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If the US$’s World Reserve Status fails, what next?

USD $ World Reserve Currency

USD $ World Reserve Currency

There have been growing calls that the dollar should be replaced by another reserve currency. DisruptionBanking takes a brief look at what that could be; crypto, gold, CNY or shells?

On 22nd July 1944, the Bretton Woods system was brought into practice and banks were legally obliged to convert gold to dollars. Less well-known is that during those discussions, John Maynard Keynes, the famous economist that was representing the British side of the negotiations, proposed to establish a world reserve currency (which he thought might be called “bancor“) administered by a central bank vested with the possibility of creating money and with the authority to take actions on a much larger scale. The United States negotiator however won out instead for the dollar to be all-powerful, as after two World Wars, the USA was the only large still-solvent nation. Money talks.

So, when Mark Carney, the Bank of England’s governor raised the concept that “the dollar’s influence on global financial conditions could similarly decline if a financial architecture developed around the new [digital currency] and it displaced the dollar’s dominance in credit markets. By reducing the influence of the US on the global financial cycle, this would help reduce the volatility of capital flows to emerging market economies.” – not everyone was surprised.

And he is not the only one to make a prediction that fiat is in an unstable place. Deutsche Bank has claimed in its ‘Imagine 30’ report, released lately, that “the forces that hold the fiat money system together look fragile, particularly decades of low labour costs. Over the next decade, some of these forces could begin to unravel and demand for alternative currencies, from gold to crypto, could take off” under it’s The end of fiat money? heading and that “until now, cryptocurrencies have been additions, rather than substitutes, to the global inventory of money. Over the next decade, this may change. Overcoming regulatory hurdles will broaden their appeal and raise the potential to eventually replace cash” under Cryptocurrencies: the 21st century cash. It is hard not to read between the lines regarding which fiat currency would be hardest hit by their 2030 marker.

A question on the dollar

And a liquidity crisis in the US$ repo market does seem to be brewing once again, reminding financiers of the 2008 repo freeze. As Zero Hedge notes, since middle September 2019, the United States Federal Reserve has intervened and injected more than $350 Billion to keep the rate in line. If a crisis like the Great Financial Crisis of ‘08 hit consumers and savers again, faith in faith-based (fiat) money might come to an abrupt end. But what is to replace it?

The corporate stable coin basket-peg Libra, by Facebook, is widely cited as a possibility. Probably modelled on the International Monetary Fund’s (IMF) Special Drawing Rights (minus the Renminbi), one of the world’s largest data companies is looking to get in on the fiat fragility. The danger with the Libra concept however is not just that it could replace the dollar’s reserve currency standing but that it could outright supplant an unstable national currency in an emerging market. A corporate-led currency controlling institution would open up a bag of worms for potential abuse.

In fact, David Marcus, the architect of the Libra project acknowledged that “we should assume that there is a chance that this could have systemic risk”. It is hard not to see how powerful the Libra project could become if Facebook’s 2.7 billion users worldwide were introduced to it. Although the Libra whitepaper claims that “the Libra Association is an independent, not-for-profit membership organization headquartered in Geneva, Switzerland.” – much political power can be gotten from an institution prospected such as the Libra Association and it could also be noted that Switzerland goes to extreme lengths to protect its bankers from outside pressure.

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Many argue that the trade in dollars is so large that there is no way for a shift to another reserve currency, say the internationally traded Chinese Renminbi (CNY), to be made. Figures from the IMF however put this in doubt as the United States’ economic sway may be dwindling. Measuring the portion of global Gross Domestic Product (GDP) in terms of Purchasing Power Parity (PPP), the USA was actually overtaken by China in 2013; the USA now stands at just 15.1% and China at 19.2%. Amongst the list of skeptics may be an analyst in Saxo Bank as one of the financial institution’s “Outrageous Predictions for 2020” is that of “an Asian, AIIB-backed digital reserve currency takes the US dollar index down by 20% and tanks the US dollar 30% versus gold.” The ‘outrageous’ prediction by the bank posits that “the USD as reserve currency is outliving its usefulness for the region. To confront a deepening trade rivalry and vulnerabilities from rising US threats to weaponize the US dollar and its control of global finances, the Asian Infrastructure Investment Bank creates a new reserve asset called the Asian Drawing Right, or ADR, with 1 ADR equivalent to 2 US dollars, making the ADR the world’s largest currency unit.”

From Saxo Bank’s innermost ponderings

The fact that so much oil is traded in dollars makes many economists point towards the petrodollar as the source of the dollar’s strength. However, here too China is eyeing a takeover. Yuan-denominated oil futures trading on the Shanghai International Energy Exchange were launched by the Chinese government in March 2018. Daily trade volume on the Shanghai market topped 500,000 contracts many times in December of 2018. This is in contrast to 1,200,000 contracts around the same time of the USD-denominated oil benchmark, West Texas Intermediate, that has been traded since 1987. That means that in one year alone, the Chinese currency-traded oil market has gone from 0 to 42% of the volume in comparison to the oldest oil market benchmark, thirty years old. A major reason that countries or companies would prefer to trade Yuan oil contracts is if they themselves were also under tariffs and/or sanctions from the US and wanted to avoid the difficulties arising from the trade in dollars.

However, the volume of yuan trade settlements remains lacklustre, just 2 per cent of the world’s total. While the US dollar’s share of global currency reserves has been shrinking gradually – to around 62 per cent in the second quarter, its lowest level since 2013 – it is still well above the yuan’s portion.

USD hegemony is useful for American politicians to make points in political disputes, but using it too much would likely push other countries to create alternative trading systems. As seen in the BRICS recent meeting. The Block reported last month that “Brazil, Russia, India, China and South Africa, has proposed creating a cryptocurrency for settling payment transactions between the countries.” The article also mentions that Russia, India and China are exploring an alternative inter-trade mechanism that could bypass the American-controlled SWIFT system. The timing of the move does make sense as President Donald Trump’s protectionist trade policies have even hit at some of America’s closest allies, such as the EU bloc.

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What about the outlying alternatives? Making the case for gold is a tricky one. Although the precious metal is a sound long-term investment, it lacks many of the basic tenants of a widely-used currency. Gold is; hard to transport, easy to counterfeit and is a variable store of value. The fintech Glint has solved the first three of those problems, but alas has been unable to keep the price of gold stable. What is possible is that the price of an ounce of gold could be included in a basket of assets to settle on an amalgamation.

Looking to the sea, one sees the possibility of following in the footsteps of the Tolai people of Papa New Guinea and utilizing shells as a medium of exchange (200 Tabu shells = $0.88) is hampered by climate change as the people of the island have had to import shells from neighboring islands. For this scenario, financial experts are concerned (we only asked one) that “the problem is multi-layered in that they are; fragile and so not easy to transport, there is no authority overseeing the distribution of shells and so it could become an unequal society”.

Predicting what people measure global economic output by in 5, 10 or 20 years instead of the dollar is no easy feat, but a country seems to have solved the answer quite some time ago. The Kingdom of Bhutan has opted for measuring their output not in GDP but via their Gross National Happiness Index. At that point the question becomes how much is your smile worth? A query not everyone in South Sudan, coming in at 156th in the 2019 World Happiness Report, would like to answer. Another unequal dead-end. Seems that’s gold, shells and happiness ruled out.

USD Smiling
Bhutan’s eye-catching exchange rate

“I believe that we will move from a largely dollar-based settlements system to a multicurrency settlements system, in which the dollar, euro, and yuan are all used for international settlements,” noted Jeffrey Sachs. Sachs is an economist that for past 30 years, has advised dozens of heads of state and governments on economic strategy across the world and was the main architect of Poland’s debt reduction operation around the end of the cold war.

With the list of stablecoins (a cryptocurrency security tied to that of a fiat currency trading at 1:1) growing, that “multicurrency system” is looking increasingly likely to be crypto in nature.

The opinions expressed above are those of the author and do not necessarily represent those of DisruptionBanking or its partners.

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