The fate of the US dollar
HDN | 10/31/2009 12:00:00 AM | GARY LACHMAN
Despite the decline in the US dollar, the Chinese yuan, the IMF's SDR and the euro all have drawbacks preventing them from becoming the new reserve currency of choice.
For the past few weeks, one of the constant subjects of discussion at the many dinner tables at which I have sat is the sustainability of the U.S. dollar's role as an international reserve currency.
Recently, the president of the World Bank, Robert Zoellick, has weighed in with his two cents. Although it is undeniable that the dollar has seen a recent decline in value, I believe that any major shift away from the dollar as a reserve currency is in the distant future. The basis for my opinion is that the three most likely candidates to replace the dollar in this role – the euro, the Chinese renminbi and the IMF's Special Drawing Rights, or SDR – all have substantial drawbacks for that purpose.
The fact that many believe that the dollar and its use/abuse led to the global economic crisis is compounded by the fact that there are now several other economies that have demonstrated the possibility of reaching the same proportions and stature as that of the U.S. Although the dollar's pre-eminence may already be in decline, it is unquestionably still the most widely held currency in the world’s central bank foreign reserves. Despite this fact, the data available indicates that the U.S. dollar's share of central bank reserves has fallen from 71 percent 10 years ago to 65 percent in the first quarter of 2009. Not a complete reversal of fortune, but noteworthy, nonetheless. The euro has been the currency du jour in filling the gap, rising from 18 to 26 percent during the same period.
The dollar will maintain its status as the primary reserve currency for the foreseeable future because alternatives remain extremely limited. In order for a currency to be appropriate for use as a central bank reserve currency, sufficient assets distributed throughout the world must already be denominated in that currency for it to be a capital asset of reliable value. To qualify for that status, a reserve currency must be highly liquid in times of economic stress. The Chinese renminbi, which literally means “People’s Currency” and is known as the yuan, is increasingly being considered as a potential competitor of the dollar. However, it does not meet the requirements for having much liquidity. The Chinese government bond market is still in a very early stage of development while bonds can only be bought and traded by Chinese residents.
Although the government has just launched its first series of yuan-denominated bonds in Hong Kong, it is unlikely that they will remove these restrictions anytime soon. The Chinese government fears that opening their bond market to the world would put an unsupportable burden on their nascent financial system. When the Chinese do finally liberalize their currency, it will take a long time for yuan-denominated assets to become stable and liquid enough to enable the world’s central banks to enjoy a sufficient comfort factor in holding them as reserves.
The SDR enjoys an advantage over the yuan in that they are at least tradable in international markets, although only among governments and central banks. Unfortunately, without their being accessible to private and institutional sectors, they cannot achieve sufficient liquidity to be viable as a major reserve currency. Furthermore, virtually no bonds are issued in SDR denominations. This condition is not likely to change because governments prefer to issue bonds in their own currencies to avoid exchange-rate risk.
The only potential currency available that might rival the dollar is the euro. In fact, it is the only one of those discussed above that is already a significant reserve currency besides the dollar. Despite recent stress from the global economic crisis, the EU has demonstrated respectable economic stability while its central banks have been willing to step in and take aggressive action to keep it that way. Nevertheless, euro liquidity is not overwhelming because its debt market is highly fragmented between member states. The rest of the world is as worried about EU sustainability as it is about the US-driven economic recovery. For these reasons, euro-denominated assets have limited global appeal. They are held as reserves primarily by other central banks in Europe, and represent minor portions of the reserve accounts of central banks in other regions. For the time being, it therefore appears that we will still be stuffing our mattresses with greenbacks.
© 2009 Gary S. Lachman. Gary Lachman is an international lawyer formerly with the U.S. Department of State, a real estate developer, an associate professor at Johns Hopkins University and has a consulting practice in Istanbul. He can be contacted at [email protected]