The dollar is king but for how much longer? How reserve currencies fell.
The U.S. dollar has been the world’s dominant reserve currency for as long as most people alive can remember. Dedollarization talk in the past has never amounted to much, but with renewed calls to dedollarize, is king dollar about to lose its reign?
I should say never is a very long time. I shouldn’t say never. We’re nowhere near it today, how about that?
Peter Zeihan, geopolitical strategist
Most strategists will agree the dollar is in a safe space at the top for now. But history shows nothing lasts forever and a look back at previous world reserve currencies proves it.
Simone Del Rosario: If we look at the timelines of reserve currencies in history, I would say they average about a century in power. The U.S. is kind of getting up to that point now, so why is it so out there for you to think that another currency is going to rise and take its place?
Peter Zeihan: Well, I should say never is a very long time. I shouldn’t say never. We’re nowhere near it today, how about that?
So if you look at the big currencies of the past, first you had Spain, which was basically a metals-based currency based off the Potosi silver mines in what is today Bolivia. And for several decades, the Potosi mine produced more silver than the rest of the world combined.
So we got the worst kind of inflation you can possibly imagine out of that. Silver was available in limited quantity and so if you wanted to have trade, you had to get silver, which pushed up the value of the currency.
But the Spanish were literally mining the currency. And whenever the Spanish had an interest, they would go into a local market and buy up whatever they needed: equipment, steel, ships, men, whatever, to launch wars.
So you got disruption, you got supply-side inflation, you got demand-side inflation. At the same time, you had global disconnects and disruptions. So yes, it was our first true global currency, but it was never going to last because of the way the Spanish managed it.
The Brits came up with the pound and gold and that was a technological currency because they had their technological revolution at a very similar time frame. And as they became the global navy, combined with the industrial revolution, they were able to do it on military and economic terms and that was much better for everyone, unless of course you are one of the hundreds of countries that happened to be under the colonial boot every once in a while because the Brits really did control everything for a while.
That was ultimately displaced when the technologies of industrialization went other places. By the time we get to the end of World War II, France is industrialized, the Netherlands is, Germany is, Japan is, the United States is. And because of the destruction of the war, the United States emerged from the war with an economy roughly the same size as everybody else put together, meaning we didn’t even have an option as to what the currency would be then.
We are now entering a period where globalization is breaking down and the United States was already, of the major countries, the one least involved in trade. So again, at this moment, the United States is the only one on the board.
If you fast forward 50 years, if we get a different global economic system that is based on something else, if we find out what sort of economic model we’re going to get in an environment where demographic decay has been going on for decades and capitalism and socialism and fascism no longer work, then we’ll have a conversation about what the currency is going to be.
But right now, the United States has the healthiest demography of all of the G20 countries except for Argentina. It’s the largest economy by far. It’s the least involved in international trade and it has rule of law. So you might not like the United States for this, that or the other reason, but from a mechanical point of view of what makes a good currency, no one else even scratches one of those categories, much less all three.
Countries are souring on the US dollar. Is dedollarization really a risk?
Is the U.S. dollar really at risk of losing its reserve currency status? Dedollarization talks are heating up as more countries look to cut the U.S. dollar out of trade transactions. What would a move away from the U.S. dollar mean for the U.S. economy and what currency could replace it? Geopolitical strategist Peter Zeihan joins Straight Arrow News for an in-depth conversation.
This year’s buzzword: Dedollarization
In 2023, more and more countries are talking about mobilizing against the U.S. dollar, which has been the global reserve currency for nearly a century. The idea of dedollarization is not new but the world is seeing renewed momentum behind it, enough to get the attention of bigwig economists and major financial institutions.
First, the basics: What does it mean to be the world’s reserve currency?
The global reserve currency is the dominant currency countries hold and use for international trade. For example, over the past two decades, about three-quarters of trade invoicing in Asia happened in U.S. dollars, not the Japanese yen, not the Chinese yuan. Central banks and other financial players hold more U.S. dollars than any other currency by a long shot. The U.S. dollar became the official global reserve currency in 1944 (read more about how that happened here).
A large percentage of commodities, like gold and oil, are priced in the global reserve currency, so other countries hold this currency to pay for those goods.
What does it take to be the world’s reserve currency?
A reserve currency needs to be stable and safe. There has to be a massive amount of that currency in circulation to be able to facilitate transactions all over the globe.
“You have to not care at all what happens to the value of your currency on any given day because if you go in and actively manipulate the exchange rates for trade purposes, then no one is going to use your currency because they don’t know what it’s going to do. It’s not reliable,” geopolitical strategist Peter Zeihan told Straight Arrow News.
Because of that, Zeihan said it’s hard to see a currency like the Chinese yuan taking the place of the U.S. dollar someday.
What’s driving dedollarization talk?
The most pressing anti-dollar movement is coming from BRICS countries (Brazil, Russia, India, China, South Africa). The group of nations is discussing whether to introduce a common currency to use for trading purposes to cut out the greenback.
Why is this significant? The BRICS bloc consists of more than 40% of the world population and about a third of global economic output.
Despite heads of state proposing a BRICS currency as an option, Zeihan told Straight Arrow Newshe has serious doubts the bloc would ever agree to it.
“We’ve got R and C whose relationship is a tryst. We’ve got R and S who compete. We’ve got R and I who don’t trade, I and C who don’t trust, C won’t let enough happen to make anything move and that just leaves B and S and you know, color me a skeptic.”
Even without BRICS nations agreeing to create a new currency, international investors are still moving away from the U.S. dollar, weakening its dominance as the global reserve currency. Trends show investors and countries are diversifying into the euro and yuan, mainly.
What’s driving it? Inflation and higher interest rates are piling on the dollar’s problems. Then, in August, Fitch Ratings cut the U.S. government’s credit rating in the latest blow to dollar dominance.
The U.S. dollar’s share in central bank reserves has fallen from 71% in 1999 to less than 59% in 2022, according to IMF data.
The sanctions sting
The U.S. action to aggressively sanction Russia following its invasion of Ukraine was largely so powerful because of the U.S. dollar’s standing as the world reserve currency. But the move is now also triggering dedollarization fears as countries look at how to get away from the overpowering influence of the U.S.
“They’re creating a secondary economy in the world totally independent of the United States. We won’t have to talk about sanctions in five years because there’ll be so many countries transacting and currencies other than the dollar, that we won’t have the ability to sanction them.”
Would your money lose value if another currency takes over?
There are a lot of dedollarizing theories out there, even though most experts cast doubt the U.S. will lose the reserve currency status anytime soon. One such theory is that the U.S. dollar would become worthless if it is not the reserve currency.
While Zeihan insists dedollarization will not happen — “I should say never is a very long time, I shouldn’t say never” — if it did, he said the dollar would just revert back to a normal currency.
“There is a cost in that scenario that would probably force our political leaders to be a little bit more judicious with their spending in the long run because we wouldn’t be able to just dump our debt on everyone else’s system. That’s probably the real superpower: It allows us to not be fiscally responsible.”
British Finance Minister Kwarteng fired ahead of planned economic U-turn
British Prime Minister Liz Truss fired her finance minister, Kwasi Kwarteng, just weeks after the release of a controversial economic plan. A hastily-arranged news conference was set for later Friday after Kwarteng rushed back to London overnight from IMF meetings in Washington.
His firing makes him the country’s shortest serving chancellor since 1970 after being appointed just over a month ago. Kwarteng’s successor will be the fourth finance minister in four months.
“You have asked me to stand aside as your Chancellor. I have accepted,” Kwarteng said in his resignation letter, which he posted to Twitter Friday. “When you asked me to serve as your Chancellor, I did so in full knowledge that the situation we faced was incredibly difficult, with rising global interest rates and energy prices.”
The British finance minister was fired exactly three weeks after he and Prime Minister Truss announced a “mini budget” that delivered Truss’s vision for vast tax cuts and deregulation to try to shock the economy out of years of stagnant growth. The announcement of the plan caused the pound to plunge, with the response from markets being so ferocious that the Bank of England had to intervene to prevent pension funds from being caught up in the chaos, as borrowing and mortgage costs surged.
“As I have said many times in the past weeks, following the status quo was simply not an option. For too long this country has been dogged by low growth rates and high taxation,” Kwarteng said in his resignation letter. “That must still change if this country is to succeed.”
At the Friday news conference, Truss named Jeremy Hunt the next finance minister. He was most recently the minister for health and social care under former Prime Minister Boris Johnson and a supporter of former Prime Minister candidate Rishi Sunak. Truss also abandoned a planned cut to corporation tax, scrapping a key part of the initial plan.
Supreme Court in session; Brazil runoff election; Britain backs off tax cuts
On Oct. 3, 2022, the Supreme Court will begin a new term; the contentious presidential election in Brazil is now headed for a runoff at the end of the month; and Britain backpedals on new Prime Minister Lis Truss’ plan to cut taxes on the country’s wealthiest.
Supreme Court back in session – The Supreme Court kicks off a new term Monday. It marks the debut of the newest justice, Ketanji Brown Jackson, who became the first Black woman appointed to the bench earlier this year. There are some big cases ahead of the court right away. The justices will be hearing a case that could limit the scope of the Clean Water Act of 1972 and the Voting Rights Act of 1965.
Brazil election set for runoff – Brazil’s presidential election is headed to a runoff after conservative President Jair Bolsonaro outperformed expectations over the weekend. Some polls had leftist former President Luiz Inacio Lula de Silva beating incumbent Bolsonaro by double digits. However, Lulu was able to secure only 48% of the vote, which is shy of the majority needed to secure a victory. The runoff election is set for Oct. 30.
Britain’s backpedal on wealthy’s tax cuts –The British government scrapped plans to cut taxes for the country’s top earners Monday. The plan was announced 10 days ago but sparked turmoil in the financial markets. The announcement sent the pound to record lows. Americans who look to take advantage of a weakening pound could be surprised by the currency’s rebound. It rose back to roughly where it was before the tax cuts were announced.
Dow, S&P 500, Nasdaq in bear market with global recession highly probable
The three bears have officially arrived. At Monday’s market close, the Dow Jones Industrial Average officially joined the S&P 500 and Nasdaq composite in a bear market, with all three indexes down more than 20% from January’s highs.
The Dow closed down 20.48% while the S&P was down 23.79%. The Nasdaq has fallen 31.76% since the beginning of the year. Monday’s rout followed turmoil abroad in the U.K., where the pound neared parity with the dollar as markets reacted to the new government’s budget.
While stocks on Tuesday opened higher, the bears see more bad news ahead as their forecasts are getting grimmer by the day. Ned Davis Research has updated its global recession model to 98% probability. According to Bloomberg, the model has only been this high during acute downturns, like 2020 and 2008-2009.
“Historically, a bear market has never ended before a recession has started,” NDR Chief U.S. Strategist Ed Clissold said earlier this month.
Wells Fargo Chief Economist Jay Bryson also updated his forecast on Federal Reserve rate hikes Tuesday, now projecting the target rate will rise to 4.75%-5% by March 2023, “which we estimate will be restrictive enough to push the economy into recession by mid-year,” he wrote in a note.
The current fed funds target rate is 3%-3.25%, 3% higher than at the start of 2022.
“We’ve just moved, I think, probably into the very lowest level of what might be restrictive, and certainly in my view and view of the committee, there’s a ways to go,” Fed Chair Jerome Powell said when announcing last week’s rate hike.
Morgan Stanley Wealth Management’s Lisa Shalett warned in a note, “This bear market is not over and investors should expect more negative surprises if they continue to underestimate the impact of rapidly rising rates.”
Pound plunges to record low against dollar as markets weigh tax cuts, spending
The British pound took a beating Monday, reaching a record low against the U.S. dollar. The plunge came as markets reacted to the new U.K. government’s plan to deliver the biggest tax cuts in 50 years while simultaneously boosting spending.
“High tax rates damage Britain’s competitiveness,” U.K.’s new finance minister Kwasi Kwarteng said Friday when announcing tax cuts across the board.
According to an independent analysis by the Institute for Fiscal Studies, the tax cuts will cost an estimated £45 billion a year by 2027, while a previously-announced energy relief plan could cost £60 billion over the next six months. Kwarteng plans to plug the ensuing deficit with increased public borrowing at a time when interest rates are rising.
The news sent sterling down near $1.03 against the dollar on Monday before rebounding slightly later in the day. A pound near parity with the dollar means American travel to the U.K. is cheaper, but for the U.K., a low pound means it costs more to import commodities like oil and gas — which are priced in dollars — right when the region is facing an energy crisis and high inflation.
“My view is, we absolutely need to be incentivizing growth at what is a very, very difficult time for the global economy,” U.K. Prime Minister Liz Truss said on CNN.
The Truss government hopes the “mini-budget” and tax cuts will increase investment in the U.K., boosting revenue. But the IFS is bringing attention to a more near-term problem.
“Injecting demand into this high-inflation economy leaves the government pulling in the exact opposite direction to the Bank of England,” economist and IFS director Paul Johnson said.
The pound’s rout on Monday put pressure on the Bank of England to take aggressive action to calm the volatility, including calls to announce an emergency rate hike. At the end of London’s trading day, the Bank settled on releasing a statement instead.
“The Bank is monitoring developments in financial markets very closely in light of the significant repricing of financial assets,” Governor Andrew Bailey said. “The MPC will not hesitate to change interest rates as necessary to return inflation to the 2% target sustainably in the medium term.”
