After the Bell: Reports of the dollar’s death have been greatly exaggerated
My guess: we are going to have a very long BRICS discussion on the topic, and then very little is going to happen, much like lots of other BRICS talks.
People have been talking for years about the decline of the dollar as the global currency underpin. There seems to be another bout of conversation along these lines from global leaders about its dominance, especially from the BRICS group (Brazil, Russia, India, China, and SA).
Honestly, this discussion makes my head hurt. I have the vague feeling that it’s important, or it must be important, or at the very least it’s about to become important soon.
The reason it’s so hard to comprehend is that macroeconomics is generally hard to understand, and as soon as you launch into a discussion about it, you quickly descend into what I call the macrosoup; a hotchpotch of important-sounding phrases and clichés which seem designed to make everything even more complicated. In defence of macroeconomics, it is complicated. And even worse, it’s almost impossible to conduct scientific experiments in macroeconomics, which is why it’s generally so much a matter of philosophy and feel.
Anyway, allow me in my simplistic, journalistic way to try to summarise and explain what is happening here.
Is this important?
First question: is this important? And I mean, is it important to you and me, as opposed to, just notionally important? As Groucho Marx used to say, absodoodly. The US economy is about 25% of global GDP, but about 65% of global foreign exchange reserves are held in dollars; roughly half of all trade invoicing happens in dollars; about 45% of global debt is held in dollars; and about half of cross-border loans are made in dollars.
As the French finance minister Valéry Giscard d’Estaing said way back in the 1960s, this provides the US with an “exorbitant privilege” because it tends to massively increase investment in US assets. One of the consequences is that the world tends to get bounced around, like it or not, by the domestic peculiarities of the US economy, even if the macro requirements of their own economies are pulling in a different direction.
Arguably, now is one of those times. Comparatively high US inflation has resulted in nine interest rate increases in the US over the past year. US inflation was about 9% last year, and it’s around 5% now. That’s actually higher than SA’s inflation rate over the same period on average, but SA has been forced to match US interest rate increases, for lots of complicated reasons.
But – second question – why is there more talk about alternative currency systems now? And the answer to that is simple: the Russian invasion of Ukraine. Shortly after the invasion, global banks froze about $300-billion in Russian foreign exchange reserves. For nations around the world, this is a huge wake-up call, particularly for the BRICS nations.
I think the common response around the world was roughly this: “What? They can do that?” Previously, the critics of dollar dominance argued that the dollar would decrease in significance roughly in line with the rise in importance of economies like China, in the same way as the pound declined as the UK’s global economic dominance diminished in the 19th century. But this is an entirely different thing.
Imagine for a moment that China invades Taiwan, as it has threatened to do on multiple occasions. Would that mean China’s huge US-dollar investments could be seized by the US? The Ukraine war situation suggests it could be possible.
Which is why – third question – the BRICS nations are at the forefront of this battle, and why it will be a big topic at the BRICS conference in SA in August. The Ukraine war has given huge impetus to an existing longer-term trend. The Chinese renminbi’s share of trade finance has more than doubled since the invasion of Ukraine, and that presumably has to do with Russian sales of oil to China which are now denominated in the Chinese currency.
But you have to remember the currency in which trade takes place is really not much of an issue here. You can trade in bitcoin, or any other currency, and then swap it back into your own currency, or any other. The big issue is what do you do with the money when you get it. For countries that run current account surpluses (not us), this is a particularly tricky question. Up till now, the default has been US Treasuries, because if there is one thing you want to do with your cash once you get it is to make sure it doesn’t disintegrate.
US Treasuries are liquid, safe and huge, which is another reason the dollar is so dominant. It’s comparable to the network effect: the more people that sign on to your network, the more valuable it becomes, so even more people sign on, and so on. In this sense, the dominance of the dollar is a huge benefit to the global economy because it creates this stable, liquid, safe underpin.
And that brings us to the last question, what do BRICS countries, for example, need to do to create an alternative? And the answer is that it’s not easy, and probably not advisable either. Of course, given that the Chinese economy and the US economy are now roughly the same size, it would make sense for more trade to take place in the Chinese currency.
The problem is that the renminbi does not trade freely; its value is fixed by a currency board, which allows the currency to trade in a 4% band, 2% up or 2% down, every day. That indicates the direction the currency is moving in, but severely curtails its response to larger-scale economic events. China also has very severe capital controls (restrictions on residents owning foreign currency), as do India and South Africa.
So when you hear the BRICS leaders thump their chests about dollar dominance, it’s worth remembering that a big part of the solution lies in their own hands. All they have to do is dump their own capital controls, and trust me, they are not going to do that. Autocratic and fragile states don’t generally have capital freedom because, at root, autocrats are afraid of their own citizens.
My guess: we are going to have a very long BRICS discussion on the topic, and then very little is going to happen, much like lots of other BRICS discussions. As Mark Twain might have said, reports of the dollar’s death have been greatly exaggerated. DM/BM