World reserve currencies — are the US$’s days numbered?
By Jonny Fry on The Capital
“Every dog has its day” is an expression believed to have come from around 405 BC when a Greek playwright, Euripides, was mauled and killed by a pack of dogs. An analogy to this tale could be the US Dollar. Is the end nigh — has the mighty Greenback ‘had its day?’
Having been on the boards for a selection of private and public companies and having been involved in managing money and studying financial markets globally for over four decades, I have learnt that one of the key attributes needed for a successful business is trust. Investors will give their money to you if they trust you, whether it be investing in a pension/ISA you manage, buying shares, or lending money to a company for which you are a director. For this very same reason, it is interesting to note that, after over two years of writing Digital Bytes on a weekly basis (an analysis of some of the developments within the Blockchain and Digital Assets sectors) the recurring attribute cited as to why Blockchain technology is being harnessed is trust. Making sense of the deluge of information, sifting through the PR and marketing spin, as well as the all too common fake news, is sometimes a real challenge when trying ‘to see the wood from the trees.’ Unsurprisingly, it is judicious to look rationally at where we are, the direction of travel and the likely impact on our lives and businesses, which is what Digital Bytes aims to do.
Understandably, the focus for many has been on Covid-19 and the dreadful loss of life caused by this pandemic sweeping the world. Even prior to this, the global economy had been stumbling along under a mountain of debt for companies, governments, and individuals. This ‘binge’ on borrowings had been fuelled largely by weak economic growth, with governments forcing interest rates down, potentially breaking their own laws by engaging in ‘monetary financing’. This practice is illegal in many countries and occurs when a central bank creates money to buy government bonds thus enabling those government to, in effect, spend without limits. In 2014, it was prohibited for the European Central Bank (ECB) to do this. Indeed, its quantitative easing programme has already been questioned by the German constitutional court, which has threatened to no longer provide the ECB with further financial support. Germany’s Constitutional Court reached a verdict in May 2020 that the ECB had potentially acted illegally in buying €2 trillion of government bonds. The court ordered the Bundesbank to exit the scheme unless the ECB was able to justify its actions within three months. Whilst the ECB has agreed to release documentation to the Germans, German judges are saying the decision whether to pull out of the ECB’s bond buying program ought to be made by the Bundesbank. If Germany were to withdraw, it could mean the beginning of the end for the EURO! The worrying fact is, that artificially pushing interest rates lower can do more harm than good, whereby helping fiscally irresponsible governments and, in doing so, addicting nations to cheap credit and denying savers a decent return on their savings.
Meanwhile, the US debt has increased $2.6 trillion since the beginning of April 2020 to $26.6 trillion in June 2020. However, following the law of diminishing returns, the more money is pumped into the economy then, seemingly, the smaller is the impact. In the interim, the economy becomes increasingly indebted, governments spend more, corporate share buybacks continue, which has now resulted in only 14 companies in the S&P 500 currently being net cash positive. Investors chase bonds and equities prices ever higher, pension funds and insurance companies become increasingly unstable, the banking system weakens, bank lending retreats and unproductive ‘zombie’ companies stay afloat via low borrowing costs. Longer term, these levels of debt across the pond undermine the value of the US$, impacting the confidence and trust in its enduring value.
The US$, itself, has been the reserve currency for 94 years. Subsequentially, from a historic perspective spanning over 500 years, has the time come for it to be replaced? After all, America’s currency replaced Britain’s, which replaced France’s, which replaced Holland’s, which replaced Spain’s, which had replaced Portugal’s currency back in the 15th century!
The world reserve currencies historically
Source: JPM / Hong Kong Monetary Authority, 2011
Unremittingly, there is no doubt that a growing debt burden becomes a big problem for everyone. According to the World Bank, the ‘tipping point’ is reached when a country’s debt-to-GDP ratio approaches/exceeds 77%. In Q4 2019, the US debt-to-GDP ratio was 107% and even now still stands at an excessive 84%!
On 21st July there were 57,777 reported new cases of Covid-19, in the USA. and over 140,600 people have now died, according to the US Center for Disease Control and Prevention. Will Covid-19 undermine the US economy to such an extent that the strength of the US$ is questioned? Indeed, the ‘Fed’ has just announced that banks must cancel any proposed share-buy backs or dividend payments. As unemployment hits 19.5%, the Fed is concerned about bank balance sheets and the breaching of capital reserves in the event of potentially $700 billion of loan defaults. As we see the end of the era of hyper-globalisation, an increase in nationalisation (being mindful that America remains in a trade war with China) and, progressively, a call for more equality in society, is America’s free-wheeling capitalist ‘style’ genuinely what the world aspires to going forward?
So, what could replace the US$ as the world reserve currency? The ‘knee-jerk’ answer would probably be the Chinese Digital currency, which has recently been launched by the second biggest economy in the world. Therefore, in order to gain international usage, will the Chinese insist that its digital currency becomes the method of payments at the airports, railways, roads, bridges, and harbours China has built in over 60 countries as part of its ‘Belt and Road’ initiative? Indeed, the IMF and Bank of International Settlement have both been advocating digital currencies for a while and, notably, there are many nations presently researching digital currencies for their own countries.
The global reach of China’s Belt and Road initiative
Source: Mercator Institute for Chinese Studies
However, there are two other alternatives. Firstly, what about a worldwide digital currency backed by a basket of global equities, bonds, commodities, properties, and foreign exchanges? This would be sure to remove the interdependency on any one nation or set of politicians. The second alternative would be to see a far more complex scenario with a multiplicity of corporate digital currencies issued by global corporations weary of using the current complex, expensive, and relatively inefficient analogue payment systems. The front runner (resisted to date) is Facebook’s Libra, powered by its 2.6 billion monthly users. Others such as Amazon, Google, China’s Tencent, and Alibaba already dominate payments in China, but may be forced to look overseas as the People’ Bank of China rolls out its own Digital Currency. Either way, the use of digital currencies is set to expand, and many are likely to be built using Blockchain-powered platforms which give greater levels of transparency, thus hopefully engendering trust by those that use them. After all, digital currencies leave a digital footprint and are, therefore, ideal in helping governments with their fight against the shadow economy of money laundering, drug lords, and terrorism-funded activities.
World reserve currencies — are the US$’s days numbered? was originally published in The Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.
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