A Conversation About King Dollar and Its Possible Demise as the World's Reserve Currency
Over the past few weeks, we have all witnessed countless media posts about the status of the U.S. Dollar as the reserve currency of the economic world. It is clear that such result is a key policy objective of China and Russia, and possibly many others. Saudi Arabia is reportedly considering accepting Chinese yuan as payment for oil sold to Beijing. The yuan has become the most traded currency in Russia, according to Bloomberg, a year after the western world-imposed sanctions on the Kremlin over its invasion of Ukraine.
Such developments, along with sentiments expressed recently by French President Emmanuel Macron, have led to declarations that King Dollar is dead. But I would submit that such pronouncements seem a bit premature.
History is full of economic and societal collapses. The Incan and Roman societies disappeared, the Ottoman Empire fell apart, the United Kingdom saw the pound lose its reserve currency status. So, anyone who says the US, and the dollar, couldn’t face the same fate doesn’t pay attention to history.
The key question is: will it? Russia, China, Brazil, and others, including Saudi Arabia, all seem to think they can find a way to replace the dollar and undermine US dominance on the world economic stage.
They may try. And they may cause many to fret, but I highly doubt these countries will succeed. In order to understand why I think this, it is important to understand the ascendancy of America. In the late 1700s, the US was a patchwork of colonies barely clinging to the Atlantic Seaboard.
But it wasn’t victory in the Revolutionary War that made America strong, it was the writing of the Constitution and the culture that created the Constitution. The rule of law, private property rights (especially to inventors through patents), democracy (and free elections) made America different and ushered in two centuries of supercharged human progress.
While the US ran up large debts to fight wars, it managed to grow its way out of such debt. At the same time, our monetary system (Thank you Mr. Hamilton!) kept the dollar fairly strong and stable relative to other currencies. The combination of all of this led to deep and robust capital markets, and a dominant 60% representation by the dollar in foreign currency reserves and nearly 90% of global financial transactions.
For decades to come, the greenback is likely to remain the dominant reserve currency, mainly because of the familiar TINA: There Is No Alternative. That doesn’t mean that that it won’t lose value, whether measured against other currencies or gold, which for centuries WAS money.
In fact, we have already witnessed the devaluation of the dollar versus gold. It now takes nearly 60 times as many dollars to buy an ounce of gold as it did in the early 1970s when gold’s price was fixed at $35 an ounce under the old Bretton Woods system. That said, investments in dollar denominated assets, such as the S&P 500, have returned eight times more than gold in the past 35 years.
As a peg for the global monetary system, Gold is also far from ideal. Gold’s constrained supply, its greatest strength as a bulwark against inflation, is also its greatest weakness, because it can’t expand to accommodate global growth.
The US dollar performs that role admirably. To provide an adequate supply of liquidity for world trade and finance, any competing currency would have to be issued by a nation willing to run current account deficits. And those deficits would eventually undermine the desirability of any such currency.
The US runs a persistent current account deficit and covers the difference with IOUs in the form of Treasury securities and other instruments, which the rest of the world readily uses as safe, liquid assets. Foreigners also flock to other desirable US investments, from NASDAQ stocks to Florida condos. So, the symbiosis works!
This symbiotic relationship has its flaws. It has made the US dependent on capital inflows. This was not a problem during the dot-com boom of the 1990s, when money surged into our country to buy American securities. But the massive fiscal borrowings following the 2008-09 Great Financial Crisis and the Covid-19 pandemic have raised concerns about the limits of Uncle Sam’s credit.
Despite America’s twin deficits - in the federal budget and the current account (primarily trade) - respected global financial experts see no alternative to the dollar emerging, even if the greenback likely will decline in value versus other major currencies.
To compete with the Buck, a rival would require free flow of capital, a liquid bond market such as Treasuries, implicit acceptance of less control of exchange and interest rates, a strong rule of law, and the willingness of a central bank to be the banker of last resort to its counterparts, a role we have seen the Federal Reserve assume through its capacity to expand its balance sheet to provide dollars when needed to stabilize the global economy.
The most proximate threat to the dollar and its global status would be a US default from the failure to raise the debt ceiling. For America, maintaining financial independence is a matter of national security. The kowtowing of the French President to the Chinese government in recent days is a grim reminder of why we must retain the economic shining city on the hill.
What made America strong is not our natural resources (which are abundant), but it is our Human Resources and our Freedom. China, Saudi Arabia, and Russia may have resources, but they are not free. It will not be any of these countries that replaces the dollar, and it is highly unlikely to happen in our lifetimes. However, that’s not to say that it won’t happen in our children’s lifetimes. Bad policies beget bad outcomes. King Dollar will only stay that way if the US keeps its fiscal and monetary house in order. Limiting government spending, keeping tax rates low, and returning our Federal Reserve to a more restrictive monetary approach are key components to preserving our King on its throne.
David A. Pickler, Esq., CFP®, ChFC®, CDFA®
Pickler Wealth Advisors