 2013.
Any sustained move to unseat the dollar, whether over years or decades, will be complicated by the breadth and depth of dollar holdings worldwide and the preeminent position of U.S. Treasuries in terms of global market liquidity. Currently U.S. Treasuries offer un-paralleled liquidity, with average trading volume of about $500 billion per day—approximately 10 times the level for the next largest top quality European sovereign.
Beyond purely financial considerations, moreover, the dollar’s global dominance remains linked in large part to U.S. diplomatic and military influence around the world, particularly with its strategic partners in Europe and East Asia. Viewed strictly in terms of the relative size of defense budgets, the U.S. continues to play an outsized role relative to its allies—U.S. defense spending is almost three times higher than that of all 27 other NATO members combined.
While there are and will continue to be financial and geopolitical motivations to find a currency to replace or augment the U.S. dollar as a global reserve currency, it may take a long while until a meaningful challenge to the dollar’s preeminent role takes place.