Don’t expect currency wars to dethrone the dollar yet

The battle with the greenback for global supremacy will be long – even with the fight underway, rivals are not ready to replace it

The battle with the greenback for global supremacy will be long – even with the fight underway, rivals are not ready to replace it.
Nicola Ferrarese
The battle with the greenback for global supremacy will be long – even with the fight underway, rivals are not ready to replace it.

Don’t expect currency wars to dethrone the dollar yet

A changing world order means there is a fight being waged to challenge the dollar for supremacy in the world financial system.

The US currency has not been short of rivals in these so-called currency wars, the latest of which seems to be underway as the globe moves towards a multi-polar future.

Not least, there are a lack of alternatives to the dollar, even if hopes for one go a long way back. In 1855, the famous French writer Victor Hugo spoke of Europe’s dream of a unified currency.

A century later, it was starting to come true. The first blueprint for a shared currency came in 1969, drawn up by Luxembourg’s prime minister, Pierre Werner.

Enter the euro

By the final year of the 20th century, the euro was launched, for commercial and financial transactions, with notes and coins following in 2002.

For the first time, the monetary power of much of the continent that had dominated the old world was brought together into one currency. When it began, the euro was adopted by eleven members of the European Union, which was then made up of 14 nations.


Analysts and experts were quick to predict that this new internationally backed monetary unit would become a rival to the dollar for status as the world’s main reserve currency.

It seemed to be conventional wisdom for a time that the euro would, at least, emerge as a potential alternative to the dollar in this respect.

It did not turn out like that.

It seemed to be conventional wisdom for a time that the euro would, at least, emerge as a potential alternative to the dollar in this respect. It did not turn out like that.

The past two decades have made such predictions look more like wishful thinking than objective reasoning.

Expectations over the renminbi

A similar pattern is now emerging but through different means: the rise of China. The advance of what is now the world's second-largest economy has come with high expectations for a bigger international role for its renminbi, a name which translates as "the people's currency".

Chinese yuan.

But for all this talk, the renminbi is just the fifth biggest unit in the main mechanism held by the International Monetary Fund for use in cross-border financing, a basket of currencies that can be used by nations known as Special Drawing Rights, or SDR. The renminbi is behind the dollar, euro, yen, and pound sterling.

Since the beginning of the last decade, Beijing has struck international agreements opening up the wider use of its currency.

Read more: Is the petrodollar losing its lustre?

Under their terms, the renminbi is used to price oil and gas transactions, financial bonds, and cross-border commodity deals.

Beijing has also removed some restrictions on capital flows and opened more than 15 offshore trading centres where transactions can be made in the renminbi and other currencies.

The largest centres are in Hong Kong and London, followed by Paris, Frankfurt, and Luxembourg. A payment system has been established to facilitate commercial transactions in the Chinese currency and payment clearing houses have been set up.

Alternative to Swift banking system

A national Digital Currency Electronic Payment (DCEP) system has been introduced to reduce reliance on the international payment messaging system Swift, which is run from the West and can be closed off to countries under economic sanctions.

Despite all this, the renminbi – also known as the yuan – is still difficult to consider as a fully-fledged worldwide currency. It can better be described as a commonly used currency internationally, one that has risen up from being an emerging currency.

Read more: Yuan for dreamers: Talk of dollar's demise exaggerated

Its potential as a global currency is there but is as yet unfulfilled.

The yuan's potential as a global currency is there but is as yet unfulfilled.

Although the IMF calls the renminbi an official reserve currency, true status is not defined by the labels of officials, but by the collective wisdom of financial markets.

International reserves are revealing

That helps shape another big indicator – the proportion of foreign currency reserves held in global central banks. The renminbi makes up only 2.69% of that, compared with 20.47% for the euro and the dominant position of the dollar at 58.36%.

There is a clear reason for this weakness: the Chinese government's unwillingness to liberalise the exchange rate and open a full capital account to allow market forces to determine the exchange rate of its currency.

Moreover, China's own financial markets remain limited and underdeveloped due to numerous constraints, including a strict interest rate structure.

Chinese government and corporate debt markets are large, but they have limited trading volume and weak regulatory frameworks. This doesn't help build international confidence in Chinese financial markets.

International expansion needs liberalisation

The irony is that while the Chinese authorities insist they have ambitions to internationalise their currency, the actual financial and economic policies in place lean in the opposite direction.

The irony is that while the Chinese authorities insist they have ambitions to internationalise their currency, the actual financial and economic policies in place lean in the opposite direction.

It makes it look like Beijing wants the geopolitical benefits from a stronger, or even dominant role for its currency, while it continues to resist the costs inherent in getting there.

That rings especially true over any liberalisation of the extent of monetary control it already has over the currency, the lifeblood of its economic expansion.

Structural constraints

The Chinese economy is surrounded by structural surpluses stemming from weak domestic demand because Chinese households have a low share of the overall size of the country's economy.

In short, it depends on exports for growth. The limited domestic consumption capacity is a constraint on the renminbi's global expansion.

The major trade surplus with the outside world, in effect, shuts off foreign access to China's financial assets, since it is so far away from needing to raise money on international markets, let alone fund a deficit. Such limited international demand for its assets pushes back against a wider global role for its currency.

And so even as the size of China's economy fast approaches that of the United States, the renminbi retains its fifth-place ranking for global foreign exchange reserves, and is below countries it has long since overtaken in terms of economic heft.

The political dimension

It is also difficult to consider the renminbi as a haven currency for international investors, due to the extent of political control over it. To appeal properly to major institutional investors in world financial markets, liberalisation is needed, but it is not enough.

There also needs to be a fully sound institutional framework – an independent judiciary, an open and transparent government, and strong public institutions, especially an independent central bank.

China does not provide this.

Dollar domination remains

It means that experts think the greater international role of the renminbi has not really come at the dollar's expense.

Eswar Prasad, professor of international trade policy at Cornell University and a fellow at the Brookings Institute, believes that the gains made by China's currency in the last decade undermined the euro and sterling instead.

At the moment, there is little likelihood of the renminbi providing a challenge to the dollar's lead in offering global liquidity, payments, and reserve formation, and as a haven in times of crisis.

Nonetheless, rapidly changing geopolitics can feed through into the global financial system, most likely over a longer period. And senior Washington figures have acknowledged this.  

Janet Yellen, US Secretary of the Treasury, told CNN in April that monetary and economic sanctions against Russia, China, Iran, and other countries put the dollar's dominance at risk over time as target countries seek to find an alternative to the greenback.

But she expected the dollar's leading role to continue, she added,  because its rivals lack either the size of the US's capital markets or the extent to which the rule of law is so strongly established, or both.

The euro looked to have that kind of potential when it was launched. Its countries enjoy the rule of law, and their total sovereign debt balance is similar to that of the US.

But a common market in government debt is largely missing in the eurozone. Without a regularly issued bond on offer covering the whole currency area, buying euro-denominated sovereign debt is more difficult than investing in US Treasuries, which are seen as safer and more straightforward.

That is why the euro's share of central bank foreign exchange reserves is lower than the dollar's and why it has not become a full-scale rival in global commercial and financial transactions. It also limits the euro's weighting in the IMF's Special Drawing Rights basket – to 29.31% compared to the dollar's 43.38%.

Brics face a wall

Experts point out that the limitations of the euro are likely to apply to other international currencies that may emerge in the future as potential dollar rivals.

Jim O'Neill is a former commercial secretary to the UK Treasury and the economist who coined the term "Brics" for the fast-growing nations of Brazil, Russia, India, China and South Africa seen as a potential counterweight to the G7 industrialised countries.

He says moves by the Brics group to deepen ties and potentially establish an international currency will hit similar obstacles to those faced by the euro and will also have to overcome even more complex ones.

And if the group expands as it looks towards the Gulf countries, East Asia, Africa and South America, including Mexico, that complexity will intensify.

There are deeper contradictions in the group – not least in bringing together historical opponents such as China and India –and members will worry about their relative status.

 "This means that the US dollar's dominance will never be in doubt," O'Neill concludes.

Krugman's dictator

Professor Paul Krugman, the 2008 Nobel Prize in Economics winner, agrees.

"The dollar's dominance in global markets isn't at risk; it's more liquid than the renminbi, and the US legal system provides protection for dollar holders," he said.

"As long as one isn't a dictator perpetrating atrocities, there's no need to fear that the government will confiscate their property."

He went on to draw some comparisons:

 "This is unlike China, where one's money could be compromised when they say or do something the leader doesn't accept," he added.

"If the dollar's dominance declines, it wouldn't be a disaster for the US economy, which has a lot of leverage. Economic growth continued in England despite the decline of its currency after World War II. The only thing that has a big impact on dollar confidence is a default on US debt."

World economic war

There are other more trenchant views. In his book Currency Wars, the lawyer Jim Rickards argues that the world is currently living a form of international financial conflict that will continue for a while.

Its battle lines are clearly formed, he argues, and its weapons are not soldiers, tanks, bombs, and aircraft, but gold reserves, currencies, stocks, bonds, and financial derivatives.

These munitions can inflict damage: monetary collapses, inflation, bankruptcy, stagnation, and unemployment. A new, balanced, and multi-polar global monetary system will be formulated eventually, he concludes. 

This currency war means the dollar will continue to lose its market share slowly. The world economy has never known eternal constants, and there's no indication that the dollar era will go against this historical rule and be more durable than that of any other currency, he suggests.

US dollars.

Nonetheless, he also concedes a currency to replace it has yet to emerge. For the time being, the dollar's rivals are only ready to fight rather than to take over. Even if one does emerge as a clear winner, what guarantee is there that the same deviations and distortions won't be repeated?

Back to Bretton Woods

According to currency experts Ronald-Peter Stöferle and Mark Valek, authors of In Gold We Trust, the titular precious metal will rise steadily until the world forges a new international accord covering its currencies, as it did with the Bretton Woods agreement that founded the modern monetary system at the end of World War II.

Read more: Why the world needs a more just and inclusive monetary system 

Now, as there was in the 1940s, there is a need for the globe's primary currencies and its many alternatives to be balanced within a mechanism that serves the wider interests of humanity through consistent financial and monetary stability.

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