Let’s start with the conclusion: I think the dollar is not going through a crisis of the level that the world is saying. It is true that there’s a trust crisis, which may cause the dollar to devaluate much more than today’s levels. However, I don’t see any reason to be worried about it or believe it’s going to lose its international status very soon.
The dollar is the major reserve currency of the world. 64 percent of the world's central banks’ reserves are dollar-denominated assets and paper dollars. However, the dollar is not the only reserve currency in the world; the euro, the yen, the pound and the Swiss franc enter this category as well.
From the 18th to the 19th century we worked pretty well under a global monetary standard called “gold specie standard”. It implied that all bills (fiduciary money) were backed by a certain amount of physical gold. During that time all goods and services were translated into this relative price against the intrinsic value of gold. Gold was used as a means of exchange, as value reserve and besides it regulated the making of money (new gold discoveries caused inflation).
At the end of the World War II in 1944, this monetary standard was substituted by the “gold exchange standard” (in the famous Bretton Woods). This new monetary system set the value of a foreign exchange in terms of a determined gold quantity and the issuer of the foreign exchange guaranteed to return to its possessor, the amount of gold it represented - it had been established that all currencies were to be exchanged for dollars, which was of free conversion in exchange of gold, it had an exchange rate of $35 per ounce.
This system resulted in the dollar (a fiduciary currency) being put at the same level of gold and it started to become a global monetary standard. At that time, the United States owned over 70 percent of the world’s gold reserves, for which it was credible that it could guarantee its currency conversion with the precious metal.
There was an interesting detail in Bretton Woods’ system; the discretionary creation of money was allowed. The United States issued green currency without taking into account the amount of gold it represented – it didn’t concern the government much, there was a deep trust in the currency that believing that everyone were to ask for gold at the same time was unimaginable. But finally it did happen and, in August 1971, Nixon was forced to end the gold exchange standard.
After the collapse of Bretton Woods’ agreement in 1971, the world was so used to the dollar that people kept using it. The world used dollars as a monetary standard and the main reserve currency, and a reference currency was needed to regulate the creation of its own money.
At that time, the United States was the major economy in the world; it controlled around 15 percent of global trade, represented over 30 percent of the world product, and the market capitalization of its companies represented over 65 percent of the world’s market capitalization. By default, and due to the lack of currencies that could compete with the United States, the world continued to use the dollar as a monetary standard although it doesn’t have the backing of an intrinsic value as the gold any longer.
Nowadays, and based on data by McKinnon “demand and supply economies”, BIS, IMF, OECD and MSCI:
- 90 percent of interbank transactions outside Europe are made in dollars.
- The dollar is the main reference currency for primary commodities.
- The dollar is the major intervention currency used by governments to influence the exchange rate of their own currencies.
- The dollar is the chief value reserve, standing for more than 60 percent of foreign exchange reserves of central banks.
- The United States represents over 30 percent of the world’s product (nominal GDP as percentage of world nominal GDP).
- Market capitalization of the United States companies represents over 55 percent of world companies’ capitalization.
- The United States debt market accounts for, at least, 39 percent of world’s government bonds market.
Thus, there is a chance that the dollar strongly depreciates in the next few years. However, this would not necessarily have an impact on the role of currency as an international value reserve. The dollar is the main reserve currency, but not the only one. There is also the euro, the yen, the pound and the Swiss franc. The role of the dollar as a value reserve is not at risk.
Of course, if the whole planet chooses to reduce their possession of dollars simultaneously, the consequences on the dollar could be devastating (in terms of value loss). Personally, I don’t think this will happen, I think it is a remote possibility (I hope so).
Looking at the future, the role of the dollar as a global currency standard could be questioned. The world is possibly going towards a currency standard shared by many currencies (dollar and euro). Moreover, if the euro survives the big battle it’s going through, mainly against its own organization, I see that the new currency standard will be shared between both currencies. The euro is the most used value reserve after the dollar, representing nowadays 27 percent of the of the world’s central banks reserves. And, it is not only used in Europe for many countries in the Middle East and Africa are adopting the euro as a main currency for international exchange.
But, this is not an immediate transition. At this moment, the dollar is very well installed as a global currency standard and main value reserve. The transition to a new-shared currency standard has begun many years ago and we have many years ahead to accomplish it (if this is what is going to happen).
Disclosure: No positions
