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The Dominant Dollar In An Age Of Advancing Digital Currencies

by: John M. Mason
John M. Mason
Banks, long-term horizon
Summary

Digital currencies are being discussed all over the world, and questions are arising about how these "technological" currencies will advance relative to the current financial system and the "dominant" dollar.

The fact is that there is more to the use and value of a currency than just its technological capabilities: Technologies cannot solve all the currency issues alone.

For this reason, even with the rise of digital currencies, it is not expected that the current system of reserve currencies with US dollar dominance will be replaced.

Gita Gopinath, the chief economist at the International Monetary Fund, argues, "Digital currencies will not displace the dominant dollar."

This is a very important point to consider for investors and businesses because digital currencies present us with the possibility that the whole financial framework, now dependent upon fiat currencies, could, in fact, disappear.

Such a transformation could really change the way investors and businesses go about their daily tasks.

The Gopinath article comes just one day after my post discussing how Chinese developments in the payments area are presenting us with the possibility that China may be "completely redesigning finance."

In fact, John Thornhill of the Financial Times goes so far as to suggest that, given the scale that China has reached within its own country and the possibility that it may bring its systems to much of the underdeveloped world:

"China has the chance to rewire 21st-century finance."

The conclusion that one can draw from all these advances is that:

"This has all sorts of implications for the US banking system, the US economy, and the US political system. A question coming from this conclusion concerns whether or not the US dollar can maintain its position within the world financial system."

Ms. Gopinath counters this with the argument that:

"Advances in payment technologies do not address fundamental issues of what it takes to be a global reserve currency."

It seems though we have here a debate growing about the future of the banking and monetary system that will not go away but must be dealt with over time if the world's financial system is to function properly and contribute to economic expansion throughout the world.

Advances in payment technologies are attaining more and more attention these days, particularly since Facebook Inc. (NASDAQ:FB) announced plans for its own digital currency, Libra.

Ms. Gopinath continues that "While Libra's own prospects have dimmed, major central banks are considering where 'public' digital currencies are needed to fill a gap in retail payment needs."

Furthermore, big tech firms could have some advantages in developing their own payment systems. Alibaba (NYSE:BABA) and Tencent (OTCPK:TCEHY) have done this very thing and Ms. Gopinath mentions how Tencent's WeChat Pay offers "seamless interaction of multiple services on a single platform, combined with a low-cost and user-friendly payment system."

Sounds good!

But, these developments have not reduced the expense of moving among currencies. And, this is where the whole issue about maintaining dollar dominance comes in.

Right now, in terms of trade invoicing and global banking, the dollar accounts for five times the US share of world trade. People use the dollar because many other people use the dollar. In some emerging markets, trade relies primarily upon the dollar.

Behind this are the institutions, now in place, to support dollar exchange, the legal rules that govern the markets, and the trust that people have in the United States to keep the dollar strong and acceptable in use.

A digital currency may grow in use and acceptance, but it seems that meeting some of these other standards will be extremely tough.

That is unless the United States acts in a way that the trust that has been built up over all these years is lost.

Ms. Gopinath suggests that:

When sovereign governments, investors, and traders are confronted with digital currency choices, they are likely to reassess what currency to use for transactions across borders. Their chic will be based on many of the same factors as in the past-liquidity, stability, convertibility-but also new concerns, such as technological superiority of the issuing country. This latter issue could become a decisive factor, given legitimate concerns about privacy and security with digitized monies."

But, Ms. Gopinath states very strongly:

"Few sovereigns will meet such criteria."

Furthermore, for the time being, the big tech offerings will continue to be tied to a "fiat" currency, one offered by a sovereign body. Not only would it be tough to separate a digital currency from a sovereign offering, but the regulatory and jurisdictional issues that would have to be dealt with would also be almost prohibitive.

In other words, investors and businesses, as well as ordinary people, need to have a "safe haven" to go to, someplace where they can put their wealth and feel secure. This is what "money" ultimately comes down to.

And, this gets us to the bottom line of Ms. Gopinath's argument.

Technology cannot solve the issue alone.

What big tech is placing its bets on is the reduction in cost and the efficiency of transferring funds from place-to-place. Referring back to Ms. Gopinath's quote presented above, the Chinese firms will offer "seamless interaction of multiple services on a single platform, combined with a low-cost and user-friendly payment system."

But, just providing this does not ensure "trust" in the currency, the trust that is available from a government that maintains the value of the currency and regulates the institutional structure surrounding the currency.

This trust is something that investors and businesses, and ordinary people, will not easily give up.

So, the issue discussed in this article and my previous article will not just go away even though the more digitized the world becomes, the greater will be the call for a common currency, a digital currency.

Right now, I only see the move to a digital currency succeeding in the case, as I mentioned above, of the United States government, somehow, producing an environment that destroys the trust in the dollar as a reserve currency. If that happens, the world will have to create a monetary foundation that will take over from the dollar and earn the trust of investors, businesses, and ordinary people.

Let's hope, therefore, Ms. Gopinath is correct: "Digital currencies will not displace the dominant dollar."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.