Requiem for a Currency... The Slow Death of the U.S. Dollar
By Kim Iskyan
It was November 25, 1980 when Sugar Ray Leonard II pummeled defending champion Roberto Durán for nearly 24 minutes during their World Boxing Council welterweight championship bout (billed "The Super Fight").
With 16 seconds left in the eighth round and knowing he was going to be beat, Durán uttered no más, no más – Spanish for "no more, no more" – as he turned away from Sugar Ray.
Durán waved his glove at the referee and retired to his corner. It was the first time in more than 15 years that a champion had quit a title fight.
And no más might be what global investors say to the U.S. dollar soon...
The steady debasement, through ever-escalating mountains of debt, the dollar is increasingly threatening its status as the world's reserve currency.
At some point – and this is historically inarguable – the dollar won't be king of the castle anymore.
Tectonic shifts like this happen over decades... and almost invisibly. And it's happening now. The good thing is, there's still time to prepare.
The U.S. Dollar Makes the World Go 'Round
Though many Americans may not realize it, the U.S. dollar is the cool kid of the global economy: Everyone else wants to be around him... craves his attention... and wants a piece of him. For more than a century, it's been the world's primary reserve currency.
Central banks around the world hold reserves – in currency or precious metals – so they can trade goods abroad or invest in other countries. Some central banks also use it to maintain exchange-rate pegs. Around 59% of the $7 trillion held by governments around the world in reserves are held in U.S. dollars. Seven different countries use the U.S. dollar as their official currency, while 65 others peg their national currencies to it.
And greenbacks are the world economy's most important medium of exchange, unit of account, and store of value. If they don't use U.S. dollars, it's a lot more difficult – and expensive – for countries, companies, and people to buy oil or gold, sell toys or cars, or invest in hotels or bridges.
When a Vietnamese (or Argentine or Canadian) company wants to buy goods from Brazil (or South Africa or Singapore), they'll likely use U.S. dollars... because it's the common currency between the two parties in most global transactions.
Similarly, when a tourist from Mexico City visits Moscow... or someone from Sao Pãulo goes to Sydney... she'll take dollars with her, not her local currency. Uncle Sam's money speaks every language on Earth, and no matter where you go or what you want to do, you can use your U.S. dollars to buy other money.
The Dollar Privilege
Because everyone wants dollars, the U.S. government – that is, the Federal Reserve, the American central bank – has enjoyed a unique advantage: It's been able to borrow, seemingly endlessly, from everyone else to create new dollars. And the government has been able to defer repaying its lenders by constantly rolling over – and increasing – its debt, seemingly forever.
In the 1960s, French politician Valéry Giscard d'Estaing called the benefits that accrue to the United States thanks to the U.S. dollar's status as a reserve currency an "exorbitant privilege."
Thanks to its privilege, the U.S. national debt stands at $28 trillion (up 20% in 2020). For context, U.S. GDP – that is, economic output – totaled $21 trillion in 2020. That's around $85,000 for every single American citizen.
And there's more. We're moving into a brave new world where trillions (that is... 12 zeros) are discussed with the nonchalance that was recently reserved for mere hundreds of billions, as COVID-19 relief packages revises the notion of big numbers. Total COVID-19 aid has amounted to $5.3 trillion, only some of which is included in current debt figures.
Put it all together, and 78% of all dollars that have ever been made, have been created over the past 12 months. (And... none of that, of course, includes the proposed $2 trillion infrastructure plan announced by the White House in late March.)
The federal deficit is forecasted to hit 15% of GDP in 2021, the biggest deficit since World War II. That's compared with 2.4% as recently as 2015... and 9.7% in 2009, in the depths of the global financial crisis.
It's like the United States has had an open tab at the global money bar... and it's been on a historic bender, evading hangovers with endless Bloody Mary hair-of-the-dogs – and then starting all over again.
Other countries – countries that aren't the United States (with the partial exception of the Japanese yen and Europe's euro, the RC Colas of reserve currencies) – can borrow only as much as others will lend them. As they borrow more, the price of that borrowing increases.
And the cost of borrowing for the U.S. has been rising in recent months – along with the risk of inflation. If the U.S. was a normal country – one that, say, had to pay its bar tab and eventually show up at work the next day after a long night at the pub, bleary eyed and headache-y – it would have gone bust years ago.
Since the dollar is the world's reserve currency, that's not going to happen. It can just sell more debt. But meanwhile, the decline of the dollar's status is accelerating.
America's Declining Market Share
The U.S. dollar has long been in the pole position as the global reserve currency because the U.S. is by far the world's biggest economy, and the dominant player in global investment and finance.
Correction: It was the global economy's 800-pound gorilla. Over the past few decades, America's share of global economic output fell from 40% in 1960 to around 23% today. The U.S. now trails the EU and China in terms of overall volume of exports and imports.
That's partly pure mathematics. The Chinese economy grew by an average of 10.4% for the two decades after 1991, while the U.S. economy grew by an average of only 2.5% over that period. Now China's economy accounts for around 17% of the global economy and will likely overtake the U.S. as the world's biggest within the next five years. (And according to one, lesser-used, methodology to tabulate economic output, it already has.)
So it's not surprising that the global reserve currency holdings of the U.S. dollar, as a percentage of total stockpiles, at 59% is at its the lowest levels since the 1990s.
The recent decline happened "amid questions about how long the dollar can maintain its status as the pre-eminent reserve currency," explained Bloomberg in late March. And the world's economies feel the need to reduce their U.S. dollar "overweight" reserve exposure to the U.S. dollar, as the American economy loses market share.
Reserve Currencies Come and Go
We – that is, anyone reading this in 2021 – only know of a world where the U.S. dollar has been in the cockpit. But just over 100 years ago, it wasn't... and if history is any guide, soon it won't be.
The past six centuries have seen six different reserve currencies. Each lasted for about a century, give or take a decade or two. The Portuguese real was the world's main currency from around 1450 to 1530. Then a royal succession crisis distracted Portugal, opening the door for Spain's currency to become the world standard, for around 110 years.
Subsequently the Dutch guilder took over as king of the hill, until the Bank of Amsterdam issued too much debt in the early 1700s, and lost the confidence of the market and investors. France assumed the throne, followed by Britain in the early 1800s.
The British pound's reign as a reserve currency ended with the declining importance of Britain in global commerce – compounded by the decline in global economic interdependence after World War I.
That's when the U.S. dollar became the dominant currency in the global economy. Its position at the top was solidified in 1944, when the Bretton Woods accord established the ground rules for the global monetary system.
A number of conditions – inflation, high debt, bad policy management, and just plain greed – can play a big role in ending a reserve currency's run. That, and the calendar, suggest that it's after the seventh-inning stretch for the U.S. dollar as the start of the global financial system... and it might already be in the ninth inning. And we'd be kidding ourselves to think – hope – that we're going into extra innings.
What's Next?
"One can hardly pick up a financial newspaper these days without seeing a story about the dollar's impending loss of international prominence," wrote University of California economist Barry Eichengreen... in 2005.
Right now, it's almost as if the U.S. government is doing everything it can to accelerate the extinction of the U.S. dollar as a reserve currency... escalating debt, increasing inflation, and rising deficits are all toxic to the longevity of the dollar as a reserve currency.
If not the dollar, though, then who? The options are limited. The euro – hostage to the EU's political infighting – always seems to be one debt crisis (or charismatic anti-Europe populist) away from calls for its dissolution. And the No. 3 reserve currency, the yen, has as its home an economy that's in the midst of a multi-decade drift into irrelevance.
With the rise of the Chinese economy, the renminbi is an obvious contender. But the renminbi isn't even freely convertible and is still subject to capital controls. It's nowhere close to becoming a global currency – let alone a reserve currency.
What is more promising – or, for the dollar, threatening – is currency digitalization. Many countries have been struggling to figure out how the rise of cryptocurrencies and the blockchain will impact currencies. Most central banks, including the Fed, have alternately ignored, threatened, and weakly embraced elements of the blockchain.
But China, always attuned to an opportunity to exercise ever-greater control, has since 2014 been developing a central bank digital version of the country's currency. Its digital version of the yuan will function like cash – and be completely centralized and controlled by the country's central bank.
As a commentator wrote earlier this week in the Financial Times...
... [the digitized renminbi could] hasten the decline of the dollar's dominance as the world's leading reserve currency. It could also hasten the acceptance of the renminbi as the main rival to the U.S. currency... if China captures the first-mover advantage to meet the world's demand for use of digital currencies to settle international financial transactions and own digital assets, the appeal of its [currency] could rise sharply.
Fundamental to cryptocurrencies is the element of anonymity afforded by the decentralized blockchain ledger. A digital currency controlled by the Bank of China and the Chinese Communist Party – denominated in a currency that's as useful outside of China as fish sunglasses – isn't (ever) going to overthrow the U.S. dollar as the world's reserve currency. It may, though, become widely used in the developing countries, if China were to make receipt of Belt and Road Initiative (formerly One Belt, One Road) investment contingent on using its digital currency.
Most likely is that the U.S. dollar continues to be nudged out of the ring. The other reserve currency options – euro, yen, renminbi, digital renminbi – may become more palatable in relation to a debauched dollar. And in time, bitcoin – or a future cryptocurrency standard bearer – may also be used as a reserve currency.
What to Do?
There's one asset that's held its value over time – and which will continue to do so, regardless of the Fed and China and European bureaucrats: Gold.
Your wealth will be much safer if you're holding at least a portion of it in gold... not in anticipation of the price of gold rising (though it likely will), but just as a way to preserve your capital.
Bitcoin is another – though more speculative – option. If one day the cryptocurrency blue chip becomes only a sliver of a reserve currency holding for the world's central banks, its value will explode. That probably won't happen... but in the meantime, it's the one currency that isn't subject to the whims of central banks and politicians.
And finally... reduce your exposure to the dollar (and the United States). Open a bank account abroad. Buy some foreign real estate, and shares of companies outside the U.S. If you're really feeling extreme, look into giving up your U.S. passport – though only after acquiring another citizenship first.
It's not no más for the dollar yet... But you want to be ready for when it is.
