So there’s been a lot written about the importance of the US dollar being the global reserve currency. What happens if we lose that status and is that even likely?
Periodically, you’ll read this discussion about the reserve currency status and how with the debt and other factors, the United States is at risk of losing that status. A couple of questions will follow. One is “so what?” And two is “what does it mean?”
First, what is the reserve currency? A reserve currency is basically a core currency that’s used for global trading. It’s a currency that people in other countries want to hold, and the fact of the matter is that the United States is not only a core currency, it is the preeminent core currency. The two other major core currencies are the euro and the renminbi from China.
Why is it important? Why do we care? There’s something called seigniorage which essentially means we get to write dollar bills and trade them for other people’s money in things, and all we have to do is print them. As you can imagine, that’s a pretty good gig. Only reserve currency countries get that status, and this status can be abused and lost.
But in essence, there are trillions of US dollars circulating around the world for which we’re paying no interest, and we’re enjoying all the benefit. So how did we become the reserve currency for the world? After World War II, the United States was the only significant economy left unharmed, and so it became natural that it would be the global cornerstone for the world economy.
The dollar was stable. Originally, it was so stable, it was linked to gold. Then there was the Bretton Woods Agreement, and now we have what we call a floating currency. And I think this is where a lot of the confusion and concern comes from. I think the question you’ve got to ask yourself when you talk about losing that status as the global reserve currency is – who would replace it? Today, we’re not the only global reserve currency. We actually have about 60%, and the rest is split between the euro and renminbi. 60% is probably an artificially low number because when you start going beyond dollars, you start looking at the value of treasury assets that are owned overseas and therefore depressing the interest rate that we have to pay on those assets and even high quality corporate debt, our reserve currency status is actually stronger than it looks at first glance. You could argue, well, what about the rest of the world? Well, the euro doesn’t get that benefit.
Even though the euro is a distant second to the dollar, they don’t have the breadth and depth of the financial instruments that can fully take advantage of the seigniorage function.
So when you talk about non-dollar currencies, included in that basket are dollar denominated US financial instruments. A treasury bill is not a currency, but there are treasury bills all over the world and the world’s appetite for those treasury bills keeps the borrowing cost of the United States down. So it’s a heck of a privilege and you don’t want to abuse it, but the euro doesn’t have the depth and breadth of financial instruments, nor does it have the strength of our industrial base and our economy.
Next down list, everyone’s worried about the Chinese bugaboo. Well, I’m sorry, China is a distant third on this list. And to understand reserve currencies is to understand trust. Nobody trusts the Chinese, and shockingly, the Chinese doesn’t trust anyone else. It’s not exactly a great platform for a global world currency. Nobody trusts that when the heat’s on, that the Chinese courts will defend independent people’s interests.
The Chinese are the least of a threat when it comes to this. China also has enormous amount of systemic and structural economic problems. I actually believe that this feistiness of the Chinese government, flexing its military might is in no small part because it’s economic might, the trajectory of that might is beginning to taper. And for the Communist Party to hold on to power, they now no longer can sell economic wealth as their sole reason for existence.
So trust is the key, and there’s a global lack of trust in China. Nobody seriously trusts the Chinese. They’ll do business with them all day long. The euro growth is sclerotic, there’s just nothing there. It’s a stable part of the world, there’s a lot of people, but it’s not entrepreneurial. Their economies are growing at a healthy rate, and they don’t have the depth and breadth of the financial instruments.
So what does the future hold? It’s certainly not nearly as bad as it looks for the US dollar. We live in a multipolar world, we’re probably going to see more of the same, where that reserve currency status isn’t just the United States, there are some euros and there will be some renminbis because there are certain countries that will have to do business with China in their own currency. China will impose that on them. But an imposed reserve currency is not a free ride. It’s not the, “Hey, I have some dollars, who wants them?” And we’ll trade them. It’s more like, “I’ve got some renminbi and if you want to do business with us, you’ll trade them.” It’s a very different set of rules, not based on trust.
So as the world grows, even if our share of the reserve currency shrinks, as long as it’s proportional to our economy, we actually aren’t even any worse off. In the end, the odds are the US reserve currency status will pass. In the end, we’re all dead. The end could be another a hundred years, it could be 50 years, it could be 300 years. There is no way to know that. It certainly isn’t something that should be affecting the investment horizon of our existing clients. We wish you the best of investing success.
Chen, James. “What Is a Reserve Currency? U.S. Dollar’s Role and History.” Investopedia, Investopedia, 30 Oct. 2022, https://www.investopedia.com/terms/r/reservecurrency.asp.
Majaski, Christina. “What Is Seigniorage and Does It Cause Inflation? with Example.” Investopedia, Investopedia, 4 Nov. 2022, https://www.investopedia.com/terms/s/seigniorage.asp.