Against the background of dollar inflation and large-scale sanctions against Russia, experts began to discuss possible changes in the global monetary system more actively. The Chinese yuan, or rather its digital version, is already claiming to be the reserve currency instead of the dollar.
ForkLog figured out how justified the talk about the "death" of the dollar is and why some countries advocate de-dollarization of their reserves.
How the dollar became a reserve currency
In 1944, forty-four countries concluded the Bretton Woods Agreement. According to its terms, the value of each currency of the country participating in the agreement was pegged to the dollar, and that, in turn, to gold.
The dollar was chosen because the United States was already the main economy of the planet and had the largest gold reserve. In addition, it was the only developed country at that time that was not directly affected by the Second World War.
The end of the "gold standard" of the dollar in 1971 was put by US President Richard Nixon. Officially — to fight against "speculators". The real reason, according to economists, was that by that time the volume of dollars in circulation had grown too much due to spending on the Vietnam War and social programs, and Washington simply did not have enough gold reserves to provide currency.
Nixon's decision turned out to be historic. The possibility of free conversion of one currency into another has appeared in the world, and their prices have become more determined by the open market.
However, the dollar still dominates as a global monetary unit in which states, organizations and ordinary people keep their reserves, on the basis of which international finance and trade operate.
What gives the status of a reserve currency
For the United States, the dollar's dominance among reserve currencies means virtually unlimited demand for it. This, in turn, allows the United States to increase the public debt indefinitely, through which Washington finances the American economy, starting from federal programs and ending with widespread subsidies to municipalities, ensuring the economic growth of the whole country.
In 2011, after the first powerful wave of the "printing press", which was turned on after the financial crisis of 2007, the US national debt amounted to $14.8 trillion. But since that time, it has almost doubled, to $29.1 trillion in 2021. This is more than 120% of the country's GDP, although the recommended rate is much lower.
At the same time, there is no default, which has been predicted by "analysts" for decades, in the United States: its authorities are able to cover any amount of debt by issuing currency. In the end, they simply believe in the stability of the dollar, because the entire world economy works on it.
The dollar's influence on the debt market is not limited to the United States. Other states also often raise funds through dollar bonds, and issue obligations in national currency mainly for the domestic market. According to the estimates of the Bank for International Settlements (BIS), in the 3rd quarter of 2021, the total volume of debt obligations outside the United States exceeded $13.4 trillion.
Obviously, not everyone is satisfied with the exceptional situation of the United States, and loud criticism of this system began during the Bretton Woods Agreement. So, in the 60s, the French Economy Minister succinctly described the phenomenon of unlimited US government debt as an "exorbitant privilege", and since then this term has firmly entered academic circles.
The threat of inflation
, the dollar has been the main reserve currency for more than 80 years. But his story in this role was not so smooth.
In the late 70s, uncontrolled inflation began in the United States. Its level largely reflects the stability of the currency and confidence in it. An increase in inflation leads to a decrease in the attractiveness of the currency.
In 1979, as a result of painful economic reforms, the annual value of inflation reached a record, exceeding 13%. Then its level fell, but in some years it could grow. As a result, the dollar's share in world reserves decreased from 85% in 1977 to about 45% in 1991.
Then the importance of the dollar in world finance began to grow again — the USSR collapsed, the United States became the absolute leader, and the world predicted the "end of history".
By 1999, the dollar's share in global reserves had grown to more than 70%, but then a second event happened — the emergence of the euro. Since that time, its share has been falling: central banks are actively diversifying savings.
Today, the world monetary system is already quite diverse. According to the IMF report, by 2021, the dollar's share in global reserves has fallen to a 25-year low of 59%. Next comes the euro, whose share fluctuates within 20%, followed by the Japanese yen (5.6%) and the British pound (4.8%).
And only behind them is the Chinese yuan with a share of 2.8%. Despite the fact that China is the second largest economy in the world, its currency is not perceived either as an effective means of accumulation or as a means of exchange (China is the largest exporter in the world). At least not yet.
Changing the global structure of reserve currencies. Video: Visual Capitalist
The yuan is not the main reason for the shaky confidence in the dollar, but the fear of rising inflation.
In the spring of 2020, in response to the pandemic, the US authorities launched the largest incentive program in history. In just a year, the Fed has added several trillion dollars to its turnover. In the short term, the incentive worked: instead of a crisis in the stock market, rapid growth began, and the cryptocurrency market joined this trend.
However, excess liquidity was superimposed on the deficit caused by the pandemic and led to a sharp increase in prices on the commodity market. In the same USA, the rise in prices for building materials, in particular wood, has become the subject of memes.
The surging prices accelerated dollar inflation, and in February its value was 7.9%. This is a record since 1982.
As history has shown, inflation is dangerous for the reserve status of the dollar, because it actually "eats" savings. Investors have repeatedly expressed concerns about the development of this particular scenario. Perhaps Ray Dalio calls loudest of all to abandon investments in the dollar (and fiat in general). And billionaire Elon Musk, in a semi-ironic manner, said that due to the threat of inflation, he would continue to hold cryptocurrencies, and advised investing in "physical assets".
Financier Stanley Druckenmiller also fears that the long-term stability of the dollar is undermined due to mistakes in regulating the US economy. According to his forecast, the US currency will cease to be a reserve currency over the next 15 years.
"I cannot find a single period in history when monetary and fiscal policy would be so far from economic circumstances," he is sure.
Paradoxically, even against the background of a sharp jump in inflation, the value of the dollar relative to other currencies does not change. This is indicated by the famous DXY index, which reflects the ratio of the dollar and a basket of other currencies (euro, Japanese yen, British pound, etc.). Its value, although fluctuating over the past 20 years, by 2022 returned to the level of the late 90s. That is, dollar inflation accelerated, but the same thing happened with other major currencies.
One way or another, but in the last month, another risk has been added to inflation — political.
De-dollarization as a response to sanctions
On February 24, Russia invaded Ukraine. After that, more than 40 developed countries imposed various economic sanctions in order to stop the Kremlin's aggression.
One of the most ambitious measures, as ForkLog told, was the freezing of the Bank of Russia's international reserves.
The Russian Central Bank keeps a significant part of government savings in the reserve currency — the dollar. The regulator explained that this is a common practice that allows you to prepare for possible financial crises:
"In difficult situations, they (reserves — approx.) ensure the payment of foreign currency debt, critical imports, stabilize the foreign exchange market. Keeping reserves inside the country or spending them inside the country is like having no reserves, no protection at all from external crises."
These funds were stored in Western banks, and it was them that the Western authorities froze as a response to the invasion — only about $ 300 billion, about half of all state reserves of the Russian Federation.
Because of this, the Russian authorities lost the opportunity to influence the ruble exchange rate by standard methods, which began to fall rapidly. There was a threat of hyperinflation, which was stopped only thanks to unprecedented restrictions on the turnover of foreign currency within Russia.
In addition, the Russian state may lose the opportunity to pay off foreign currency debt obligations from frozen accounts, which is why it faces default.
Such measures were used for the first time, but experts started talking about turning the dollar into a weapon. For the authorities of other countries, especially those who are unfriendly towards the United States or one of their allies, this may be a signal that the use of the dollar is no longer safe for them. Moreover, among the closest allies of the United States are issuers of other reserve currencies, such as the United Kingdom, Japan or Australia.
An obvious step for states that feel a political risk for themselves is to reduce the share of the dollar and the "allied" currencies in their reserves in favor of another asset. For example, the currency of the world's second economy and the political opponent of the United States — China.
First of all, this concerns China's trading partners. Back in 2019, Venezuela, whose economy was destroyed as a result of the usurpation of power by President Maduro and US sanctions, offered the Chinese authorities to pay for their oil supplies with yuan. This idea was never implemented.
Russia has achieved greater success. In recent years, the Kremlin, pursuing political goals, has consistently increased the volume of trade with China. They supply mainly raw materials from Russia to China — oil, gas and coal, and import technological products. Back in the winter of this year, the Russian government announced plans to increase the annual trade turnover with China to $200 billion by 2024.