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Threats to the US Dollar?
By: J SCOTT

If you’ve been following social media over the past few weeks – and especially Twitter – you’ve probably come across the term “de-dollarisation.” 

While this isn’t a new term, it’s becoming more popular as economic events related to global currencies are starting to gain media attention. Basically, what it means is that there are threats to the US dollar as the preeminent currency on the planet, and there are some who are concerned that the dollar could be on the verge of losing that status.  Or at least losing some of its strength as other powerful currencies emerge.

 

I wanted to take a few minutes to provide some historical context on how and why the US dollar is major currency in the world, and what threats it’s facing.

WORLD RESERVE CURRENCY

 

Let’s start with this idea of a world “reserve currency.”

 

A world reserve currency is a currency that is widely accepted and held in significant quantities by governments, central banks, and financial institutions around the world.  It’s the currency that is most popular for the purpose of international transactions, investments, and as a store of value (a place to keep your net worth safe and secure).

 

The US dollar is considered to be the world reserve currency today, but that’s only over the past 80 years or so.

Over the past few centuries, currencies such as the Spanish Real (16th and 17th century), the Dutch Guilder (17th and 18th centuries), the French Franc (18th and 19th century), and the British Pound Sterling (19th and early 20th century) have held this title.  Between World War I and World War II, it was mostly gold used as the world reserve.

 

After World War II, the United States emerged as the world's largest creditor nation, with a strong and growing economy and powerful military. These factors contributed to the widespread use and acceptance of the US dollar for international trade.

 

In 1944, the Bretton Woods system was established, which made the US dollar the world's reserve currency. Under this system, other countries agreed to peg their currencies to the US dollar, which was itself backed by gold.

 

Since 1944, the US dollar has been the world’s reserve, but the original system of the US dollar being backed by gold collapsed in 1971, and after that, the US dollar became a fully “fiat” currency, not backed by gold or anything else.  Despite this, thanks to the dominance of US global trade, financial markets, and even military strength, the dollar has remained the world reserve currency.

 

THE GOOD & BAD OF BEING THE RESERVE
 

There are some obvious benefits of being the world reserve currency and even a few drawbacks.

 

The benefits include the fact that having the world reserve currency makes borrowing very inexpensive (other countries are happy to give us money very cheaply for our dollars); it increases demand for our assets, products and services; and it gives us a prominent position when it comes to world political and economic affairs.

 

Basically, having the world reserve currency gives a nation a lot of leverage over political, economic, social, and even military positions around the globe.  The dominance of the US dollar has driven the dominance of the nation for the past 80 years as much as – if not more – than the other way around.

 

But, there is one big downsides to having the world reserve currency as well.

 

As the world reserve, the US has a huge responsibility to ensure economic stability around the world.  Instability – both economically or politically – can lead to a loss of trust in the ability of the US to maintain a strong currency, which in turn could lead to other nations losing faith in the US dollar and starting to use another currency for trade.

 

As you can see, there are a lot of reasons why having the world reserve currency provides tremendous power, and for that reason, there are a lot of nations out there who would love to crush the US dollar and have their own currency take over as the reserve.

THE RISE OF BRICS

 

While there have been a lot of examples of countries trying to use their own currencies for global trade over the decades, we haven’t seen an example of any prominent currencies threatening the dominance of the US dollar. 

 

But, that may be starting to change…

 

Most recently, the five BRICS nations (Brazil, Russia, India, China and South Africa) have been working closing to promote trade in a currency other than the US dollar.  Internally, these countries have been doing a good bit of trading using the Yuan (China’s main currency), and they’ve started to gain some traction.

 

While there probably isn’t much threat of the Yuan taking over for the US dollar (note that the Yuan is pegged to and backed by the US dollar, so collapsing the dollar wouldn’t help the Yuan), the BRICS nations are now starting to discuss creating a new currency that they’d use to trade amongst themselves.

 

These five nations currently comprise just over 30% of the world’s GDP.  While this isn’t nearly enough to threaten the US dollar (much of the additional 70% of GDP is comprised of US allies), things could change quickly.

 

First, it’s forecasted that these nations will grow their GDP over the next 10-20 years, potentially comprising over 50% of the world’s economic output by 2050.  Combine that with the likelihood of over a dozen other countries joining BRICS in the coming years (including Turkey, Indonesia, Argentina, Saudi Arabia, the UAE, several African countries and potentially even Mexico), and you can see how this could quickly become a larger threat.

 

And second, there is now talk that Europe is pushing to become more autonomous, pull away from the US, and emerge as a third world superpower alongside the US and China.  Should Europe reduce its reliance on the US dollar (they already have 20 countries that primarily trade on the Euro), this could end up being a fatal blow to the dollar.

SOME FINAL THOUGHTS

 

Just to add some context here, let me throw out some final thoughts on this topic:

 

* First, note that going back about 500 years, we’ve seen world reserve currencies last, on average, just under 100 years.(99 years is often thrown around as the benchmark.)The US dollar has currently served in this role somewhere between 80-100 years, depending on whether you consider the US dollar to have been the reserve after World War I.

 

* While BRICS may eventually pose a threat to the US dollar, it’s way too premature to assume that this is the direction the reserve is moving.There are a lot of challenges to taking over the reserve currency, and without near global consent, the transition to a new reserve could take decades.

 

* Currently, there are no serious contenders against the US dollar.China is the biggest short-term threat, but its economy is still facing its own struggles.India is likely to emerge as an economic superpower over the next decade or two, and could ultimately pose the greatest risk to US economic dominance.But, that’s likely a long way away.

 

* Even when the US dollar loses its reserve status (and it eventually will), this isn’t necessarily a catastrophic outcome.Many suspect that a dethroning of the US dollar would result in economic factions around the world, where different currencies were used for different types of trade.Globalization could mean that, at some point, we will see multiple dominant currencies, of which the US dollar is one.

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