The world’s acceptance of the dollar as its reserve currency has been positive for Americans. But with Donald Trump’s America First policy, will the world move away from the greenback.
When world leaders laughed at Donald Trump’s comments in his address to the United Nations last week, it was an insight into the new world order. “America First” appears to have morphed into the US against the rest of the world, with countries such as China, Germany, Mexico and Canada firmly in the administration’s sights. But his ham-fisted trade war and attacks on allies could prompt other countries to hasten moves away from the dollar. Indeed, critics of Trump’s policy argue he may be accelerating the end of dollar hegemony – something that would have serious consequences for investors globally – and a move that would hit average Americans’ wealth. But are these critics right?
Currency is a really important factor for investors because it’s necessary to have a well-diversified, global portfolio – especially as prospects for the pound remain uncertain because of the lack of clarity in Brexit talks. One of President Trump’s constant messages is that the world has been “taking advantage” of America. However, the use of the dollar globally in cross-border transactions, commodities trading and central bank reserves keeps their currency buoyant. This wide use of the greenback internationally helps keep the dollar in demand and US interest rates low. This allows Americans to continue to live in the style which they have become accustomed to over the past few decades. But all good things come to an end and, should the world make a concerted effort to move away from the dollar, it could result in the significant fall in the value of the dollar and stoke a significant jump in inflation.
According to the International Monetary Fund, central banks have held around 60% of their reserves in dollars since 1996. The Bank of England (BoE) notes that the dollar “is the currency of choice for cross-border bank lending and international debt issuance, particularly for emerging market firms”. The dollar is also the dominant invoicing currency for trade transactions between non-US countries and its acceptance globally has given the greenback “reserve currency” status. It makes up half of the foreign exchange reserves of central banks and about half of the external assets of non-US countries, the BoE notes.
Countries such as China, Russia and Iran have been trying to find ways to circumvent the dollar for some time. It is certainly of note that these counties have been categorised for many years by US politicians as the “bad guys”. Iran, in particular, has made a number of efforts to de-dollarize its oil industry. In 2012, the country with the world’s fourth-largest oil reserves launched its own oil bourse, trading in any currency other than the dollar. This increased the already-tense relationship with the US and justified the high level of interference in the Iranian economy from Washington. Interestingly, it appears that the European Union now wants to do something similar – a move that is unlikely to be well-received in Washington.
the current president’s actions are likely to boost plans to move away from the currency
A couple of weeks ago, Jean-Claude Juncker argued the euro should become the global currency for trade instead of the US dollar. In his State of the Union address, the European Commission President said Europe must strengthen the “international role of the euro” and become a more powerful global player. “It is absurd that Europe pays for 80% of its energy import bill – worth €300bn (£267bn) a year – in US dollars when only roughly 2% of our energy imports come from the United States. It is absurd that European companies buy European planes in dollars instead of euro,” Mr Juncker said.
The Trump administration’s attacks on China are also likely to prompt the Asian nation to get a yuan-based payments system in place for international trade. Chinese officials want to internationalise the currency – and it has already launched its first yuan-denominated energy futures contract. Launched earlier this year it is China’s first commodity derivative open to foreign investors. This is significant as China surpassed the United States in 2017 to become the world’s largest oil importer. It is also expected to see a rapid increase in energy imports in the next couple of decades, so it will have ever-increasing power in the oil market which could allow it to bypass the current petro-dollar system. Nevertheless, the existing price benchmarks – Brent and WTI – remain priced in dollars, and importers across the world still need to buy the US currency in order to conduct oil transactions.
But what will replace the dollar? The financial crisis demonstrated flaws in the multi-country euro and confidence in the Chinese currency is unlikely to reach that in the dollar because of their highly-managed economic model. The yuan is also not a free-floating currency. The size of the US economy and the transparency of its financial markets means the dollar will continue to be a safe haven asset and an attractive asset for central banks for many years to come.
The demise of the dollar has been predicted for many decades. And, although the current president’s actions are likely to boost plans to move away from the currency, hegemony of the dollar is unlikely to end any time soon. That doesn’t mean it won’t happen, as the global domination of the pound as a central bank reserve currency eventually gave way to the greenback in the 1920s and 1930s. However, right now, there is no other currency that could replace the dollar and it would take decades for central banks to unwind their dollar positions. Mr Juncker shouldn’t get too excited just yet.
The above article was previously published by Charles Stanley on 1st October 2018