What Would It Take to Dethrone the Dollar?

Mish

No reserve currencies last forever. So what would it take to end dollar dominance?

Thought Experiment

The US dollar Index has nothing to do with it. 

Try this thought experiment instead. What Would It Take For the Yuan to Displace the Dollar?

China Would Have To

  1. Float the yuan
  2. End capital controls
  3. Respect property rights
  4. Have a bond market big enough (China has virtually no gov't bond market)
  5. Have global trust 
  6. Be willing to have trade deficits
  7. Stop export priority mercantilism 
  8. Have a currency market big enough 

Perhaps China meets condition 8. It flunks the first 7.

Look closer and those are general requirements, not China-specific requirements.

How many requirements does the Eurozone meet? 

The Eurozone meets conditions 1, 2, 3, 5, and 8.

Germany and the surplus states will not easily or willingly give up on points 6 and 7.

The biggest holdup against the Euro is lack of a bond market. 

The individual countries have sovereign bonds but they trade at different rates due to different risks. There are no euro-denominated bonds to speak of.

Alternatives

There are no alternatives. To be an alternative, a county has to meet those 8 conditions. 

This is why talk of the yuan replacing the dollar is complete silliness. Wake me up when it meets the requirements.

Moreover, and despite periodic talk, China's actions speak louder than words. Given points 6 and 7 I do not believe China would want to be the reserve currency holder, even if the other requirements could be magically waived. 

Political Conditions 

Political conditions are such right now that there will not be any alternatives soon. That could change if politics in the US, EU, or China changed, but don't hold your breath on China.

The Euro may not even survive. It is a fatally flawed currency yet it is 1 of only 2 possible alternates that meets condition 8.

Stable Wagon

The only other thing that could derail this very stable wagon is if the US went totally insane politically.

What if the US went whole hog on AOC's global warming plan and also gave away $1,000,000 annually indexed to inflation to everyone in the US to fix income inequality?

Yep, something like that would do it.  

In the general sense, a political event that caused hyperinflation would suffice.

Faith in Central Banks 

Meanwhile, faith in central banks is weakening. For discussion, please see More Gold Hype: No Escape for Shorts.

Monetary Demand and the Price of Gold

Over the long haul, it's monetary demand that sets the price, not short squeezes, not jewelry, not Martians.

Monetary demand is a function of faith in central banks.

I commented on monetary demand on June 1 in Speculators Dump Gold But Price Goes Up Anyway.

Mish

Comments (50)
No. 1-22
michiganmoon
michiganmoon

"If" the US went totally insane politically? I think we are more than half way there already.

tokidoki
tokidoki

Gold can go back to being the reserve currency.

US gets defeated in a major war. Heck the US does not have to be defeated. China and Russia can do a proxy war through Iran, and as long as the later does not lose, it's goodbye my love.

Casual_Observer
Casual_Observer

So what happens if Biden wins and Republicants lose the Senate ? The US is still the best house in an above average neighborhood.

Casual_Observer
Casual_Observer

Monetary demand is a function of faith in central banks.

It is more a function of how much of the monetary reserve the world has. Holders cant afford for a given reserve currency they have a lot of to become worth less much less worthless.

Winn
Winn

Hi Mish, Here is the alternative reserve currency. State backed cryptocurrency which is also backed by gold. Several countries are developing SBCC and at least one will be backed by gold. Even Bitcoin - people are paying 10,000$ for which has no intrinsic value. The whole world will accept SBCC (gold) which is separated from their own currency ( politics ) instantly.

Stuki
Stuki

You don't need all, nor even strictly any, of those for your currency to become a reserve currency.

All you need is to be the indispensable supplier of what the rest of the world needs. Like the US was at the end of WW2: If you wanted oil, you couldn't get around the dollar. And everyone needed that. Ditto Marshall funds in Europe, and similar in Japan. Recovering economies needing aircraft... Again, they're priced in dollars. Arms to defend against the commies popping up everywhere with Soviet help and encouragement? Again, dollars....

Even after the Aramco and other nationalizations, Middle Eastern producers remained dependent on US arms. Which were, again, priced in dollars.

If Zimbabwe suddenly became the sole supplier of oxygen and water, others simply would have no choice but to to hold Zimbabwean whatever-they-call-their-toilet-paper. Bond markets, deficits nor ultimately even convertibility be darned. If you needed a cushion of Zimbavean toilet paper In order to be certain you could still obtain air to breathe tomorrow, you'd find a way to keep some in reserve. And then, once someone felt he had amassed enough of the stuff to feel confident in his own future ability to breathe, he'd start trading some of his stash, for other stuff feom those not yet so confident......... While the dollar hegemony may not ever have been quite that solidly founded, it was pretty darned close. And for decades on end.

During those decades, institutions and technology grew up around the, implicit even where not explicit, assumption of the dollar as the currency for international trade and settlement. And those things are hard to change, since so much else is then built on top of them, and they are something everyone takes for granted.

But it is still ultimately founded on needing dollars, to obtain much of the most fundamental stuff everyone needs. Not on secondary superstructures, like excessive deficits and attendant America spending itself into ruin while becoming increasingly unable to produce anything of value whatsoever.

Currently, aside from the still somewhat biggie of Arab oil regimes’ dependence on US arms, it is mainly this institutional inertia which is keeping the dollar hegemony alive. If it was just up to some guy named China, he would no doubt have demanded better terms a long time ago. But it is not. Instead, it is hundreds of millions of Chinese mom and pops, working on thin margins and all accustomed to targeting the dollar when pricing their wares for export.

Suddenly throwing the monkey wrench of the Chinese government and central bank no longer attempting to keep local and dollar prices somewhat aligned, would risk serious dislocation for lots of those guys. And since “social disruption” and “instability” are the greatest fears of the Chicoms, they keep buying dollar assets.

Hence keeping price movements for Chinese goods to foreigners, fairly stable in dollar terms. Which enables those foreigners to keep treating the dollar as a reliable reserve currency. Even if most of the stuff they buy and need, is now ultimately Chinese, not American.

Augustthegreat
Augustthegreat

who said there must be a global reserve currency? China has been swapping currencies increasingly with its main trading partners, like Japan, Korea, Russia, Brazil etc. which reduces the need to hold dollars. China has also set up markets for several major commodities traded in Yuan in recent years, which should again reduce the need to hold dollars.

libertea
libertea

It’s more useful to look at the only factors that can change global demand for dollars:

  1. Will more or less goods be priced in USD in the future?
  2. Will liquidity for dollars increase or decrease in the future?

Those are the questions that matter, not “reserve currency” semantics.

I think answer to 1 is trending towards less goods priced in USD as world develops long term, and answer to 2 is trending towards increase in dollar liquidity short term.

crazyworld
crazyworld

ALL CURREnNCIES ARE EQUALLY BAD
It being given MMT (Zimbabwe method) is applied everywhere only gold keep iits average value
We are now plungedi lnto a stupid revolutionnary period where everybody kneel their leggs and apologize. What about the nobles over here apologizing to white people having lived in slavery for centuries?What about dismantling ther castels and statues?

mrutkaus
mrutkaus

I've often thought that the strength of the US Military and the potential threat it can impose have a positive effect on the dollar.

jacob_zuma
jacob_zuma

Why can't gold just be the reserve currency?

JonSellers
JonSellers

I think it is a lot simpler than Mish's list. I think there is just one criteria to be the world's reserve currency: who has a military capable of enforcing international debt to big banks? That is only the USA.

Herkie
Herkie

CNBC today: https://www.cnbc.com/2020/06/30/the-us-can-change-the-world-by-devaluing-the-dollar-analyst-says.html

Change the world..... but for the better? That would have to take down other over valued currencies (I am looking at you Euro) because if they don't devalue in tandem then they become grossly overvalued and their exports collapse. And whatever we decide to do the Chinese mercantilist export machine will go just that much better.

And what about nations that use the dollar or are pegged to the dollar but which have no ability to print dollars? Suddenly they have half as much an economy as they thought. Several use the US dollar as their currency or have hard pegs, like Ecuador, where dollars are used, and Panama where they use both dollars and a hard peg for the national currency, or Belize where the Belize dollar is hard pegged at 50 cents to the dollar. Morally we would be in a position of having to effectively put these countries on a US dollar welfare system, though I am thinking we already do when demand exceeds availability and the Fed makes swap lines available.

Nations that use dollars; Zimbabwe, El Salvador, Ecuador, Timor, Palau

Nations where their is either a hard peg or where shops price in and/or accept US dollars openly; Canada, Russia, Panama, Bahamas, Vietnam, Cambodia, Turks and Caicos, Nicaragua, Belize

Also, many Caribbean nations accept dollars for quasi legal tender like Jamaica. All these are unlike nations such as Australia where one must first go to a bank and exchange US dollars for local currency before you can do transactions.

tokidoki
tokidoki

Oh don't forget. Civil war. That should destroy the dollar pronto.

Herkie
Herkie

Mish, I think re the Euro that much of the world is still skeptical of the EU's ability to remain in one piece. We all suspect that while it probably will not happen, it is still possible that a black swan event could end the Euro overnight. If France goes back to francs, Italy lira, Germany marks, the Euro would be used for wallpaper. All Euro holdings/accounts would be dead. A hundred years from now that may not be true, but for now it is. As long as that gigantic ravenous and excruciatingly unethical russian bear sits along their frontier from Istanbul to the Arctic there will be serious concern about EU stability.

Ken Kam
Ken Kam

The question is framed incorrectly. The dollar does not have to be replaced by any 'one' national currency. The dollar could gradually reduce in % used around the world and other currencies increase. We could go back to something similar to the 18th or 19th century when gold backed national currencies ruled different regions around the world. Ultimately, a multi-polar world with several competing currencies held together by gold, that could be the best outcome.

THX1138
THX1138

What if the US went whole hog on AOC's global warming plan and also gave away $1,000,000 annually indexed to inflation to everyone in the US to fix income inequality?

Yep, something like that would do it.

OK, so what's the alternative then? You went on for 80-90% of the post detailing how there are no alternatives, then talk about how the US could lose reserve status but to whom (or what)?

Captain Ahab
Captain Ahab

All it would take is enough countries to get upset at USA hegemony, primarily using the dollar to dominate their economies, politics, and global society generally. Already, unfriendly countries avoid transacting in dollars. Add in a global recession....

I suspect those countries accumulating gold have a plan in mind--they will price international transactions in digital gold units, not in dollars. Payments will be made in physical transfers using the Bank of International Settlements, or a replacement.

Corvinus
Corvinus

There has to be a viable contender for reserve currency status to change. Maybe in 20-30 years or so China will have gone through come sort of sociopolitical upheaval such that it is no longer a centrally controlled economy and upholds property rights and offers real due process. If that happens then I would say China. Otherwise there are none.

Nickelodeon
Nickelodeon

"Have a currency market big enough "

This feels like a statement limited in scope. It reminds me of people who say that there's not enough gold in the world to go back to the gold standard.....which is untrue IMO.

The question is one of divisibility and acceptance. An IOU backed by gold doesn't have to be denominated in ounces, it can be denominated however we like to described a physical unit....whether it's grams or 1/100 of an ounce. That goes for silver too, which is more abundant and historically the "money of the people".

I'd wager almost every sovereign/state in the world accepts gold/silver as a monetary instrument even if it's residents were reluctant to do so. They almost all have precious metal reserves....

Scooot
Scooot

The American War of Independence started in 1775, coincidently the price Spot Gold settled at this weekend on the Independence Day holiday. -:)


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