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Is the Dollar Cursed?

11 min reading

The dollar's dominance in the global financial system has given the United States tremendous financial and geopolitical power at the expense of its competitors and even its allies.


The dollar's dominance in the global financial system has given the United States tremendous financial and geopolitical power at the expense of its competitors and even its allies. The uncomfortable reality for other countries is that dollar dominance makes it difficult to bypass dollar-based financial systems by pegging them into currencies and subjecting them to US sanctions. It makes no sense that Europe pays 80% of its energy import bill - worth €300 billion per year - in US dollars when only about 2% of our energy imports come from the US. It doesn't make sense that European companies should buy European planes in dollars, not euros.

Therefore, before the end of the year, KPPU will present an initiative to strengthen the international role of the euro. The euro must be the face and instrument of a new, more sovereign Europe. That is why we must first organize our own homes and strengthen our economic and monetary union, as we have started. Without this, we will lack the means to strengthen the euro's international role.

This is more of a request than a declaration - the role of the euro in international finance continues to decline as Europe continues to be plagued by political divisions and centrifugal forces that threaten to destroy the continent. However, US government officials are well aware that dollar dominance is not destined and, in particular, there is a risk that the rest of the world will be hit in response to violations of US sanctions. Jack Liu, who was Secretary of the Treasury under President Barack Obama, explained the matter: Sanctions should not be taken lightly.

They can strain diplomatic relations, destabilize the world economy, and impose real costs on companies abroad. The risk that the imposition of sanctions will eventually lead to business activity in the US financial system could be exacerbated if the alternatives, the US as the center of financial activity and the US dollar as the world's main reserve currency, play a stronger role in the global financial system. The more we condition our handling of the dollar and our financial system to comply with US foreign policy, the greater the risk of medium-term migration to other currencies and other financial systems. Such an outcome would not be in the best interest of the United States for a number of reasons and we must be careful to avoid it.

This worldview is generally not reflected in local US politics, which is more like what can be described in American language as "my street or highway". Foreign Minister Liu pointed to a particularly dangerous consequence of secondary sanctions – the threat to exclude foreigners or companies from the US financial system if they engage in activities with sanctioned companies, even if those activities do not directly affect the United States. He noted that this could stir resentment even among close US allies, who see it as an extraterritorial effort to force them to comply with US foreign policy. Indeed, there are many reasons for resentment about dollar dominance.

The demand for bitcoin as a store of value has sparked debate over whether this cryptocurrency can challenge the role of traditional reserve currencies, particularly the dollar. With the development of major technologies and the development of better validation and consensus mechanisms, it is likely that cryptocurrencies will play a bigger role as a medium of exchange. Even this proposal is weak given the high price volatility that the currency is prone to. However, this change may occur over time as the payment function of cryptocurrencies takes precedence over speculative interest in them, especially as private stable coins become more powerful.

 The changing landscape of cross-border payments will have consequences. Lower fees and easier processing of cross-border transactions between currency pairs could undermine the dollar's role as the vehicle currency and unit of account in international transactions. It is hardly difficult to think of denomination and settlement of contracts for oil and other commodities in other currencies, perhaps even in emerging market currencies such as the yuan. In fact, China's oil purchases from Russia and Saudi Arabia can be easily negotiated and transacted in yuan, as these countries can use this income to pay for their imports from China. China has also started issuing yuan-denominated futures contracts to divert more financial transactions related to buying and selling oil, including the derivatives market, from the dollar. Such developments are important, but need to be kept in the right perspective. While the existence of yuan-denominated oil derivative contracts is a remarkable development, it is far from playing a significant role or in any way replacing dollar-denominated contracts.

Despite this change, the role of the dollar and other traditional reserve currencies as reserves of value will not be affected. Safe financial assets – assets that retain their value even in times of extreme national or global financial stress – have many properties that cryptocurrencies cannot compare to. An important requirement for a currency portfolio is depth. This means that a large number of financial assets must be denominated in this currency so that authorized investors, such as central banks, and private investors can easily acquire these assets. There are a large number of US securities, not to mention other dollar-denominated assets, that overseas investors can easily buy. Another important feature. because the value of a stock that is closely related to its depth is its liquidity. That is, it should be possible to trade large amounts of assets without any problems. Investors should be able to rely on the availability of a sufficient number of buyers and sellers to enable such trading even in difficult circumstances. This certainly applies to US government bonds which are traded in bulk.

For ambitious currencies, asylum, depth and liquidity in the appropriate financial instruments in this currency are very important. More importantly, both domestic and foreign investors in the financial crisis trusted the currency because it was backed by a strong institutional framework. Elements of the framework include an institutionalized system of control and equilibrium, the rule of law and a reliable central bank. These elements provide protection to investors and ensure that the value of these investments is protected and that domestic and foreign investors are treated fairly and are not exposed to the risk of expropriation.

There is a well-founded concern that Donald Trump and his activists have inflicted irreparable damage on the institutions that underpin trust in the dollar. More worryingly, the proud US system of control and balance did not work well during his reign. Republican congressmen have abandoned their role as a test of the president's power by tolerating his attacks on the independence of the Federal Reserve, violations of the rule of law, and fickle economic policies. Fortunately, the United States (and the world) is ultimately against the self-correcting mechanisms of democracy. Some of the damage to the US institutional framework and investor confidence in it could be long-lasting. In international finance, however, everything is relative. While the US institutional framework has dealt some physical blows, there is no rival to match the combination of economic, financial and institutional forces that cement the dollar's dominance.

While reserve currencies may not be challenged as a store of value, digital versions of existing reserve currencies and enhanced cross-border transaction channels could increase competition between reserve currencies themselves. In summary, current or emerging financial developments indicate some changes in national and international financial markets, but revolutions in the international monetary system are not fully foreseeable in the future. In particular, the state of the dollar is not threatened. Is this an overly optimistic perspective when not just cryptocurrency enthusiasts but the world as a whole want a change?

The passionate desire of government leaders and officials around the world to take the dollar off its pedestal has moved closer to finding a safe alternative asset. This desire has been given new life with the emergence of cryptocurrencies and their new technologies. In September 2019, Benoît Cœuré, then a member of the Governing Council, gave a speech in which he speculated whether a globally stable coin like Libra/Diem “could be a contender for the dollar iron throne”. He argues that "under certain circumstances and if allowed to thrive, private digital forms of money can more easily and quickly question the superiority of the US dollar over currencies issued by other countries."

Kyore made two important points. First, no longer widespread use of the existing reserve currency will give them a permanent advantage over the new currency. Such network effects usually make it difficult to remove existing ones. Cœuré finds that the exchange rates for mass consumer payments (as we saw in Chapter 3) are much lower than the traditional currencies used for cross-border trade and wholesale finance. Second, he argues that the factors governing the use of international currencies are also changing and that new currencies have an advantage. He noted that "it may be easier to connect a new currency to an existing network - in the case of Libra - than to build a new network on top of an existing currency - in the case of the euro".

This rationale suggests that international currencies can benefit from other uses by reversing the traditional paradigm that currencies used for payments, or in this case electronic payments, are used for other purposes from time to time. Adding the functionality of paying with digital tokens or global stable coins to existing messaging platforms like WhatsApp will allow direct money transfers between platform users. The core business model of messaging and communications services is not affected by these additional payment-related functions. Such a stable coin initiative, built on a service platform with a broad international reach, could actually enable relatively smooth domestic and cross-border payments, at least between private individuals and small businesses. In this way, the competition between new and old international currencies can become more intense and dynamic in the future, where the profits of the holders are no longer as strong as before.

Given the widespread friction that international payments require, it is certainly reasonable to assume that stable coins could gain strength as a medium of exchange that complements, but does not replace, existing payment currencies. In either case, the dollar will be least affected by competition from alternative payment currencies. The more likely outcome is the erosion of stocks in currencies such as the euro, British pound sterling and the Japanese yen, while the dollar remains largely unharmed.

Ultimately, a stable coin pegged to the dollar will only make it easier to access the world's leading currencies. If Diem offers available versions of the coin that are pegged to the dollar, euro, and several other major currencies, it would be fair that demand for dollar-backed coins would be the strongest, at least initially. Moreover, it is difficult to assume that such a stable coin would represent an alternative store of value. In fact, the attractiveness of stablecoins is precisely because their value is closely tied to the existing reserve currency favored by savers and investors around the world. In short, the emergence of stable coins pegged to existing reserve currencies will reduce the immediate demand for these currencies for international payments, but will not fundamentally change the relative balance of power between the major reserve currencies.


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