It might trade at 60 on the DXY but still be around.
From Palladium, December 5:
t the close of the Second World War, the United States represented almost a third of world GDP, and an even larger share of manufacturing. The proportion is stark: the UN’s World Economic Report for 1948 breaks a chart of global manufacturing down into two roughly equal halves: the United States and “Other”. At the time, it was unquestionable that if there was to be a global reserve currency, it would be the U.S. dollar. At the Bretton Woods conference in 1944, this was codified into a new system: the dollar was backed by the U.S.’s gold reserves, and every other major currency was backed by its exchangeability into dollars.
In 1971, that system collapsed when the gold system was closed—this was, at the time, described as a temporary contingency, meaning that the temporary adjustment to the Bretton Woods system has lasted almost twice as long as the system itself. But the dollar has not yet lost its reserve status. Around the world, commodities are priced in dollars, corporations sign dollar-denominated contracts, and central banks keep 57% of their aggregate reserves in dollars, more than three times the share of the runner-up currency, the euro.
There’s always speculation that the dollar will be dethroned as the world’s reserve currency. This happens both in the sense that people make speculative claims and in the sense that traders make speculative bets. Whenever there’s a financial crisis—COVID-19, 2008, the dot com crash, the crash of 1987—the speculation gets louder. How can the U.S. dollar be a safe currency to hold when the U.S. runs chronic fiscal and trade deficits, and when China’s economy is growing faster and will be larger than the U.S.’s in just a few years? With interest rates at zero, how can a dollar whose supply is rising, in M2 terms, by 24% annually compete with gold, whose supply increases are limited by mining technology, or Bitcoin, with a supply encoded in algorithms?
These are valid questions when it comes to estimating the near-term future of the dollar’s exchange rate, but they don’t speak to the binary question of whether or not the U.S. dollar will remain the default global currency. That question raises fascinating historical questions, and provides a look at what reserve currencies—and currencies in general—really are.
Like any currency, a reserve currency serves three purposes: a means of exchange, a store of value, and a unit of account. For central banks, the store of value question is key most of the time, but means-of-exchange matters under duress. When the world trade system is simple, currency as a means of exchange requires a very direct kind of logic: for goods that a country wants, but can’t make itself, what’s the currency necessary to buy them? Historically, most trade was either finished goods or raw materials: a country might export machinery and import grain, or export coal and import clothes.
But modern trade has gotten more complicated, largely due to the rise of containerization. Container ships make it cheap to load and unload cargo, which makes it possible for countries to import and export intermediate goods. Most of the value of a smartphone exported from China consists of components imported from places like Taiwan, South Korea, Japan, and even the U.S. American software, for now, still wins out in this industry. These complex supply chains give currencies a stronger network effect: a company that does business with companies that use Won, Yen, New Taiwan dollars, and U.S. dollars might prefer to stick with a single currency to keep things simple. And for importers of finished goods, the calculus is even easier: very few companies in China have a strong desire to own Brazilian Real, Indian Rupees, or Nigerian Naira. Conversely, nearly everyone can find a use for the dollar.
So, the dollar’s dominance of trade is self-sustaining.
There are historical analogues. Before the dollar was dominant, the British Pound was the world’s preeminent currency. American, Argentinian, and Australian entrepreneurs borrowed in pounds rather than local currency, and London was the center of the financial universe. Britain declined in relative importance in the late 19th century, as the U.S., Germany, and France caught up with its industrialization. But the pound remained important. It was by far the dominant reserve currency in the late 1940s, representing over 85% of global reserves, and it wasn’t dethroned by the dollar as the top reserve currency until the mid-1950s. As recent as the late 1960s, pounds represented over a quarter of global foreign exchange reserves, at a time when Britain was a mere 4.4% of GDP.
Why was Britain’s share of reserves over five times its share of the global economy? There are several reasons:
- As Barry Eichengreen et. al argue in How Global Currencies Work (the source for the reserve data above), reserve currency status depends not just on economic output, but also on how open a country’s financial markets are, how complex its financial institutions are, and pre-existing reserves. Britain scored well on all of these counts.
- British policy went through constant contortions to convince banks to keep reserves in pounds....
....MUCH MORE
