US Dollar Dominance & Global Reserve Currencies

Hyperinflation? Most likely No

13 Jun

The US Dollar as the Global Reserve Currency

The US dollar's role as the global reserve currency is deeply rooted in the international financial system. It accounts for approximately 40% of global payments, with the euro trailing at 35%. The dollar's dominance is due to several factors, including the size and stability of the US economy, the liquidity and depth of US financial markets, and the widespread use of the dollar in international trade and finance.

Another lesser known part of the dollar’s dominance is the vast amount of dollar denominated debt. Former hedge fund manager Hugh Hendry believes that the major theme in the current global economic situation is a dollar-denominated debt problem. As the US dollar strengthens, emerging markets and entities with excessive dollar-denominated debt outside the United States face significant challenges. As the World Bank predicts the lowest growth rate since the 2008 financial crisis and central banks increase interest rates to combat inflation, emerging market economies find themselves in a vulnerable state, grappling with the challenge of servicing debt loans denominated in US dollars. This action may lead to a worse recession than the one experienced in 2008.

 

Potential Threats to the US Dollar's Dominance

Alternative cross-border payment systems have emerged as a potential long-term threat to the US dollar's status as the chief global reserve currency. Countries, particularly those that are adversaries to the US government, have been developing a range of cross-border payment systems, including those developed by China and Russia.

China's Cross Border Interbank Payment System (CIPS) is seen as the biggest threat, with over 1,400 financial institutions participating and processing more than $14tn in transactions. Russia has also established a substitute for the Society of Worldwide Interbank Financial Telecommunication (SWIFT) called the Financial Messaging System of the Bank of Russia, also known as the SPFS. Iran has connected its SEPAM national financial messaging service to the SPFS, and India has established an agreement to adopt the SPFS when executing banking payments to Russia.

Additionally, the BRICS bloc of emerging economies is looking into creating a common currency mechanism for multilateral trade, as they seek an alternative to the US dollar. The group is seeking to protect itself from the impact of sanctions similar to those imposed on Russia.

Implications of a Shift Away from Dollar Dominance

A decline in the US dollar's dominance would have significant implications for the global economy. The end of dollar dominance would require a transformation of the structure of global trade and the end of mercantilist policies. This would be a positive development for the global economy, but it would be disruptive for surplus countries like Brazil, Germany, Saudi Arabia, and China.

The US must refuse to continue absorbing global imbalances as it has for the past several decades. A world in which trade isn't structured around the dollar will require a massive transformation of the structure of global trade. The closest comparison to today was 17th century Spain when Spain ran large, persistent trade deficits, but these were the automatic consequences of huge inflows of American silver, and Spain didn't accommodate foreign demand for its currency.

Will The US Dollar Hyperinflate

There is a common thread among many currencies that have experienced hyperinflation: they were often replaced by a new currency that was pegged to the global reserve currency. Several countries, including Argentina, Lebanon, and Venezuela, have experienced soaring inflation rates, exceeding 100%, 250%, and 500% respectively.

The demand for the US Dollar is driven by its widespread use in international transactions, as well as hyperinflated currencies that choose to re-peg their domestic currency to the dollar. Additionally, the presence of dollar-denominated debt that extends beyond US borders contributes to the upward pressure on the demand for the US Dollar. Each transaction, currency failure, and failed debt obligation that necessitates additional loans to sustain debt servicing only serves to further escalate the demand for the US Dollar, perpetuating an unending cycle.

 

For more analysis on these topics, check out these articles:

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