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The Past, Present and Future of International Reserve Currencies:
Is the Dominance of the US Dollar Sustainable?
By
Matthew Del Bel Belluz
A thesis proposal submitted to
Dr. Greg Tkacz
Faculty of Economics
April 2, 2015
In partial fulfillment
Of the requirements for the degree of
Joint Honours Bachelor of Business Administration and Economics
Gerald Schwartz School of Business
St. Francis Xavier University
Antigonish, Nova Scotia
1
Table of Contents
Abstract…………………………..…………………………..…………………………..………………………….3
(1) Introduction…………………………………………………………………………………………………4
1.1 What Makes the Dollar #1?………………………………………………………………………...…...4
1.2 Exorbitant Privilege of the United States…………..……………………………………………...6
1.3 Thesis…………………………..…………………………..…………………………..………………………10
(2) The Past: The Emergence of the Dollar as the Dominant World Currency..13
2.1 Gold-Sterling Standard: The Rise of the Dollar…………………………..……………………
13
2.2 Bretton Woods System: Dollar Dominance Begins…………………………..………...……15
2.3 The Fiat IMS and the Birth of a New Reserve Currency…………………………………...17
2.4 The Financial Crisis of 2008: The First Sign of Unsustainability………………………19
(3) The Present: Alternatives and Threats to the Dollar Today……………………...21
3.1 Composition of Official Foreign Exchange Reserves………………………………………..21
3.2 Why the Dollar Retained its Role After the Crisis……………………………………………22
3.3 The Euro, the Only Current Alternative to the Dollar………………………………………23
3.4 China, the IMF, the UN and the SDR……………………………………………………………….25
3.5 Quantitative Easing and Why US Inflation Remains Normal……………………………29
3.6 Derivatives: Growing Markets Make for Growing Risk……………………………………33
3.7 The War on Gold: Market Manipulation to Maintain Currency Legitimacy……….34
(4) The Future: Decline of the dollar…………………………..…………………………………...37
4.1 The Rise of China and the “Multi-Polar” Reserve System………………………………...38
4.2 The Economic Apocalypse and a Return to the Gold Standard………………………...45
4.3 The Petrodollar, Defending Exorbitant Privilege………………...
…………………………..52
(5) Conclusion: Is the Dollar’s Role in the IMS Sustainable? …………………………..61
Bibliography…………………………..…………………………..…………………………..……………..…64
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Abstract
This paper seeks to answer whether or not the role of the United States (US) dollar
in the international monetary system (IMS) is sustainable. The US dollar is the most
important monetary asset in the world; as a result, the dollar also makes up the
majority composition of global international reserves. Through our analysis, we
determine that the dollar’s role in the IMS is unsustainable for the primary reason
that the size and liquidity of financial markets in other countries will one day rival
those found in the US. We also determine that the current IMS that places a single
currency at its center is also unsustainable, because it leads to global disparities in
balance of payment accounts and encourages central banks to engage in potentially
destabilizing monetary policies. While the dollar may lose its status as the global
reserve currency of choice, we predict that it will remain an important reserve
currency nonetheless. This is because the US will do anything in its power to ensure
the dollar remains important in global markets, particularly in commodities such as
oil. In the next 10 years, as long as the Euro Area recovers from its debt crisis and
pursues the creation of fiscal unity between member countries, we will see the euro
composition of reserve currencies increase, decreasing the share of dollar reserves.
Similarly, if the Chinese renminbi attains international reserve status, we will see
the renminbi become a significant portion of international reserves, leading to a
smaller role for the dollar. If the euro and renminbi fail to diversify international
reserve currencies, it is possible that the next US financial crisis could cause a
violent shift away from the dollar towards safe assets such as gold. We find this an
unlikely scenario however, and conclude that the international reserves will
differentiate away from the dollar, but will not replace it outright.
3
(1) Introduction: Understanding the Role Of the Dollar
Before we discuss how the dollar became the dominant international reserve
currency, it is important to analyze what benefits the US receives on account of its
currency being the most important in the world. First we will analyze why the dollar
is considered so important in international trade and finance, then we define
exorbitant privilege and how it affects US balance of payments.
1.1 Why is the dollar #1?
The US dollar is the most liquid, the most widely accepted and the most
widely used currency on the planet. It is the most used currency in settling and
invoicing international trade settlements, including imports and exports that never
touch US shores. All principal commodity exchanges such as oil and gold use dollars
to quote their prices. Over 85% of all foreign exchange transactions worldwide are
dollar transactions.1 Many countries base the value of their currency off the dollar,
as countries wish to base the value of their currencies off the currency most used.
Because of its importance in international trade and finance, countries around the
world have accumulated massive reserves of American dollars to maintain their
exchange rates by intervening in foreign exchange markets, and as a form of
insurance based on the fact that the dollar is regarded as the safest currency to hold
in the world. According to the International Monetary Fund (IMF), the US dollar
makes up just over 60% of the world’s total foreign exchange holdings.2 This
1 http://www.bis.org/publ/rpfxf10t.pdf
2 http://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4
4
percentage has remained remarkably stable since the 2008 financial crisis, which is
interesting considering it was the United States that is primarily blamed for the
global recession that resulted. Its widespread use, and majority component of
international reserves makes the dollar the single most important monetary
instrument in the world today. The dominance of the dollar in international trade
and finance is generally attributed to the Bretton Woods system implemented in
1944, which began the widespread pegging of foreign currencies to the dollar and
the creation of the IMF. The United States was the largest importer in the world at
the time, the main source of trade credit, held over half the world’s manufacturing
capacity, and held the majority of the world’s gold.3 Therefore it made sense that the
dollar be at the center of the new global monetary system after the breakdown of
the old system because of the Second World War.
But what made sense in 1944, makes less sense now according to many
economists. The United States today is no longer the largest exporter, third to China
and the euro-area (if counted as a single entity).4 The United States is also the source
of less that 20% of foreign direct investment, down from over 80% between 1944
and 1980.5 The US is simply less dominant economically now than it was 50 years
ago, so why then is the dollar still the most held reserve currency in the world?
Academics, investors and economists worldwide have researched the answer to this
question. Despite many varying views, there is one central characteristic that they
all agree gives the dollar its global currency status. The primary reason for dollar
3 Mishkin, Eakinds (2003, pg. 349)4 http://data.worldbank.org/indicator/BX.GSR.GNFS.CD5 Eichengreen (2011, pg. 2)
5
dominance in the world today, is that the US has the most liquid and largest
financial markets in the world. There is no other currency that gives investors and
central banks alike as much freedom to purchase, borrow, lend, invest and divest in
what they want, where they want and when they want as the dollar. The treasury
market in the Unites States is the largest and widely regarded as the ‘safest’ debt
market in the world. Government issued debt such as US Treasury bills and bonds
make up the majority of foreign reserves held by central governments because they
earn interest. US debt is so liquid, and markets so large, that central governments
can very quickly convert their dollar debt into usable cash when they must correct
their balance of payments, intervene in foreign exchange markets, or react to a
crisis.
1.2 The Exorbitant Privilege of the United States
The prolific use of the dollar in international trade, debt and investment
transactions and settlements has given the US what some call a monopoly on money,
in that it is the only country capable of creating the lifeblood of the world economy.
Not surprisingly, this ‘world money’ status of the US dollar, gives the US several
advantages for its citizens, businesses, economy and government. These advantages
are categorized as the exorbitant privilege of the United States. The phrase
“exorbitant privilege” was coined in the 1960s by Valéry Giscard d’Estaing6 the then
French Finance Minister and future President of the French Republic. D’Estaing
complained of the United State’s ability to run a permanent balance of payments
deficit, without having to worry about a balance of payments crisis. In other words,
6 Eichengreen (2011, pg. 40)
6
the United States could continuously import more value from abroad than it had to
create domestically, because it had a monopoly on the underlying asset which value
was denominated in internationally. For a foreign country to acquire $100, it would
have to sell something worth $100, whereas the United States can simply print a
$100 bill at virtuously no cost.
Despite only 13 countries in the world officially pegging their currencies to
the dollar today7 the US still derives many benefits from its importance. For
American tourists, the widespread acceptance of dollars spares them the
inconvenience and cost of having to exchange their currency when travelling
abroad. Similarly, US exporters receive payments in the same currency that it uses
to pay their workers, suppliers and shareholders. A foreign exporter would have to
exchange those dollars for their domestic currency, incurring additional costs and
risks associated with fluctuating currency exchange rates. Banks in foreign
countries accept deposits in their currency, but make loans in dollars exposing them
to exchange rate risk as well. To mitigate this risk, foreign banks use derivative
contracts to hedge against exchange rate movements, but this is an added cost of
doing business, and something American banks are largely spared from. These
benefits however, are petty compared to the most controversial form of exorbitant
privilege, which is the enormous and consistent negative external balance of
payments of the US.
Source: World Bank Data
7 http://www.investmentfrontier.com/2013/02/19/investors-list-countries-with-fixed-currency-exchange-rates/
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Other countries need to keep their current account balances close to zero, or
else they could face a balance of payments crisis. Looking at Figure 1, we see that in
2013, the United States had a current account deficit of -$400 billion. This means
that in 2013, the US imported $400 billion dollars more than it exported. As we can
see, the exorbitant privilege of the US is very significant.
The ability for the United States to run a continuous negative international
investment balance, and still earn income on its net position, has been described as
the ‘Income Puzzle’. Over 12 papers have been written on the subject, and the most
recent one published by the Board of Governors of the Federal Reserve System in
2013 combines the findings of all previous papers on the subject. Its findings
conclude that the United States can earn income on a negative investment position
with the rest of the world because of persistent return differentials, between US
2005 2006 2007 2008 2009 2010 2011 2012 2013
-900000000000
-800000000000
-700000000000
-600000000000
-500000000000
-400000000000
-300000000000
-200000000000
-100000000000
0
100000000000
Figure 1: US Current Acount Balance VS Global Average
Average
United States
United Kingdom
Net
Bal
ance
($
Bil
lion
s)
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foreign investment, and foreign investment in the US.8 Because foreign
governments, banks and firms value the convenience of dollar securities they are
willing to pay more to obtain them. For debt securities, a high price translates to a
lower yield, meaning that investors are willing to accept lower interest rates in
order to satisfy their demand for Treasury securities that are so liquid they’re seen
as cash equivalent. This has a very substantial effect on the United States. The
interest that the US must pay on its foreign liabilities is two to three percentage
points less than the rate of return on its foreign investments.9 The US can run an
external deficit in the amount of this difference. This allows the US to import more
than it exports and consume more than it produces year after year, without having
to worry about becoming indebted to other countries. This phenomenon has also
been used to explain the ‘paradox of capital flows’ and the huge accumulation of
dollar reserves by developing countries in the last 15 years. The paradox of capital
flows is that capital from poor countries which could receive higher returns
domestically, is instead invested in the United States, as a tool for controlling
exchange rates (which is a very important component of the export centric growth
model adopted by many developing countries), and as a form of insurance, the need
for which was made apparent during the Asian Financial Crisis of 1997.10
In recent years, foreign governments have become increasingly perturbed
with this obviously asymmetric financial system. Since the 2008 financial crisis
there has been increased criticism and scrutiny of the dollar dominated IMS. The
8 Curcuru et al., 20139 Habib, 201010 Bibow, 2010
9
main question on economists’ minds is whether or not the dollar-centered system is
sustainable. A growing body of research has shown clues as to dollar’s future role in
the world. Developing country governments are crying out for change. Powerful
international organizations such as the United Nations (UN) and IMF are discussing
what a new IMS would look like without the dollar at its center.
1.3 Thesis
This paper looks at the role of the dollar in the international monetary
system through the lens of sustainability. The question this paper seeks to answer is
whether or not the dollar’s dominant role in the system is sustainable. We define the
system as sustainable if the dollar will retain its position as the highest weighted
component of international currency reserve assets worldwide for the next 10
years. The system is defined as unsustainable if the dollar is likely to be replaced by
another currency as the dominant international reserve asset in the next 10 years.
Three books that have been published on the subject of the sustainability of
the IMS are The Big Reset by Willem Middelkoop, Exorbitant Privilege by Barry
Eichengreen and The Death of Money by James Rickards. The three books provide
different perspectives on the current state of the international monetary system.
Barry Eichengreen is an economics and political science professor at the
University of California, Berkley. His book, Exorbitant Privilege, provides an in depth
history of the dollar’s role in the world and predicts a future where the dollar must
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share its role as the dominant international reserve currency with the euro and the
renminbi.
Willen Middelkoop is a Swiss investor that has been studying international
monetary policy for over 10 years. His most recent book The Big Reset, discusses the
importance of gold as a base for deriving the value of currencies. His book makes the
argument that the massive build up of debt and printing of fiat currencies, especially
the American dollar, has poised the world for a dramatic shift away from the dollar.
James Rickards is an American lawyer and author. Rickards has worked as an
advisor for the Department of National Defense where he was involved in the
development of a program called “Project Prophecy” that could predict terrorist
plots by analyzing insider trading taking place leading up to an attack. He is also a
lecturer at John Hopkins University and at the School of Advanced International
Studies. Rickards believes the world is headed towards economic ruin and that a
new IMS will be created based on the gold standard.
The framework for this literature review is the story of the American dollar.
We will begin by analyzing the history of the dollar’s role in the IMS. We will then
look at the alternatives to the dollar today, and explain why the dollar still
comprises the majority of foreign exchange reserves as of 2015. Finally we will look
at the future of the dollar’s role in the IMS and determine whether or not its
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dominance can be maintained. As the history of its role in the IMS unfolds, the
differing views of the authors will be compared and contrasted with one another.
The central argument of this paper is that the US dollar’s role in the IMS is
both unsustainable and sustainable. It is unsustainable because the dollar will no
longer make up over 50% of foreign exchange reserves. The future IMS will not
place a single currency at its center, as it has in the past. We find the dollar’s role
sustainable however in that the dollar will still make up the majority of
international reserves, if only slightly. The reduction in the international importance
of the dollar will result from 2 potential sources:
1. The Eurozone and China will have debt markets that can rival those of the US
in the next 10 years resulting in multicurrency reserve system.
2. The global economy will undergo a serious crisis in the next 10 years caused
by unrestrained money printing policies, debt and derivative growth,
resulting in a loss of confidence in the current IMS and the dollar’s role
within it.
Despite it’s reduced importance, we find that the dollar will most likely still be the
most important reserve currency because of the US’s ability to control the currency
pricing of major commodities, primarily oil
(2) The Past: The Emergence of the Dollar as the Dominant World Currency
12
In this chapter, we will outline how the dollar became the dominant reserve
currency it is today. We will begin with the creation of the Federal Reserve in the
early 1900s during the gold-sterling IMS. Then we will look at how WWI and WWII
helped increase the importance of the dollar through the implementation of the
Bretton Woods system. We will conclude with the rising importance of the Euro and
how the 2008 financial crisis affected dollar reserves.
2.1 Gold-Sterling Standard and the Rise of the Dollar
The story of the dollar begins in 1913, with the creation of America’s central
bank, the Federal Reserve. After the financial panic of 1907, it was decided that the
United States needed a central bank to help stem and prevent crises in the future.
The Fed was officially created in December 1913. The bank would have a monopoly
on the creation of dollars, and would be owned privately by Wall Street banks. At
the time the world was using the gold standard IMS and the British pound sterling
as the international reserve currency of choice. The United States, despite having
had the largest economy in the world since the late 1800s, was still almost
completely dependent on the pound for settling international trade and financial
transactions. The US dollar was hardly used internationally. World War 1 (1914-
1918) changed everything for the dollar. According to Eichengreen (2011, pg. 35), it
rose from obscurity in 1913, to completely overtaking sterling and reigning as the
dominant international reserve and trade currency by 1925. Its meteoric rise is
attributed to the strong international market making efforts of the Fed- encouraging
the development of international branches of US banks and multinational
13
companies. And the political and economic instability brought to Europe as a result
of the war.
The great depression (1929-1939) saw a systemic reduction in foreign
reserve holdings as a result of declining international transactions and trade. Thus,
it also saw a large reduction of the international role of the dollar. In 1933, the US
and Britain left the gold standard freeing the printing press and allowing for greater
implementation of expansionary monetary policy. With less foreign borrowing and
less commitment to defending exchange rates, there was little incentive for
countries to hold large reserves of international currencies. American dollars were
sold off in larger numbers than the pound. It is noted by Eichengreen (2011, pg. 37)
that the most important reason for sterling regaining its lead as an international
currency was Commonwealth countries maintaining their reserve holdings in
London. The practice was a result of political solidarity and imperial prerogative.
The US, not being an imperial nation, did not have the same support structure as
Britain. It is important to note that it was political forces that allowed sterling to
retain its dominant international role. This is a recurring theme in the study of
international monetary policy; politics often play just as great a role as economics
when it comes to international currency reserves. It would take another major
political event, World War 2 for the US dollar to finally solidify its place on the
monetary throne.
2.2 Bretton Woods System: Dollar Monopoly Begins
14
World War 2 (1939-1945) was the bloodiest and most expensive war in the
history of the world. It also created economic and political turmoil in Europe. The US
experienced a considerable accumulation of gold from several countries including
the UK throughout the war amounting to over half of the total amount of gold in the
world. In 1944, with the European economy in a state of disarray and the end of the
war approaching, a conference was held in Bretton Woods, New Hampshire to
decide the future of the global monetary system. The United States used its status as
the largest economy, the largest creditor nation, the largest gold reserve holder, and
its victory over the Axis powers as immense leverage in creating a new economic
world order that placed the US at its center.11 The Bretton Woods conference also
gave birth to the IMF, of which attendant countries would join to help ensure
economic stability in the future. The plan would mean all participating countries
would abandon their currency’s link to gold and fix their exchange rates to the
American dollar. The issue was that by the end of the war, Europe and Japan didn’t
have the dollars needed to purchase imports from the US and commodities priced in
US dollars. The solution was the Marshal and Dodge plans, the former for Europe
and the latter for Japan. The plans involved giving Japan and Europe billions of US
dollars to help them rebuild their economies and export sectors so that they could
begin importing abundant goods and needed supplies from the United States. The
world powers agreed to the plan and the new IMS as long as the United States dollar
was backed by gold at $35 an ounce. Thus solidified the American dollar as the new
world currency, the value of which all others were based.
11 Mishkin, Eakinds (2003, pg. 349)
15
With a now constant demand for dollars around the world, countries ran
trade surpluses to accumulate their dollar reserves. By the 1950s the dollar
shortage was over, and an inherent problem in the system was exposed. The dollar
was supposed to be as good as gold, but foreign-held dollars were now becoming
larger than US gold holdings. This was a major sign of the Bretton Woods system’s
unsustainability. With no other country able to rival the financial and goods markets
of the US, the only real alternative to the dollar was gold; no other currency could
compete. It was called the Triffin Dilemma, and its solution was what Middelkoop
(2014, pg. 136) describes as an international gold market manipulation effort called
‘The Gold Pool’. By pooling their gold reserves, the Fed along with 7 other European
central banks were able to defend the $35 gold price through interventions in the
London gold market. The gold pool is recognized as one of the first examples of
international gold market manipulation; a phenomenon some believe still exists
today. It was around this time, that the term exorbitant privilege came into use. The
French labeled the Bretton Woods system as abusive and dangerous, and
championed a return to an independent gold-based system. A more sustainable
solution was needed and so the IMF created the Special Drawing Right (SDR). The
SDR would come to be known as paper gold and would be issued periodically by the
IMF in order to provide countries with the additional reserves they needed to
expand their trade and payments without acquiring more dollars. The SDR was
composed of a basket of currencies from the member countries of the IMF. The SDR
solution was not implemented until 1970, and by then it was too little too late. The
Bretton Woods system now faced a much larger problem; the massive dollar
16
printing operation by the US in order to finance the Cold War, particularly in the
Vietnam conflict. As a result, the dollar had become grossly overvalued at $35 an
ounce and after a few devaluations, the system collapsed in 1973.12
2.3 The fiat IMS and the Birth of a New Reserve Currency
The end of the Bretton Woods system marked the beginning of a new IMS. It
is the same system that we use today. It is a system in which money is not backed by
gold or the US dollar; it is backed by the economic stability and production of the
country from which it originated. The new system would allow the values of these
fiat currencies to float freely against one another. The US ending the Bretton Woods
system was essentially equivalent to a default. Interestingly, after a brief period of
volatility in dollar value, demand for dollars around the world increased, and as
outlined by Eichengreen (2011, pg. 64) by 1977 the dollar portion of international
reserves peaked close to 80%. Some economists, including Middelkoop (2014, pg.
81), believe that it was OPEC’s decision to price their oil exports in US dollars in the
early 1970s that allow the dollar to regain its strength so quickly.
High inflation in the United States during the 1980s caused dollar
composition of international reserves to plummet below 50%. By increasing the
interest rate to 20%, dollar holdings around the world rose again and by 1990 it had
rallied back to 65% of global reserves.13 From the end of Bretton Woods to the turn
of the 21st century, despite huge devaluations and economic instability in the United
12 https://www.imf.org/external/about/histend.htm13 Eichengreen (2014, pg. 64)
17
States, no other currency was able to take its place as the dominant reserve
currency. The reason is the same as it was in the 1940s and as it is today; no other
currency on earth can rival the markets of the US. The US has had, for the better part
of a century, the largest and most liquid asset pools in the world and the largest
economy in the world. The dollar was completely unrivaled in its usefulness
internationally until 1999, when a new currency, backed by an aggregate economy
that was larger than the US was created.
Currency instability in the 1980s and a desire for Europe to become more
economically integrated led to the signing of the Maastricht Treaty in 1991. The
treaty called for the creation of a new currency to be used across Europe and called
the Euro. The Euro has since become the second largest reserve currency asset in
the world. Making up just over 20% of the world’s allocated reserves. Europe’s
combined economy is larger than the United States’, and there has been a decline in
US dollar reserves since its implementation. From 1999-2008, dollar reserve
holdings decreased approximately 5%.
2.4 The Financial Crisis of 2008: The First Sign of Unsustainability
In 2008, the global economy was shook with the largest financial crisis since
the Great Depression of the 1930s. With the United States at the center of the global
credit meltdown, the dollar’s role internationally should have been threatened
18
considerably. According to Eichengreen (2011, pg. 97), stability is the most
important characteristic of a currency that is widely used in international
transactions. Therefore, nothing poses a greater threat to a currency than a financial
crisis. All three authors contend that 2008 should have been a turning point for the
US dollar. The crisis proved that US financial assets were not safer simply because
they were issued in dollars. It exposed that the US had been lying about the credit
worthiness of their complex mortgage backed securities, purchased around the
world because of their AAA rating. It also raised suspicions as to whether the US
would try to inflate away the massive debt burden placed on the system as a result
of the stimulus policies of the Fed.
The 2008 financial crisis is similar to the Triffin Dilema in the 1960s in that
they were both the first signs of the unsustainability of their respective IMS. With
the newly formed euro providing a practical alternative, it seemed likely that there
would be a migration away from the dollar by importers, exporters and central
banks.
Source: US Department of the Treasury
19
Interestingly, the result was the complete opposite. The dollar strengthened
against the Euro and other currencies as central banks and investors around the
world continued to purchase US treasury securities in the wake of the crisis. In fact,
as shown above in Figure 2, foreign holdings of Treasury securities increased at a
much faster rate in the years directly after the crisis compared to the years before
the crisis.
Since 2008 there has been little to no movement away from the dollar in terms of
international reserve holdings, or for invoicing and settling trade agreements. A
recent study discussed by Eichengreen (2011, pg. 123) shows that almost 75% of all
imports from countries other than the US are still invoiced in dollars.
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20140
1000
2000
3000
4000
5000
6000
7000
Figure 2: Foreign Treasury HoldingsB
illi
ons
$
20
(3) The Present: Alternatives to the dollar today
In this chapter we outline several theories as to why the dollar has continued
to hold its dominant position despite the 2008 financial crisis. We begin by outlining
where currency reserves stand today, then move into some alternatives to dollar
reserves. We conclude this chapter by looking at the unstable monetary and
regulatory policies of central banks around the world and how possible gold market
manipulation is the reason investors aren’t moving to safer assets.
3.1 Composition of Official Foreign Exchange Reserves
Before we look at alternatives to the dollar, we must look at where currency
reserve standings are today. Figure 3 shows the most recent IMF data on foreign
reserves.
Source: IMF COFER Data
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20140%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Figure 3: Composition of Official Foreign Exchange Reserves
Euros
Other
U.S. dollars
22%
16%
62%
21
As of the most recent IMF reports, the dollar comprises just over 62% of the
world’s reserve currencies. The Euro makes up just over 22%, and all other
currencies combined make up about 16% of total allocated reserves. In the last 15
years the dollar has lost 10% of the total composition, indicating a gradual shift
away from the dollar by central banks around the world. Since the financial crisis,
the dollar has lost about 2% of the total weighting.
3.2 Why the Dollar Retained its Role After the Crisis
There are 3 key explanations for why the dollar has retained its role in the
world economy. The first is that the US is still the largest economy in the world, and
it still has the worlds largest and most liquid financial markets. All three authors
agree that liquidity and size of financial markets is the ultimate determinant of the
dominant reserve currency. The second is what Eichengreen (2011, pg. 124) calls
“advantage of incumbency”. Advantage of incumbency is essentially the same thing
as a network effect, in that something becomes more valuable as more and more
individual parties use it. If most exporters are invoicing in dollars, individual
exporters have an incentive to invoice in dollars as well. This creates value for the
exporter as it limits fluctuations in their prices relative to competitors. For central
banks, if other countries are stabilizing their exchange rates using the dollar as an
anchor, it makes sense for individual central banks to do the same. As mentioned
before, this requires a stockpiling of dollars to intervene in foreign exchange
markets, and a stockpiling of dollars usually comes in the form of Treasury
securities.
22
The third factor is that there is still no good alternative to the dollar. There
are 7 official reserve currencies recognized by the IMF. These are the US dollar, the
Canadian dollar, the Australian dollar, the Japanese yen, the British pound sterling,
the Swiss franc and the Euro.14 Market size and liquidity are two very important
characteristics for a reserve currency, and in these two aspects, the countries of
Canada, Australia, Japan, Britain and Switzerland are simply too small to compete.
This leaves the euro as the primary contender to the dollar. The Euro Area exports
nearly twice as much as the United States and has a larger GDP, but the euro still
only accounts for 22% of foreign reserves.
3.3 The Euro: the Only Current Alternative
Eichengreen (2011, pg. 134) points to two key reasons why the Eurozone
cannot replace the dollar at this time. The first is that the euro area’s bond market is
both smaller and less liquid than the US. The larger issue however, is that the euro is
a currency without a state. It is the first ever currency not backed by a government.
Without a united fiscal policy, the Euro Area has continued to experience instability
in its member countries, and managing these problems requires cooperation
between its member countries, which cannot be assured. Eichengreen’s solution for
increasing the euro’s use amongst its trade partners, is the creation of an emergency
financing mechanism that can make decisions quickly when crisis occur, and
policies that will increase monetary and fiscal union between countries. These
actions should improve economic stability and thus increase confidence in the euro
14 http://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4
23
leading to its more widespread use. Because institutional reform is predicted to be
slow, it is predicted that the euro’s rise as an international currency will be slow.
Given Russia’s recent economic sanctions on the European Union (EU) and
increasing political tensions in the area, it is possible that there could be further set
backs for the euro in the near future. Russia is one of the Euro Area’s biggest trade
partners and a deterioration of this relationship would hurt the euro. Eichengreen
does expect however that the Euro will continue to gain market share amongst EU
member countries not part of the Euro Area. The EU is also developing stronger ties
to non-EU countries to the south and east. Until the Euro Area moves deeper into
political integration and develops a bond market that can rival the liquidity of the
US, it is very unlikely for the euro to rival the dollar as a global currency.
Rickards (2014, pg. 137) also sees the euro as a potential dollar substitute.
He points to the Euro Area’s resilience and ability to stay together despite economic
crisis, as a sign of its worthiness as an international currency. The world also
increased its share of euro reserves during the European Debt Crisis, which he
interprets as a clear vouch of confidence. Like Eichengreen, he doesn’t see the euro
rivaling the dollar until the Euro Area’s monetary union is combined with greater
fiscal union. Through the continued development of its bond market, Eurobonds will
eventually provide a deep, liquid pool of investable assets larger than the US
Treasury market. A true gold bug, Rickards (2014, pg. 137) also notes that the Euro
Area’s combined members’ holdings of gold exceed 10,000 tonnes, which is 25%
24
more than the US Treasury official gold holdings. This combination of the largest
economy, the largest bond market and the largest gold reserves holder makes the
euro likely to replace the US dollar by 2025. Once again we note that both authors
agree it is the size and liquidity of the bond market that determines the dominant
international currency. If the Euro Area continues to further integrate its members’
fiscal policies and continues to grow its Eurobond market, it is very likely that the
euro will eventually become more important than the dollar. A larger economy
usually means a larger financial market. This poses a direct threat to the
sustainability of the dollar’s status as the dominant reserve asset.
3.4 China, the IMF, the UN and the SDR
While the euro is no doubt a threat to the dollar in the long run, all three
authors believe that it is China that may pose the largest foreign risk to dollar
currency dominance today. The reason for this is that China is the largest holder of
US debt securities in the world. If China were to sell off a significant number of its
dollar reserves, the US dollar would greatly depreciate. This could trigger a wave of
selling that could lead to the demise of dollar as the global currency. All three
authors admit this is not likely to happen however, because China would suffer
considerable losses on its remaining reserves. It would also make US imports more
expensive, which would hurt Chinese exports, which China relies on for its economic
growth.
25
After the global financial crisis of 2008, China declared that it wished to
diversify away from dollar reserves. As mentioned before, there doesn’t currently
seem to be any currency that could take the dollar’s place. This explains why China
has continued to increase its share of Treasury securities. In 2009, Zhou Xiaochuan,
the governor of the Chinese central bank argued that the IMF’s Special Drawing
Rights (SDR) should replace the dollar as the world’s reserve currency.15 Other
BRICS (Brazil, Russia, India, China, South Africa) countries have also supported this
idea, as it would eliminate the exorbitant privilege of the US.
According to Eichengreen (2011, pg. 137-142) however, SDRs do not present
a likely alternative to the dollar. His reasoning rests on the limited use of SDRs. They
can be used to settle debts to governments and the IMF, but not for other purposes.
There exists no private markets for SDRs, and SDRs can’t be used to settle trade. If
governments ever wanted to use their SDRs, they would have to first convert them
into some other currency, which is inconvenient and expensive. Again, the
importance of market size and liquidity is brought up, SDRs will only pose as an
alternative to the dollar if there were deep and liquid markets on which SDR priced
securities could be bought and sold. Governments and corporations would have to
be able to issue SDR bonds, and its market would have to be just as large if not
larger than the market for dollar denominated securities. On top of that, banks
would have to accept SDR-denominated deposits and make loans using the
currency. It would require a restructuring of foreign exchange markets and financial
15 http://www.reuters.com/article/2009/03/23/china-sdr-idUSPEK18455820090323
26
institutions. SDRs are very unlikely to play a large role in the international monetary
system, let alone rival the dollar concludes Eichengreen.
Despite Eichengreen’s pessimism concerning the SDR, there are some
powerful institutions that also champion an increase in its use. Middelkoop points to
a report by the UN that calls for a new global reserve system based on the SDR. The
UN report outlines how global imbalances and large disparities between different
countries’ balance of payments played a part in the cause of the financial crisis, and
caused its widespread effect on global markets. It notes that the financial crisis may
cause countries to further increase their reserves and may in turn lead to further
imbalances.16
The easiest metric of measuring global economic imbalance is current
account surplus and deficit. In the years leading up to the 2008 financial crisis
current account disparity between countries, measured by standard deviation,
reached an all time high as shown in Figure 4 on the following page.
Source: World Bank Data
16 http://www.un.org/ga/president/63/letters/recommendationExperts200309.pdf
27
We see a large convergence of current account balances immediately after 2008. In
the years since however, they have again begun to diverge. This is a sign of stress in
the IMS, and an indication that the unsustainability of the system may not have been
corrected after the crisis. Ideally, balance of payments disparity should be equal to
zero. As we pointed out earlier, the exorbitant privilege of the US is a large
contributor to the divergence of current account balances.
There is also a 2010 IMF report, outlined by both Middelkoop and Rickards
in their books, that looks at the possibility of a new financial system featuring the
SDR instead of dollar as its anchor.17 Both the IMF report and UN report point to the
imperfections and asymmetries that result from the current system, many of which
were discussed in the introduction of this paper. The IMF report claims that the
necessary practice of reserve accumulation that is an inherent part of the current
IMS makes it “ultimately unsustainable”. Both organizations recommend reforms
that will lead to a reduction in demand for international reserves and a
17 http://www.imf.org/external/np/pp/eng/2010/041310.pdf
2005 2006 2007 2008 2009 2010 2011 2012 20130
100000000002000000000030000000000400000000005000000000060000000000700000000008000000000090000000000
Firgure 4: Global Current Account STD Deviation
28
diversification of their composition. In 2009, the IMF increased the number of SDRs
in circulation from 21.4 billion to 204 billion, valued at $309 billion.18 Because SDRs
are not considered a currency, they are not included in the IMF’s composition of
foreign exchange reserves (COFER). If they were however, SDRs would make up
approximately 5% of allocated international reserves.
In 2012 the IMF added the Canadian and Australian dollars to the basket of
official reserve assets. By adding 2 new reserve currencies and drastically
increasing the number of SDRs in circulation, the IMF demonstrates its support for a
move towards a more diversified global reserve composition. These reports by two
very accredited and important organizations add to the mounting evidence that the
dollar-centric IMS is unsustainable.
3.5 Quantitative Easing and Why US Inflation Remains Normal
Another source of unsustainability in the dollar-dominated IMS is the
unprecedented money printing policies that have been implemented in advanced
economies after the crisis of 2008. This dollar printing strategy is called quantitative
easing (QE). QE is conducted when a central bank prints money in order to buy back
bonds and assets that have lost considerable value because of a crisis. It was first
implemented by Japan in the mid 90s and has since been used by the US, Eurozone
and Britain since the financial crisis of 2008. According to Middelkoop (2014, pg.
90) From 2008-2013, central banks worldwide have created over $10 trillion of new
money. The goal of QE is lower long-term interest rates and to provide liquidity to
18 http://www.imf.org/external/np/exr/facts/sdr.htm
29
financial institutions. QE is an unsustainable policy, as it has resulted in a large
increase in government debt. This debt is not financed by other countries as it
usually is; instead it is financed by the central bank of that particular country. QE is
thus money printed to fund the deficit. US national debt has grown by about $8
trillion from 2008-2013, to $17 trillion. To put that in perspective, Middelkoop
(2014, pg. 92) points out that it took 169 years (1836-2005) for the first $8 trillion
of debt to accumulate. This huge buildup of debt has not caused the global economy
any problems because interest rates on this debt have fallen to close to 0%. In the
US, public debt as a percentage of gross domestic product (GDP) has increased from
about 65% in 2008 to over 100% today.19 While this debt level is not currently
considered a serious threat to the US economy, it leaves the US vulnerable to
exogenous shocks. If another crisis were to face the US, increasing its current debt
level to provide liquidity would be almost impossible. It is important to remember
that it is not just the US implementing these unorthodox expansionary monetary
policies. The Eurozone, Japan and Britain are also pursuing these strategies. The
result is not just a more unstable US economy, but also a more unstable global
economy.
We know however that central banks and governments are regulated in their
ability to print money and increase debt by rising inflation. Remarkably, since
quadrupling its monetary base, the US has not experienced high inflation. There are
several theories for why this is the case. Middelkoop (2014, pg. 42-45) suggests that
the reason we aren’t seeing inflation on a greater scale is because governments are
19 https://research.stlouisfed.org/fred2/series/GFDEGDQ188S
30
constantly adjusting economic data. The consumer price index (CPI) is a basket of
goods whose average rise in prices is reported as the official inflation numbers.
There are several issues with these numbers; the first is that they don’t take into
account local taxes, which have risen sharply in the US in recent years. The second
issue is that the government changes this basket of goods to “better reflect”
domestic consumption. These adjustments come in three forms: 1. Replacement of
cheaper alternatives, justified by peoples shift to less expensive substitutes when
prices rise, 2. A change from arithmetic weighting to geometric weighting, causing
product prices that rise the most to be weighted less heavily, 3. Hedonic
adjustments, which involve lowering the prices of goods to reflect changes in
quality. Another consideration for CPI misrepresenting inflation is that not everyone
purchases the goods and services in the basket, leading to bias. There are others
who agree that inflation metrics in the US are manipulated. Middelkoop (2014, pg.
44) points to a report by Crédit Agricole in 2006, which claims that the real inflation
rates in the US have been around 6.7%, similar to the growth in US money supply,
instead of the official numbers of around 2%. The US also stopped publishing M3
money supply data in 2006.
Finally, Middelkoop (2014, pg. 129) claims that official inflation numbers are
being kept artificially low by a top-secret war on gold, which cause gold prices to be
lower than what they would be without market manipulation. Governments have a
vested interest in keeping inflation numbers low because it increases real GDP
growth, and allows for greater tax revenue for the government without having to
31
actually increase taxes. But even if it was true that the US government underreports
inflation, hyperinflation is not something that can be hidden simply by changing the
model for how it is calculated. People will notice when prices rise dramatically. How
much debt can the US government create before it becomes dangerous for the
economy? Middelkoop (2014, pg. 93) turns to retired professor at the University of
Basal, Peter Bernholz to answer the question. Bernholz has studied the 12 most
sever episodes of hyperinflation and has concluded that all of them were caused by
financing public deficits through money creation, what we now call QE. The point at
which hyperinflation occurs was found to be when government deficit exceeds 40%
of its expenditures. The US reached this level in 2009, but has since brought it down
considerably. In 2015 the ratio is expected to be only 15%.20 It appears for now that
the United States is safe from hyperinflation.
Rickards (2014, pg. 9) also believes inflation to be a serious problem facing
the US, and the reason we are not experiencing it is because there are also massive
deflationary forces acting on the economy. The deflationary forces come from the
record low money velocity in the United States. Consumers are not spending nearly
as much as before the recession. To combat this, the United States has vastly
increased money supply through money printing by the Federal Reserve. Since the
beginning of QE in the United States, the Fed has printed over $3 trillion effectively
quadrupling the monetary base of the United States. The money printed by the Fed
has been used to purchase long-term bonds and toxic assets of the largest banks and
corporations in America. By channeling the newly printed money into large
20 https://www.whitehouse.gov/omb/budget/Historicals
32
corporations and not into consumer’s hands, the Fed has been able to avoid the
inflationary forces that usually accompany an increase in the monetary base.
Rickards claims that this balancing act between inflation and deflation cannot go on
forever and eventually one will overtake the other. Given the choice, the Fed will
always choose inflation. The massive deflationary and inflationary forces acting on
the US economy in combination with the second highest debt level in US history
lend tremendously to the instability of the US economy, and the unsustainability of
the dollar’s role in the IMS.
3.6 Derivatives: Growing Markets Make for Growing Risk
Another potential source of global economic instability hypothesised by
Rickards is the large increase in bank derivatives since 2008. There has been a
staggering increase, considering it was derivatives, namely mortgage backed
securities that caused the last financial crisis. The gross size of bank derivatives is
larger now than ever before. Today it exceeds $700 trillion, more than 9x global
GDP.21 Rickards (2014, pg. 267-270) claims that this increase has been allowed
because bankers are still using risk models that do not take complexity theory into
account. The greatest threat is counterparty failure, such as AIGs inability to pay
back all of the credit default swaps it owed in 2008. Counterparty failure causes a
liquidity crisis in financial markets and triggers a panic. He claims that financial
markets today have increased in complexity due to derivatives, making them
impossible to fully understand let alone compute. As mentioned above, Rickards is a
critic of the models used to calculate risk. He calls the value at risk model “make-
21 http://www.bis.org/statistics/dt1920a.pdf
33
believe” and unsound. Because derivative instruments can be recorded off bank
balance sheets, they do not appear from the outside to make them unstable. The fact
that the US and global derivatives markets have continued to grow unabated since
the financial crisis is another sign of unsustainability of the dollar. If derivatives
were to cause another financial crisis, the US will not be able to use QE as a strategic
response. The dollar will most likely suffer a loss of confidence as investors realize
that little was done after 2008 to prevent a financial crisis from occurring again.
3.7 The War on Gold: Market Manipulation to Maintain Currency Legitimacy
With a massive increase in global debt, excessive money printing by
governments, an ever-growing derivatives market and a call by large governments
and organizations to move away from the US dollar we see an IMS under
considerable stress. With growing systemic instability usually comes a flight to safe
assets. As the safety of dollar assets continue to come under scrutiny, the only
remaining truly safe asset is gold. Gold poses a direct threat to the American dollar
system because it provides a safe alternative. If gold is seen as valuable and useful as
a form of currency, the value of the dollar is seriously undermined, because unlike
gold, fiat money has no intrinsic value. Therefore, according to Middelkoop (2014,
pg. 129) and Rickards (2014, pg. 278) the US will do anything it can to prevent a
rush to gold. The war on gold, as they call it, revolves around keeping gold prices
artificially low. Low gold prices help keep inflation expectations low, and thus
dissuade investors from seeking out ‘hard assets’, which retain their value when
currencies depreciate. The survival of our current monetary system and the
34
exorbitant privilege of the US depends entirely on people preferring fiat money to
gold.
The war on gold is thought to have started in the 1960s, when the dollar first
became overvalued in the Bretton Woods system. In 1961 the ‘London Gold Pool’
was created in order to keep the price of gold below $35 an ounce, by dumping gold
on the open market when prices climbed too high. In 2009, wikileaks released
secret US reports from 1968, outlining a propaganda campaign to convince the
public that central banks would remain ‘the masters of gold’, and that investors
should not speculate on rising gold prices.22 Their schemes did not work however,
the London Gold Pool was disbanded later that year and the Bretton Woods system
collapsed only a few years later. Since the collapse of Bretton Woods, Middelkoop
(2014, pg. 139) claims that the IMF and United States has been working together to
keep gold prices suppressed. Though he provides no discernable proof of this.
In 1995 the Fed created a system of ‘gold swaps’, whereby gold would be lent
out to the Fed by Western central banks, which would then be sold to Wall Street
banks in order to keep the price down. Middelkoop (2014, pg. 147) claims that in
1998 Fed Chairman Greenspan is quoted to have said “Central banks stand ready to
lend out enough gold if the gold price rises”. Middelkoop claims that thousands of
tones of gold were dumped through gold swaps in the late 90s, but provides no
sources to confirm this information. In 2003, however, a lawsuit launched by gold
22 http://www.zerohedge.com/article/declassified-state-dept-data-highlights-global-high-level-arrangement-remain-masters-gold
35
dealer Blanchard against Barrick Gold Corporation and JPMorganChase shone some
light on these swap agreements. Barrick confirmed that it had borrowed gold from
Western central banks through ‘gold swaps’ at the request of the Federal Reserve in
order to sell this gold on the market.23 Today, the primary tool used by central banks
to manipulate gold prices is through derivative instruments. Middelkoop and
Rickards claim that the trading of futures contracts on the global markets sets the
price of gold. Large positions can be taken in these markets without actually having
to hold gold. Rickards (2014, pg. 285) claims that the amount of gold traded in
derivative contracts is 100x the amount of physical gold backing those contracts.
This is because gold is almost never physically traded in these transactions.
Middelkoop (2014 pg. 153) points to the fact that in April 2013 the price of gold
dropped $200 in only 2 days because of a wave of sell orders in the futures market.
A dramatic drop in price however does not mean that it’s the government
doing it. There have been many reports on gold price manipulation by investors and
analysts all over the world. There are also dozens of websites dedicated to exposing
the ‘truth’ about the government’s role in the pricing of gold. The US government
and the Federal Reserve have both denied any manipulation of gold on their parts.
Middelkoop’s theory, is that central banks around the world issuing fiat currencies
don’t want people investing in gold because it directly undermines the value of their
currencies, but the fact is that there just isn’t enough proof. Even if central banks sell
gold on the open market, there are an endless number of reasons other than to
suppress the price. Between 2009-2012, gold experienced a 60% increase in price,
23 http://www.gata.org/node/1858
36
yet there has been no surge in inflation, or a flight from US assets. In fact, there was
a flight to US dollars and treasury bills during this time. Furthermore a rising price
of gold is not going to detract from dollar reserves because gold debases all
currencies, not just the dollar. Rising gold prices are correlated with financial
instability, and so we can assume, that if the fall of the American dollar dominated
system is caused by crisis or economic instability, it is a valid argument that gold
could play a role in the new system.
(4) The Future of International Reserves: 3 Theories
In this chapter we look 10 years into the future to determine whether or not
the dollar’s role in the IMS is sustainable. We focus on three theories here. The first,
by Eichengreen, discusses a future IMS that uses the dollar, the euro and the Chinese
renminbi with relatively equal weighting. The second theory, championed by
Rickards, discusses how a collapse in the financial system will result from a loss of
confidence in the dollar and how the future IMS will be gold-centric rather than
dollar-centric. The final theory we’ll discuss focuses on an area neither author
delves very far into; the petrodollar, and how the US might defend its exorbitant
privilege.
4.1 The Rise of China and the “Multi-Polar” Reserve System
Dollar supremacy today can ultimately be explained by a lack of viable
alternatives, but a new international currency is coming. China is trying to develop
its own reserve currency, the renminbi. Aside from decreasing US exorbitant
37
privilege, if the renminbi were used widely in international transactions, China
would be freed of having to hold foreign currencies to correct its balance of
payments or aid domestic firms with foreign obligations. It would be able to simply
print more of its own currency, like the US. According to Eichengreen (2011, pg.
143) A 2008 report by the China Banking Regulatory Commission suggested that the
renminbi would become an international currency by 2020.
Eichengreen (2011 pg. 143-147) admits that the renminbi has many barriers
to overcome before it can be used as an international currency. The first is that the
renminbi is currently inconvertible, meaning that it can only be used to purchase
goods and services from China. This inconvertibility is one of the tools that allow
China to control its capital flows. They allow China to manipulate financial markets,
but they also restrict its international use. Another issue for the renminbi is China’s
‘growth model’, which revolves around keeping its currency pegged below the
dollar to ensure it sustains its export sector. Exchange rates will have to become
more flexible to accommodate a larger volume of capital flows if the renminbi is to
become convertible. China also doesn’t have a deep and liquid bond market as until
recently, renminbi denominated bonds were only allowed to be issued by Chinese
banks, which are all state owned enterprises. China has restricted the issuance of
foreign renminbi denominated bonds because it pulls savings away from
government control. Another issue is that even if the renminbi was made fully
convertible, and foreigners allowed to issue renminbi denominated bonds, the size
of the Chinese economy is still less than half that of the US at market exchange rates.
38
Therefore, the size of the bond market would not be able to compete with the depth
and liquidity of the US.
Eichengreen (2011, pg. 147) concludes that renminbi-denominated
securities will be most attractive to countries that trade heavily with China and
conduct financial business there, because fluctuations of the renminbi will matter to
them the most. Eichengreen’s view of the renminbi is very similar to that of the
Euro. Both will become more important in their respected regions, but are unlikely
to completely overthrow the dollar. It is viable to assume however, that as the
renminbi becomes more important in Asia, it is likely to replace dollar reserves
there more than euro reserves. This is because China holds far more US reserves, an
estimated 65% of their holdings according to Eichengreen, and because Asian
countries conduct more trade with the EU than the US, making them likely to swap
out their dollars for renminbi.24
Rickards (2014, pg. 126) also shares this view. In his book he quotes an
article by The Washington Post that reports between 2011 and 2013 Chinese
companies have invested over $20 billion in the EU, compared to only $11 billion in
the US. On top of this, China has been very vocal concerning the asymmetries of the
current IMS and the unfair exorbitant privilege the US derives from it. Middelkoop
highlights this in his book, and discusses commentary by the Chinese state news
agency Xinhua. The report calls for a ‘de-Americanization’ of the world, and
discusses the need for reserve asset diversification and the ushering in of a new IMS
24 http://ec.europa.eu/trade/policy/countries-and-regions/regions/asean/
39
that does not place a single currency at its center.25 (xinhuanet.com) A US Treasury
Department report released in 2012, using data gathered from the Chinese State
Administration of Foreign Exchange (SAFE), shows a widening gap between Chinese
US security holdings and total Chinese foreign reserves as shown in Figure 5 on the
following page.
25 http://news.xinhuanet.com/english/indepth/2013-10/13/c_132794246.htm
40
Source: US Treasury Department, Report of Foreign Portfolio Holdings of US Securities as of June 30, 2012
This data provides irrefutable evidence that although China is still
purchasing US treasury securities, it is indeed diversifying its reserve portfolio away
from the dollar. It is also worth noting that this chart indicates US reserves
representing less than 50% of total Chinese reserves. Recall that according to
Eichengreen, it is estimated that US holdings represented approximately 65% of
Chinese reserves. This is because Eichengreen’s calculation factors in the reserves
held by China’s sovereign wealth fund. This discrepancy also explains why China’s
US treasury holdings have continued to increase despite the Federal reserve data
showing a decrease in 2012.
Despite the many hurdles the renminbi must cross before it becomes an
international reserve currency, there has been considerable progress made in the
Figure 5: Chinese Total and US FX reserve holdings (Billions)
41
last few years towards renminbi convertibility and international use. Eichengreen
(2011, pg. 184-186) reports that in 2009, HSBC Holdings became the first foreign
bank to sell renminbi denominated bonds in Hong Kong. In 2010, a Hong Kong
construction company became the first company other than a bank to receive
authorization to issue renminbi denominated bonds offshore. The value of trade
settlements made after only the first year in which cross-border renminbi
transactions were permitted, more than doubled from $78 billion to $220 billion.
China has also established a market with Japan that allows for direct yen – renminbi
exchanges without having to first convert to dollars. Foreign firms in China are now
allowed to issue renminbi denominated bonds in Hong Kong and use the funds to
invest in Mainland China. Offshore renminbi can now be used to invest in China’s
stock market. The British Treasury has been granted authority to trade offshore
renminbi in London. The central banks of Malaysia and Nigeria now hold a portion
of their reserves in renminbi. Despite the renminbi bond capitalization still
amounting to only one tenth that of the United States, it is clear that China is serious
about renminbi internationalization. As its bond market continues to grow, and
capital flows continue to loosen, more and more international transactions will be
settled in China’s currency. The dollar will have to learn to share the Asian market
with the renminbi, just as it must now share the European market with the Euro.
Eichengreen (2011, pg. 148) acknowledges that it is possible, given the
massive accumulation of debt in the US and around the world since the financial
crisis, there could be a loss of confidence in the dollar resulting in a possible flight to
42
safe assets such as gold by investors and central banks alike. He dismisses however,
the argument that gold will play an important role in the new IMS. He points out
there has been a move away from gold by investors and central banks in the last
century. The reason for this is because financial instruments are more convenient
for emergency financial transactions. It is simpler to support a currency, by buying it
with reserves of dollars, then to first have to convert gold to dollars and then to the
currency. Gold must be physically exchanged in a transaction, where as currency
can be invoiced and settled electronically. Gold is therefore not highly demanded by
central banks.
Source: World Gold Council using information from the IMF
Recent data on country’s reserve gold holdings support Eichengreen’s claim
that central banks don’t want more gold. As seen above in Figure 6, Global gold
Q1 2000
Q4 2000
Q3 2001
Q2 2002
Q1 2003
Q4 2003
Q3 2004
Q2 2005
Q1 2006
Q4 2006
Q3 2007
Q2 2008
Q1 2009
Q4 2009
Q3 2010
Q2 2011
Q1 2012
Q4 2012
Q3 2013
Q2 20146%
7%
8%
9%
10%
11%
12%
13%
Figure 6: Gold as a % of total reserves
All countries
43
holdings have increased since 2008, but have been decreasing since 2012. In the last
3 years China has consecutively lowered its reserve gold holdings.
Eichengreen (2011, pg.149) concludes that the dollar-dominated IMS is
unsustainable, for the simple fact that one day, other currencies will match the
dollar in terms of the size of depth of their debt markets. The change will be gradual
and won’t take place for at least 5 years, when the renminbi is predicted to claim
reserve currency status. The primary currencies that will end the dollars reign will
be the euro and renminbi, but there could be others as well such as the Indian rupee
looking farther in the future. Despite his skepticism concerning its usefulness, he
also believes that the SDR will play a small, but still relevant role in the new IMS.
Eichengreen believes that gold will most likely not play a role in the new “multi-
polar” IMS. He proclaims, “Gold bugs are forever. But it is not obvious that one can
say the same for the monetary role of gold.”
Despite Eichengreen’s pessimism, there is a compelling argument for why
gold might play a role in the new IMS. An OMFIF report from 2010, titled “Gold, the
Renminbi and the Multi-Currency Reserve System” shines some light on the role of
gold in the future IMS. The report claims that as the world moves away from the
dollar and accumulates a more diverse portfolio of reserve holdings, that there will
most likely be substantial fluctuations in currency values. Because gold is a hedge
against all currencies, it makes sense that investors and central banks will increase
44
their gold holdings to protect themselves.26 The report does not believe that gold
will be placed at the center of the new IMS, only that it will play a larger role.
According to Eichengreen, US dollar dominance and the exorbitant privilege
it benefits from it are not something the US will enjoy forever. The system is
unsustainable because the US will continue to be less dominant economically in the
future global economic landscape. The euro and the renminbi will greatly reduce the
dollars role internationally. Although the dollar will still maintain its status as an
important reserve currency, it will lose its status as the reserve currency and may
even be replaced as the most important currency by the euro.
(4.2) The Economic Apocalypse and a Return to the Gold Standard
To Middelkoop and Rickards this view is far too optimistic. They don’t
believe that the current system will last long enough to see this new “multi-polar”
reserve system. To them, the IMS is already on the brink of total failure, and any day
now the value of the dollar is going to collapse causing a global financial crisis like
none the world has ever seen. In his book, Rickards (2014, pg. 242) proclaims
“There is no paper currency that will come close to replacing the dollar as the
leading reserve currency in less than ten years...The world cannot wait ten years for
the paper SDR, the yuan [renminbi], and the euro to converge into Barry
Eichengreen’s “Kumbaya” world of multiple reserve currencies. The consequences
of misguided monetary leadership will be on display in far fewer than ten years.”
26 https://www.gold.org/sites/default/files/documents/gold_renminbi_multi- currency_reserve_system.pdf
45
The direct cause or tipping point of the end of the dollar dominated IMS is
difficult to predict according to Rickards, but it will most likely stem from a loss of
confidence in the dollar. The root of the problem according to both Rickards and
Middelkoop, is the fact that money is no longer backed by anything of real value. The
US dollar is the most important financial instrument in the world, and its value is
derived from faith, not gold. If something were to cause a significant loss of
confidence in the value of the dollar, the dollar would cease to serve as money, and
the global financial system would collapse because so many things are valued in
dollars.
Rickards (2014, pg. 290) predicts that an American default “will come from
across-the-board inflation that will steal from savers, depositors, and bondholders
alike.” This inflation will come from a breaking of the deflationary psychology,
currently found of the American economy. Despite what the media says about the
recovering United States economy, pointing to inflation rates close to targets,
increasing housing prices, recovering stock market indexes and falling
unemployment, Rickards claims these gains are artificial, caused by financial
engineering and speculation.
“…a close examination of both shows that stock market volumes have been low, with
leverage quite high. These are indications that the rising indexes are really asset
bubbles, driven by professional traders and speculators, principally hedge funds,
and that participation by everyday citizens has been shallow. Likewise, rising home
46
prices have been held up not by traditional family formation but by investor pools
purchasing large housing tracts with leverage, restructuring homeowner debt, or
converting mortgages to rentals. Cash flows can make these pools attractive bond-
like investments, but no one should mistake this financial engineering for a healthy,
normalized housing market.” Rickards (2014 pg. 190) claims that the Fed has
managed to channel inflation into major stock indexes, creating the illusion of a
recovering economy.
If we compare the rising Dow Jones Industrial Average (DJIA) to the
increasing monetary base of the US, we do find a striking correlation.
Source: FRED data
By conducting a regression analysis on the daily change in the DJIA and the
monetary base of the US we find there is a significant correlation as shown in Figure
7. This analysis serves as evidence of a US stock index that is potentially in an
inflationary bubble.
20092009
20102010
20112011
20122013
20132014
20141500000
2000000
2500000
3000000
3500000
4000000
4500000
6,750
8,750
10,750
12,750
14,750
16,750
18,750
Figure 7: Monetary Base vs. Dow Jones
MON BASEDOWJ
47
Adjusted R Square Significance t - value Beta
0.039 0.054 1.962 0.23
According to Rickards (2014, pg. 291), when consumption and investment do
return to pre-crisis levels, the already overwhelming inflationary policy of the Fed in
combination with the inflationary forces of a healthy economy will cause
hyperinflation. On the other side of the coin, if deflationary forces continue for too
long, investors may lose confidence in the Fed’s ability to continue propping up the
economy with money creation. Either way, there is a loss of confidence in the value
of the dollar and thus a collapse of the monetary system. We know now that a loss of
confidence will probably not come from investors worrying about the Feds ability to
fight deflation because in November of 2014 the Fed ended QE and we’ve yet to
experience a loss of confidence in the dollar.
Rickards believes that gold will not simply supplement the dollar and other
fiat currencies in the new IMS. He argues that the world, including the US will
return to a gold standard after the next major crisis. The American economy will
experience an inflation crisis, long before a global rebalancing can occur. With an
overleveraged balance sheet the US will be unable to defend itself financially.
Because other advanced economies are also so highly leveraged, they too will be
unable to rescue the system. After the fall of the old system, gold will once again be
placed at the center of the global economy.
Rickards (2014, pg. 279-280) argues that world leaders are also predicting
this collapse and that they understand that when the system fails, currencies will
need to be placed back on the gold standard to regain confidence. Therefore, central
48
banks should be accumulating gold in order to ensure it will be able to participate in
the new system. A country that does not have enough gold reserves to back its
currency will suffer considerably. If every other currency is backed by gold, the
currency that isn’t will be considered far less value than its alternatives. Rickards
believes that the primary motive of gold price manipulation by the Fed and other
central banks is to allow the major economic powers of the world to rebalance their
gold reserves before the collapse at a reduced cost. This will provide a more even
playing field in the new IMS and will eliminate the likelihood of political conflict
resulting from implementation of the new gold standard. Rickards claims that there
is currently a scramble for gold by central banks, but recent data on gold reserves
held by central banks does not support his argument. The global percentage of
central bank reserves held in gold equaled 8% at the end of 2014. This is lower than
the percent of gold reserves held at the end of 2007, which was approximately 10%.
Despite gold’s decrease in percentage share of global reserves, the actual number of
tonnes of gold held by central banks has increased from 30,000 in 2007 to
approximately 32,000 today, a increase of about 7%. This increase makes sense
given the global financial instability that has resulted from 2008. We can not
conclude that a 7% increase in the amount of gold held by central bankers
worldwide indicates that the world is preparing itself for a return to the gold
standard, especially considering that central banks have been acquiring other
reserves (all denominated by fiat currencies) at a rate faster than they have been
acquiring gold. While on a global scale the changes in gold reserves appear marginal,
there is some evidence of rebalancing between the G20 countries.
49
Source: World Gold Council using information from the IMF
For our comparison, shown above in Figure 8, we have broken down the G20
countries into 4 groups. We see that there has been considerable selling of gold by
the ECB and Euro Area. Interestingly, the amount of gold sold by the ECB since 2000
is roughly equal to the amount of gold purchased by all the other G20 countries
combined. Other countries’ gold reserves still don’t come close to that of the United
States and Eurozone. China has doubled its gold reserves since the year 2000, but
the percentage of China’s reserves held in gold has decreased from 2% in 2000, to
1% in 2014. The evidence does not support Rickard’s claim that central banks are
“scrambling” for gold.
Q1 2000
Q1 2001
Q1 2002
Q1 2003
Q1 2004
Q1 2005
Q1 2006
Q1 2007
Q1 2008
Q1 2009
Q1 2010
Q1 2011
Q1 2012
Q1 2013
Q1 2014 -
2,000.00
4,000.00
6,000.00
8,000.00
10,000.00
12,000.00
14,000.00
Figure 8: Total gold holdings of G20 countrys
USEuro AreaBRICSOthers
Ton
nes
50
He is quick to point out that the BRICS countries and many other developing
countries have doubled their gold reserves in the years since 2008. This is true, but
the fact is they have also been drastically increasing their number of currency
reserves, including dollars. Rickards (2014, pg. 282-284) acknowledges that the
evidence found through official sources and databases is not convincing. He believes
that some countries, primarily China, have been secretly buying gold and not
reporting it. It is possible that countries have been secretly building their gold
reserves so as not to affect the market price of gold and potentially cause a
premature flight to safe assets, but he does not provide substantial proof to confirm
that this is happening. A lack of proof makes sense for his theory however, if the
most powerful countries in the world are colluding to keep something a secret, it
will be well guarded. It is here that we cross the line into conspiracy theory. There is
a saying that extraordinary claims require extraordinary proof, and it is here that
Rickards falls short. In conclusion, Rickards theory lacks the necessary evidence to
make such a bold claim. Ultimately, there is little evidence that the world is
preparing for a return to the gold standard. However, if confidence was lost in the
dollar, it is possible that the US would reinstate the gold standard as a very last
resort.
4.3 The Petrodollar: Defending US Exorbitant Privilege
All three authors mention the petrodollar in their works, but do not delve
into its true importance. The petrodollar is what I believe to be the most important
reason for dollar dominance today. Conversely, the fall of the petrodollar is also the
greatest risk to the US economy and position as the worlds leading currency issuer.
51
The petrodollar is the global phenomenon of pricing oil in dollars, which creates a
huge demand for the currency. It also explains how the US can afford such enormous
military spending. To understand the importance of the petrodollar, and its
implication for the future of the IMS, we must understand how it came into
existence.
The petrodollar system was created in 1971, when the US signed an
agreement with Saudi Arabia. In exchange for guaranteed military protection for as
long as the petrodollar was used, Saudi Arabia would price all of its oil in dollars and
invest some of its profits in US treasury securities, a system known as petrodollar
recycling. By 1975 all member countries of the Organization of the Petroleum
Exporting Countries (OPEC) were selling their oil in dollars. From 1971-1977 the
global composition of dollar reserves increased from 65% to almost 80%, it’s
highest level ever.
OPEC today is made up of 12 member countries, predominantly in the Middle
East. These countries are Iraq, Iran, Kuwait, Saudi Arabia, Venezuela, Qatar, Libya,
United Arab Emirates, Algeria, Nigeria, Ecuador and Angola. OPEC controls
approximately 81% of the world’s oil reserves and produces about 40% of the
world’s crude oil.27
The petrodollar is a large contributor to the US’s military involvement in the
Middle East. To maintain the petrodollar system, the US must protect the countries,
27 http://www.opec.org/opec_web/en/data_graphs/330.htm
52
specifically the leaders of those countries, who make the decisions concerning the
pricing of their oil. Figure 9 is a map from 2003 showing the number of US military
bases in the Middle East.
Figure 9: US Military Bases in the Middle East
Source: Zoltan Grossman
It is important to understand the relationship between US military
dominance and the petrodollar, as they are mutually reinforcing. The petrodollar
cannot exist without an enormous military capable of protecting and sometimes
coercing oil-exporting countries. The US military can only exist on this scale because
of the income generated by the petrodollar system. The windfalls that the
petrodollar system create for the US, in the form of massive demand for US dollars,
is undoubtedly a factor that contributes to the size of the US military. In Figure 10
53
we see that in 2013, US military expenditure was $640 billion. This amount is
greater than the next 9 largest military spending countries in the world combined.
Figure 10: Top 10 Military Expenditures 2013
Source: Stockholm International Peace Research Institute
We noted earlier that the exorbitant privilege of the US roughly equals its
current account deficit. This amount was $400 billion in 2013. It is very possible
that some of the income generated from the exorbitant privilege is channeled into
military spending. The reason the US can afford such enormous military spending is
because it is actively being used to maintain one of the key components of US
government income; the exorbitant privilege created through the huge demand for
US currency.
54
Over the last two decades the petrodollar has come under attack by several
oil producing countries, including members of OPEC, and opposition to the
petrodollar system has been swiftly crushed by the United States. In 2000, Iraq’s
President Saddam Hussein converted all Iraqi oil transactions to Euros.28 Three
years later the United States invaded, under the guise of looking for “weapons of
mass destruction”. No such weapons were found, Saddam Hussein was removed
from power and all Iraqi oil was reverted to being priced in dollars, the way it is still
priced today. Even Fed Chairman Alan Greenspan admitted in his memoirs “I am
saddened that it is politically inconvenient to acknowledge what everyone knows:
the Iraq war was largely about oil.”29
In 2010, Libyan President Muammar Gaddafi proposed a new pan African
currency to be used instead of the dollar for pricing their oil. In 2012, Libya
experienced a revolution, and has not spoken of a move from the petrodollar since.
Syria switched its oil transactions to euros in 200630 and the country has
been plagued by civil war since 2011. The Syrian civil war also created the current
primary military enemy of the US: ISIS. ISIS poses a direct threat to the petrodollar
system in the Middle East today, and because it is not a sovereign entity, it can dealt
with using military force.
Today, Iran is the only OPEC country that does not price its oil in dollars. In
2008 Iran created its own oil burse and began selling its oil in gold, euros, dollars
28 http://www.rferl.org/content/article/1095057.html29 http://www.theguardian.com/world/2007/sep/16/iraq.iraqtimeline30 http://www.informationclearinghouse.info/article11894.htm
55
and yen. Iran has since met strict economic sanctions imposed by the US. According
to Rickards (2011, pg. 263-264) in his book Currency Wars, in 2012 the US banned
any bank who did business with the Central Bank of Iran from participating in the
US dollar payments system; the Iranian currency, the rial, devalued by over 40%
within days of the announcement. Iran still prices its oil using multiple currencies,
but tension between the US and Iran is still high today.
Finally, we look at Venezuela. Venezuela has supported a move away from
the petrodollar system despite exporting most of its oil to the US. Venezuela today
has one of the worst economies in the world and is ranked #1 on the world misery
index.31
There is a uniting theme here. Bad things happen to countries that try to stop
pricing their oil in dollars. The petrodollar is an extremely important enabler of US
exorbitant privilege. The US will do anything in its power to protect the petrodollar
system, as it is one of the key pillars of the dollar-dominated IMS. If there were an
end to the petrodollar, there would be a massive reduction in the demand for US
dollars. This decrease in demand could cause a large enough devaluation in the US
dollar that hyperinflation and economic crisis could result. The petrodollar can be
used to explain why the US dollar is so widely used in the world today. It can also be
used to explain US foreign policy and its military activities in the Middle East. The
petrodollar and the global military dominance of the US are essential to one another.
The US will engage any enemy of the petrodollar system it can militarily. Today that
31 http://www.cato.org/blog/world-misery-index-108-countries
56
enemy is ISIS. If military force is not an option, the US will revert to financial warfare
in the form of economic sanctions. We see examples of this in Iran and Venezuela
today.
Iran and Venezuela, though significant, are relatively small compared to the
largest threat to the petrodollar system, Russia. Russia is the third largest oil
producer in the world today behind the US and Saudi Arabia.32 Russia and China
signed a $400 billion oil deal in May of 2014.33 Originally the deal was priced in
dollars as they always have been, but in late June of 2014, Russia announced that it
would be accepting payment for its oil in either rubles or renminbi.34 By not pricing
its oil in dollars, Russia now poses the greatest threat to the petrodollar system. This
is a very big deal for the US. Russia pulling out of the petrodollar system could be
the tipping point for the end of international dollar dominance. Something
remarkable happened soon after Russia announced it was going to price its oil in
rubles. As Figure 11 shows, the price of oil was cut in half over only 5 months. The
red line in Figure 11 indicates June 26, 2014. This is the day that zerohedge
published a statement by Gazprom’s (Russia’s state-backed oil company) CFO
Andrey Kruglov claiming that the company was ready to settle oil contracts in
rubles or renminbi. Amazingly, this date coincides with the last highest price of oil.
Since Russia announced leaving the petrodollar, oil has fallen steadily.
32 http://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=50&pid=53&aid=133 http://rt.com/business/203679-china-russia-gas-deal/34 http://www.zerohedge.com/news/2014-06-26/gazprom-ready-drop-dollar-settle-china-contracts-yuan-or-rubles
57
Source: FRED data
While western media points to Saudi Arabia refusing to cut production and
decreasing demand caused by renewable energy, the real cause of the drop in oil
prices comes primarily from the US itself. In September 2014, just before the crash
of oil prices, the Institute for Energy Research (IER) released a report claiming that
the unprecedented increase in oil production by the US would influence the price of
oil. “The increase in crude oil production from January 2011 to July 2014 was 3.0
million barrels per day or about 75 percent of the increase in U.S. liquid fuels
production, surpassing the global unplanned supply disruptions of 2.8 million
barrels per day.”35 Today, the IER believes that the US has surpassed both Russia
and Saudi Arabia to become the world’s largest oil producer.
35 http://instituteforenergyresearch.org/analysis/u-s-oil-production-keeping-world-oil-price-increases-check/
2014-01-0
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50
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70
80
90
100
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120Figure 11: WTI Crude Oil Price
Pri
ce $
US starts exporting oil
Russia leaves petrodollar
58
The fall in oil prices is caused by a large increase in supply by the United
States. It can also be attributed to the fact that the US started exporting its oil for the
first time since the 1970s Oil Embargo in July of 2014, shown by the green line in
Figure 11, coinciding perfectly with the sharp decrease in oil prices.36 The US
started exporting oil for the first time in 40 years only one month after Russia
announced it would stop pricing its oil in dollars.
Because of the very close relationship most OPEC countries have with the US
as a result of the petrodollar system, it is reasonable to assume that the US has
significant influence in OPEC’s oil supply as well. Falling oil prices produce a huge
win for both OPEC and the US in the long run. According to the January 2015 Bank of
Canada Monetary Policy report, Oil production is still economical in OPEC countries
as long as oil continues trading above $40 a barrel.37 This allows OPEC to continue
producing oil for longer than other countries. As other oil producing nations begin
cutting back on drilling and other oil operations, OPEC can continue to gain market
share and maintain it’s dominant position in the international oil trade. For the US,
falling oil prices serve as a form of economic warfare against Russia, whose
economy has suffered greatly from the falling price of oil. It also serves as a
protectionist measure for the petrodollar system. If the cheapest oil in the world is
priced in dollars, that is the oil people will continue to buy. The only way oil prices
will come down is if supply is reduced. OPEC and the US control the majority of
36 http://www.wsj.com/articles/oil-shipment-cracks-decades-old-ban-140676229337 http://www.bankofcanada.ca/wp-content/uploads/2014/07/mpr-2015-01-21.pdf
59
global oil supply, and so the price of oil is largely at their mercy. As Russia’s
economy continues to slide into recession, Vladimir Putin’s regime comes under
threat. We are already beginning to see civil unrest and protesting in Russia.
Perhaps if oil remains low enough for long enough, Putin could be forced out of
power. If oil prices return to normal before an economic crisis unfolds in Russia, the
petrodollar system will begin its decline. Oil importing countries that buy Russian
oil, predominantly in the EU and Asia, will begin acquiring rubles and letting go of
their dollar reserves in order to make their oil payments. This could mark the
beginning of the end of the dollar-dominated IMS.
We should not expect oil prices to increase any time soon however. The US is
the largest producer of oil in the world, and production is not slowing down. In fact,
the US is producing so much oil that it is running out of storage. Once production
begins to fall in the coming months and years as more and more unprofitable rigs
and projects are taken offline, the US will begin unloading it’s enormous storage
tanks, which have risen to a total of 468 million barrels.38 The US crashing one of the
most important commodity markets in the world in an attempt to punish countries
that leave the petrodollar system demonstrates that the US is desperate to keep the
petrodollar system alive. While Middelkoop and Rickards assume it will be a loss of
confidence in the dollar that triggers hyperinflation, we see now that hyperinflation
will most likely come from a decrease in demand for dollars resulting from the end
38 http://www.bloomberg.com/news/articles/2015-03-13/record-u-s-oil-glut-seen-by-iea-filling-storage-cutting-prices
60
of the petrodollar system. The US will continue to do everything in its power to
prevent this from happening.
(5) Conclusion: Is the Dollar’s Role in the IMS Sustainable?
The answer is both yes and no. We conclude that the dollar’s role as the
central currency or lynchpin of the modern IMS is unsustainable, because in the next
10 years countries in the Euro Area and China will develop financial markets that
can rival those of the US. And thus we assume that the US will no longer make up
over 50% composition of foreign reserves. However, despite the dollar not having as
large a share of COFER in 10 years, the dollar will retain its position as the most
important currency, in that it will still hold the largest majority of COFER. We
predict this because of the US’s willingness and ability to protect the pricing of
global oil markets in dollars.
In the best-case scenario, championed by Eichengreen, the IMS will gradually
shift away from dollar dominance. Within 10 years the renminbi and euro will
become just as important as the dollar in international trade and finance. The euro
will dominate finance and trade around Europe, the renminbi will dominate finance
and trade around Asia and the US will continue to be most important in the
Americas. Eichengreen’s future reserve system is largely based on the geography
and frequency of trade and finance transaction conducted between foreign
countries and the three major currency areas. The US exorbitant privilege will be
mostly lost, as the US dollar will need to compete to maintain its share. The dollar
61
will still be an important international reserve currency, but may lose its role as the
most important reserve currency if financial markets in Europe or China become
larger than those in the US.
In the worst-case scenario, prophesized by Middelkoop and Rickards, the IMS
and the dollar will experience a violent end. Global debts will lead to defaults,
derivatives will lead to liquidity crisis, QE will eventually result in hyperinflation,
investors will lose confidence in the dollar and a big reset button will be pushed at
an emergency G20 meeting, resulting in a return to the gold standard. While there is
little evidence that the world is preparing for such a collapse, it makes sense that a
gold standard be implemented as a last resort to save the global economy. The crisis
would have to be apocalyptic in scale if the world really was to revert to a gold
standard however. Regardless of its cause or probability, in this scenario too the
dollar loses its role as the most important reserve currency. The Euro Zone has 25%
more gold than the US and a larger economy. If the IMS does meet a violent end, it
will most likely be the euro that reigns in the new economic world order.
Finally we analyze the role of the petrodollar in the current IMS. We see that
currently, Russia poses the greatest threat to dollar hegemony, as it moves away
from the petrodollar system. All three authors underestimate the ability of the US to
protect its exorbitant privilege. Through our analysis of the history of the
international reserve system, we see that the US will do anything in its power to
protect its exorbitant privilege. The primary function of the US military is to ensure
62
that the petrodollar system and thus US exorbitant privilege remains intact. If the
petrodollar fails, so too may the US economy because it will create a decrease in
demand for dollars worldwide resulting in a massive devaluation of the dollar. The
US will not allow this to happen, and has recently demonstrated it is willing to do
anything necessary to protect its role as the dominant reserve currency.
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