Americans trust foreign currencies
The US dollar as the key currency - no alternative? –
The importance of the industrialized countries - including the USA - for the world economy has been declining for a long time. In contrast, China's share in particular has increased significantly. Nevertheless, the US dollar has largely met the criteria for a reserve currency so far, even if it is increasingly criticized in view of the protectionist stance of the USA. Accordingly, the central banks keep their reserves mainly in US dollars and transactions are largely carried out in the US currency. There are great advantages for the USA in maintaining its position as reserve currency, including making it easier for the USA to monitor and enforce sanctions. It is questionable whether other currencies, especially the renminbi, will be able to fulfill the key currency function. Likewise, it does not seem realistic that market participants could get involved in a global currency.
Key currency status of the US dollar: Quo vadis?
In the course of the rapid economic growth of the emerging countries, the global economic importance of the USA continues to decline. It seems only a matter of time before the US will lose its economic and political hegemony on a global scale. This process is exacerbated by the isolationist tendencies of the American economy, which increasingly cast doubt on the role of the USA as advocate of a liberal world economic order and advocate of globalization. These developments raise the question of whether the US dollar can and should continue to function as the reserve currency on the international goods and financial markets.
Characteristics of a key currency
A key currency is characterized by the fact that it functions as the most important international transaction, investment and reserve currency. To do this, it must be fully convertible into other currencies and be available globally in sufficient quantities to be able to meet global demand for liquidity. Therefore, the key currency country should have open, deep and well-developed financial markets. In order to guarantee trust and international acceptance as an investment and reserve currency, the key currency country must also ensure the internal value stability of the currency through a monetary and financial policy that is sustainably geared towards price level stability, have a high degree of macroeconomic stability and play an important economic and political role play in the world economy.
These criteria are still best met by the USA, although the dominance of the US currency as an international transaction and reserve medium currently appears unassailable. The US dollar is currently involved in 88% of all global foreign exchange transactions, while the euro, the second most important currency, is only used for 31% of all currency exchanges.1 With a share of currently 4%, the Chinese renminbi ranks far behind in eighth place on the The most frequently traded currencies.2 Even as an international reserve medium, the US dollar continues to dominate with 62% of the foreign exchange reserves held worldwide, while the euro only accounts for 20%
The US dollar acquired the function of a reserve currency primarily through the Bretton Woods system of fixed exchange rates, which was founded after the Second World War, with its central mechanism of the gold dollar standard, at the center of which was the sole convertibility of the US dollar into gold . For the currencies of the other countries participating in the global fixed-rate system, a fixed exchange rate parity was set against the US dollar as the key currency, which enabled these currencies to be indirectly converted into gold via an exchange into US dollars. The necessity for this construct with the US dollar as an anchor currency was essentially due to the fact that at the end of the Second World War around 70% of the world gold reserves were stored in the USA and thus a direct redeemability of national currencies in gold, as at the time of the gold standard, seemed impractical .
Although the US dollar advanced to become the unique global reserve currency in the Bretton Woods system and replaced the British pound as the world currency of the 19th and early 20th centuries, this change did not occur independently of the rise of the USA to world power and the simultaneous economic and political development Great Britain's loss of importance. In addition, this change was de facto less abrupt than it appeared through the implementation of the gold dollar standard. Indeed, this process was marked by a decade-long transition phase in which several currencies simultaneously acted as international reserve currencies. Before the First World War, for example, the French franc and the German mark were used as reserve currencies in addition to the British pound, and in the 1920s and 1930s the main reserve currencies were the pound, the franc and the US dollar The 1950s and 1960s initially played a prominent role as a reserve currency. 5
Even after the end of the Bretton Woods system and the abandonment of gold convertibility in the early 1970s, the US dollar retained its status as a reserve currency. The main reasons for this persistence are, on the one hand, the predominant dollar quotation of the commodity trade, in particular the globally important trade in crude oil, and the dollar invoicing of a considerable part of the international goods trade. On the other hand, the USA, with its particularly liquid and secure asset markets, acts as a “safe haven” for financial investments. The attractiveness of the US dollar as an investment and reserve medium has even increased significantly over the past decades, not least in the wake of the financial crises in a number of emerging countries in the 1980s and 1990s. In addition to these factors, which contribute to the continued strong demand for the American currency, the use of an established reserve currency is also linked to network effects. These are measured by the fact that the increasing use of a currency as a transaction medium increases the incentives for other traders to also use this currency to conduct their international business. Such network effects are less important with regard to the use as an investment and reserve currency, in which not only liquidity aspects but also diversification arguments play a role.
Exorbitant privilege of a world currency
The reserve currency status of the US dollar is associated with considerable economic advantages for the USA. As the issuer of the world currency, the US Federal Reserve realizes considerable money creation profits (so-called seigniorage) by providing international dollar liquidity, since the use of dollar currencies abroad represents an interest-free loan for the USA. Since a large part of these funds are held abroad in the form of US government bonds, the US government can at the same time refinance itself at significantly lower interest rates than would be possible without the US dollar as the key currency. This "exorbitant privilege" as a key currency country, denounced by the former French President Giscard d'Estaing, results in economic gains averaging around 3% of the US gross domestic product (GDP) in the US .6 American companies also realize elimination through the dollar invoicing the exchange rate risk with international engagements, transaction costs savings and in this way gain competitive advantages over foreign competitors. From a macroeconomic perspective, however, these cost savings are offset by correspondingly lower sales in the American banking sector due to the elimination of the corresponding hedging transactions.
The rest of the world also benefits from the US dollar's status as a reserve currency. In the past few decades, the US currency has shown high intrinsic stability in terms of low inflation rates compared to many other currencies. The depth and liquidity of the American financial markets as well as the economic weight of the USA on the world markets make the US dollar attractive not only as a transaction, investment and reserve currency. Countries with less liquid financial markets in particular benefit from the US dollar as the key currency, also due to the favorable refinancing conditions on the American bond markets.
The appreciation of the US dollar caused by the global demand for the reserve currency for transaction, investment and reserve purposes leads to a corresponding export of the demanded dollar stocks to the rest of the world via negative current account balances. Although the persistent current account deficits and the resulting increase in net foreign debt in the USA have been criticized many times, against this background they are a consequence of the US dollar's function as the reserve currency. The US net external debt does not in itself pose a solvency problem, as the US can print an unlimited amount of US dollars to service its external debt. However, a rapid liquidation of the dollar reserves in the rest of the world would be problematic, which could occur, for example, as a result of a sudden loss of confidence in the American currency. The resulting loss of value of the US dollar on the foreign exchange markets would possibly lead to a rapid substitution of dollar balances in other currencies and jeopardize the status of the US dollar as a world currency.
But even without a sudden loss of confidence, similar effects could result from a politically motivated liquidation or severe reduction of dollar reserves in the major dollar creditor countries, especially China. Of the official dollar foreign exchange reserves, currently around 6.5 trillion US dollars, around a third is held by the Chinese central bank alone. By accumulating dollar reserves, however, China has also made itself dependent to a considerable extent on fluctuations in the dollar exchange rate. The Chinese government is therefore unlikely to be interested in suddenly reallocating its central foreign exchange holdings to trigger a decline in the rate of the US dollar and thus the destruction of its own assets.
For several years, China has been actively promoting the use of the renminbi as an international transaction currency, which was added to the currency basket of the International Monetary Fund (IMF) in October 2016. The Chinese government is increasingly concluding bilateral trade agreements in renminbi and in March 2018 launched its own futures trading in crude oil on the commodities exchange in Shanghai, which is settled in yuan. Russia is also aiming to weaken the US dollar as a world currency. The Russian gas company Gazprom now mostly invoices its gas deliveries in euros. In addition, the New Development Bank founded by the BRICS states settles accounts in the national currencies of the member countries instead of in US dollars. American trade policy as well as the sanctioning measures of the Trump administration will in all probability further intensify the efforts of these countries to replace the US dollar as the reserve currency. In response to the impending new US sanctions, Russia intends to reduce its deposits in US government bonds, although Russia's reserve holdings, at around US $ 350 billion, are significantly lower than those of China.
Despite these efforts, the leading position of the US dollar in the international financial markets does not appear to be in jeopardy for the foreseeable future. This is mainly due to the fact that the euro area and China, which with their economic size are the only currency areas with the potential to replace the US dollar as the reserve currency, do not currently meet other essential characteristics of a world currency.
(When) will the US dollar be replaced as the key currency?
With the introduction of the euro in 1999, high hopes were associated with establishing the European currency as an equivalent reserve currency alongside the US dollar or even replacing it as the reserve currency.7 However, the financial crisis from 2008 to 2009 and the subsequent euro crisis had the structural flaws of the monetary union relentlessly disclosed and clearly reveal the economic and political heterogeneity as well as the structural and demographic problems of the participating countries in the euro area. In the future, however, the importance of the euro as an international transaction, investment and reserve currency could be strengthened by a further deepening of the credit and capital markets in the euro area. Suitable measures are the completion of the banking union after the remaining risks in the bank balance sheets have been adjusted accordingly, and the implementation of the planned capital markets union.
The renminbi is also currently out of the question as a world currency. Although China is more integrated into the world economy in terms of trade opening than the US and will overtake it in terms of economic power in the next few years, China's financial markets are still severely underdeveloped. Without deepening and liberalizing the Chinese capital markets, the renminbi cannot do justice to its potential role as a world currency. The Chinese government would also have to be ready to accept the upward pressure on its own currency resulting from the global demand for yuan and to accept the current account deficits associated with the key currency status. For some time, however, China has been taking concrete measures to make the renminbi more attractive on a global scale. In addition to the recently started dismantling of capital controls, the geopolitically motivated infrastructure measures as part of the Chinese government's “Belt and Road” initiative are well suited to promoting the use of the renminbi as a transaction and reserve currency, at least in the directly beneficiary countries.
Even if the euro area and China are able to fulfill the role of key currency country in the future, a complete displacement of the US dollar as a world currency is not to be expected. Rather, a scenario with multiple reserve currencies, consisting of the US dollar, the euro and the renminbi, appears more likely and can also make sense for economic reasons.8 In an increasingly globalized world, countries that trade with the euro area or China will become correspondingly more liquid if they exist Financial markets are increasingly indebted in euros or renminbi, and increasingly want to hold these currencies as reserve currencies. In addition to the resulting risk-reducing diversification effects, in such a system no key currency country can borrow excessively in its own currency to finance current account deficits without a substitution of investments in the competing key currencies due to a loss of credibility and confidence. In this way, multiple reserve currencies could also contribute to limiting global current account imbalances, which are forced by the international financial markets, which are undesirable in terms of economic policy.
- 1 Since two currencies are always involved in every currency exchange, the proportions of all currency transactions add up to 200%.
- 2 See Triennial Central Bank Survey: Foreign Exchange Turnover in April 2016, Bank for International Settlements, Basel 2016.
- 3 As of Q1 2018, data source International Monetary Fund: Currency composition of Official Foreign Exchange Reserves (COFER), Washington DC 2018.
- 4 See B. Eichengreen, A. Mehl, L. C. Chiţu: How Global Currencies Work: Past, Present, and Future, Princeton 2017.
- 5 Cf. C. Schenk: The Decline of Sterling; Managing the Retreat of an International Currency 1945-1992, Cambridge 2010.
- 6 See B. Eichengreen: Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, Oxford 2011.
- 7 Cf. M. Chinn, J. Frankel: Why the euro will rival the dollar, in: International Finance, 11th vol. (2008), no. 1, pp. 49-73.
- 8 See P. Lane: Multiple Reserve Currencies and the International Monetary System: Central Bank Speech, May 19, 2016, Bank for International Settlements, Basel 2016.
Key currency and world remeasurement
Not least as a result of the re-measurement of the world - the shift in focus of the global economy to Asia - the BRICS countries1 are looking to replace the US dollar as the key currency with the Chinese yuan. The shocks to the global economy caused by US President Trump's isolationism and willingness to take sanctions could accelerate the yuan's rise as a reserve currency. There is still a lot of plumbing to do before dollar dominance can be broken. This work is in full swing with the establishment of new institutions apart from the financial system dominated by the West, the establishment of new transport, energy and digital connections in the wake of the Chinese Silk Road Initiative and the disintegration of global world trade into regional trading blocs.
BRICS states and dollar dominance
The five BRICS states form an association with different interests and strengths.If there is one theme these five have in common, it is their rejection of the US-dominated monetary system. The 10th BRICS summit in Johannesburg in July 2018 once again ended with a call against the hegemony of the US dollar. Since the 2017 Xiamen summit, five other selected emerging countries (BRICS Plus) 2 have been invited to drive the dedollarization of the global economy.
The BRICS countries have been calling for the US dollar to be replaced as the international reserve currency since their first summit in 2009. In the same year, under the fresh impression of the implosion of the global financial system as a result of the Lehman bankruptcy3, the UN Commission for the Reform of the International Monetary and Financial System, headed by Joseph Stiglitz, called for the US dollar to be replaced as the international reserve currency, possibly with the Basket of Special Drawing Rights (SDRs) of the International Monetary Fund (IMF). However, the special drawing rights are a kind of artificial money that is not traded on foreign exchange markets. They do not fulfill all of the functions of money: while SDRs can function as part of a country's official foreign exchange reserves, they cannot be used to intervene in the foreign exchange markets or as an anchor currency. So it is hardly surprising that the political impetus for the SDR as the reserve currency has petered out, although this currency basket has become more representative since the Chinese yuan was adopted
The euro could be a serious candidate for reducing the dominance of the dollar as the reserve currency, provided the institutional prerequisites were created. In order to be attractive for global transactions, especially for keeping reserves, the euro should be stable in value and crisis-proof. But the previous reforms of the euro financial architecture have not managed to create this confidence. Germany's restrictive fiscal policy also restricts the supply of risk-free Eurobonds; these would be the obvious alternative to US government bonds, the dominant form of official reserve holding so far. After all, the mercantilist German economic model, which is fixated on external competitiveness, stands in the way of the internationalization of the euro because of the Triffin dilemma5, just as it did in the way of the internationalization of the D-Mark
100 years of dollar dominance
Since the British pound was replaced as the global reserve currency after the First World War, the US dollar has “dominated” the world economy, for at least a century. The USA had already overtaken Great Britain as the largest economy at the end of the 19th century, and dominated politically in the aftermath of the First World War. The dollar is still enthroned on the top floor of the international monetary system today:
- A large part of international trade, which far exceeds the USA's share of world trade, is invoiced and settled in US dollars. This also contributes to the fact that the prices for most raw materials are formed in dollars. The role of the US dollar as the dominant invoicing currency in international trade and its widespread use as a transaction currency has so far been consolidated by network effects. The global share of the US dollar in international payments is now 40%, followed by the euro at 35% .7 In contrast, the yuan share has stagnated at just under 2 since 2016 due to devaluation pressure and the implementation of state controls to prevent capital outflows %.
- Network effects are less significant with regard to the use as a reserve currency, in which, in addition to liquidity aspects, diversification arguments also play a decisive role. Nevertheless, the US dollar also remains the predominant reserve currency. At the end of the first quarter of 2018, it represented 62.5% of the world's assigned official foreign exchange reserves. The euro was in second place at 20.4%. The yuan is currently only trading at 1.4% .8
- Bank financing outside the US is mostly in US dollars: According to location-based statistics from the Bank for International Settlements, 62% of banks' foreign currency liabilities are denominated in US dollars.9 Similarly, corporate financing of non-American companies through bank loans and bonds is more in US dollars. Dollars than other hard currencies.
The key currency functions (means of payment, holding reserves and financing vehicles) are linked to one another in multiple ways. The high proportion of internationally traded goods that are invoiced in US dollars is driving the demand for secure dollar claims. Risk-free investments in US dollars typically pay lower currency-adjusted returns than risk-free investments in most other currencies. The violation of the uncovered interest parity, in turn, favors the US dollar as a cheap financing currency. This feedback loop is particularly true for an export company in an emerging market. Because of this violation, taking out dollar loans is usually cheaper than taking out loans in one's own currency. This increases the incentive for the company to settle its exports in US dollars, because it gives them more planning security for their future dollar sales. This in turn enables the company to borrow in cheaper US dollars with less exchange rate risk.
As a key currency country, the USA enjoys the "extraordinary privilege" of being able to import capital through the provision of international dollar liquidity. Non-US citizens mostly keep their dollar investments in low-interest US government bonds. Some of these capital imports are in turn channeled by the US into high-yield foreign investments, which results in considerable interest gains for the US.10 The rest of the world has also benefited from the US dollar's status as a reserve currency so far. The depth and liquidity of the American financial markets as well as the economic weight of the US economy on world markets make the US dollar attractive not only as a transaction and reserve currency. Countries with less liquid financial markets in particular benefit from the US dollar as the key currency, also due to the favorable refinancing conditions on the US bond markets. In addition, the US dollar has shown low inflation rates and a relatively high level of external value stability over the past few decades.
Emerging Markets Discomfort
So what do the BRICS countries have to criticize about the US dollar as a key currency?
1. An up-to-date answer is given by the currency crises in Argentina and Turkey - countries that until recently were preferred borrowers in foreign banks and in the global bond markets. Now in 2018 they will have to accept a rapid decline in the external value of their currencies and pay heavy fines on the “original sin” 11 typical of emerging countries. Since many emerging countries have very illiquid and tight financial markets, the violation of uncovered interest parity tempts people to take on foreign currency debt. When dollar borrowing is done by firms or banks that do not have adequate dollar revenues, currency mismatches arise on corporate balance sheets. These balance sheet mismatches are a time bomb for private actors and public budgets through contingent liabilities for public rescue operations.
2. Another current concern concerns the US's ability to take sanctions. Every transaction that is processed in US dollars or through a US bank automatically means that trading partners are subject to American law. The US is currently waging economic wars against a tenth of the countries in the world with a cumulative population of nearly 2 billion people and a GDP of more than US $ 15 trillion. These include Russia, Iran, Venezuela, Cuba, Sudan, Zimbabwe, Myanmar, the Democratic Republic of the Congo, North Korea, but also countries such as China, Pakistan and Turkey, which are not subject to full sanctions but are targets of other economic punitive measures. The resulting trade war similarly weakens the attractiveness of the US dollar in international trade and financial transactions. Countries like Iran welcome the opportunity to bypass US sanctions by exporting goods to China that can be transacted in yuan. In July 2018, SWIFT12's RMB tracker recorded a 9.9% increase in the value of yuan payments compared to June 2018, while the value of all other payment currencies decreased by 2.5%.
3. From an asset perspective, emerging markets are concerned about the risk of the US dollar depreciating. China (including Hong Kong) and the twelve largest emerging countries recently held official foreign exchange reserves of US $ 6.7 trillion, or almost 60% of the world's official reserves. In order to avert the crisis, the demand for foreign exchange reserves is forcing developing countries to transfer resources to the countries that issue these reserve currencies - a case of "reverse aid" especially in favor of the USA. Important emerging economies, often net creditors for the rest of the world and with significant stocks of US national debt, fear a deliberate devaluation strategy by the US that would devalue its enormous currency reserves by hundreds of billions of US dollars. China's net foreign assets have risen steadily over the past three decades, to half of its rapidly growing gross domestic product (GDP). Due to its notorious consumption surplus, the US expanded its net debt position to 40% of its GDP over the same period (see Figure 1) .13
Net foreign receivables position
Source: P. Lane, G.-M. Milesi-Ferretti: The External Wealth of Nations Revisited: International Financial Integration in the Aftermath of the Global Financial Crisis, in: IMF Economic Review, International Monetary Fund, 66th year (2018), no. 1, pp. 189-222 .
4. Ultimately, it is also a question of when the shift in global economic focus from the USA to China will also be reflected politically. The world remeasurement is incomplete and possibly endangered in the long term if its economic pillar is not secured by military deterrent potential and the dismantling of the dollar dominance. Historically, the key currency came from the leading economy of the time. Adjusted for purchasing power, China is the largest economy in the world according to IMF data; today (2018) its share of world product is 18.7%, while the US share is estimated at 15.1%. Since the USA (and the traditional OECD countries) have lost their relative economic importance, the question of the reserve currency has arisen again and again.
The US dollar is still enthroned on the upper floor of the international monetary system, with a leading share in cash, reserves and financing vehicles. In the basement, however, the Chinese are already diligently laying the lines to reduce the dollar's dominance through the yuan.14 The establishment of new multilateral financial institutions away from the financial system dominated by the West, new transport, energy and digital connections along the Chinese Silk Road and the breakup of global world trade in regional trading blocs form the prerequisites for the internationalization of the Chinese currency.
According to Barry Eichengreen's account of historical changes in the international monetary system15, the sequence of the internationalization of a currency is: 1. promoting its use in invoicing and settlement of trade; 2. promoting their use in private financial transactions; 3. The promotion of its use by central banks and governments as reserve currency.
According to the latest data (2017) from the WTO, China was the largest export nation with exports of more than 2.26 trillion US dollars and a share of 12.8% in world trade. China's imports totaled US $ 1.84 trillion in 2017, making China the second largest importing country behind the US with a global import share of 10.2%. The US move away from multilateralism and world trade promotes the rise of the yuan. Mega-projects that focused on the US - the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP) - have been suspended. Instead, the Pacific-Asian region is negotiating the “Regional Comprehensive Economic Partnership” (RCEP), a trade bloc sponsored by China, which includes China, India and Japan, a further 13 countries and thus more than half of humanity.
Since there has been a close empirical empirical relationship with China's trade connections and the respective yuan correlation since the dollar peg of the yuan was abandoned in August 2015, the RCEP is promoting a yuan block in Asia.16 This influence of the Chinese currency has also recently been observed in some Latin American currencies observed. The growing yuan block will therefore also promote the yuan as a reserve currency in the future for reasons of stability and portfolio theory.
The “Belt and Road” initiative (BRI) plays a key role in the internationalization of the yuan, with a planned investment volume of over US $ 100 billion Heads of State and Government of the participating countries of Asia, Africa and Europe was announced. The use of the yuan is to be promoted through the payment flows accompanying trading activities (yuan credits) in the states along the routes. The yuan loans come from the Asian Infrastructure Investment Bank (AIIB) founded by China in 2016, which grants BRI infrastructure loans outside of the US-dominated Bretton Woods system17.
- 1 Brazil, Russia, India, China and South Africa.
- 2 Egypt, Argentina, Indonesia, Jamaica and Turkey.
- 3 Cf. the contemporary talk “Ten years after the Lehman bankruptcy - financial markets stable?”, In: Wirtschaftsdienst, 98th vol. (2018), no. 8, pp. 539-557, https: //blog.zeit. de / herdentrieb / 2018/08/19 / lehman-broke-ten-years-after-10979 (27.9.2018).
- 4 H. Travel: International Monetary Fund: China receives due place, in: Wirtschaftsdienst, 96th year (2016), H. 1, S. 6, https://archiv.wirtschaftsdienst.eu/jahr/2016/1/internationaler -Currency-Fund-China-Receives-Due-Place / (27.9.2018).
- 5 With the help of a current account deficit, the reserve currency country should continuously supply the world economy with risk-free liquidity, which in the long term can undermine confidence in the reserve currency.
- 6 See S. Dullien: The German economic model stands in the way of a global euro, Makronom, 4.9.2018, https://makronom.de/swift-alternative-heiko-maas-zahlungssystem-das-deutsche-wirtschaftsmodell-estand- a-global-euro-in-the-path-27647 (18.9.2018).
- 7 M. Frühauf: The leading position of the dollar is unchallenged, in: Frankfurter Allgemeine Zeitung from September 15, 2018.
- 8 International Monetary Fund: Currency Composition of Official Foreign Exchange Reserves (COFER), 1st quarter 2018, http://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4 (27.9.2018).
- 9 G. Gopinath, J. Stein: Banking, Trade, and the Making of a Dominant Currency, NBER Working Paper, No. 24485, April 2018.
- 10 As Treasury Secretary in 1965, Giscard d'Estaing described this phenomenon as an “exorbitant privilege” for the USA.
- 11 B. Eichengreen, R. Hausmann, U. Panizza: Currency Mismatches, Debt Intolerance and Original Sin. Why They Are Not the Same and Why It Matters, NBER Working Paper, No. 10036, October 2003.
- 12 SWIFT is the abbreviation for the private Brussels-based service provider “Society for Worldwide Interbank Financial Telecommunication”; RMB for Renminbi, the alternative name for the currency of the People's Republic of China.
- 13 P. Lane, G.-M. Milesi-Ferretti: The External Wealth of Nations Revisited: International Financial Integration in the Aftermath of the Global Financial Crisis, in: IMF Economic Review, International Monetary Fund, 66th year (2018), no. 1, pp. 189-222 .
- 14 On China's measures to establish a modern market infrastructure landscape for the internationalization of the yuan, see C-L. Thiele: The renminbi in international payments, Deutsche Bundesbank, speeches, November 15, 2017.
- 15 B. Eichengreen: The renminbi as an international currency, in: Journal of Policy Modeling, 2011, vol. 33, no. 5, pp. 723-730.
- 16 R. McCauley, C. Shu: Recent RMB policy and currency co-movements, BIS Working Papers, No. 727, June 2018.
- 17 H. Travel: The Development Banks of the Emerging Markets and the Multilateral Financial Architecture, in: Wirtschaftsdienst, 95th year (2015), no. 4, pp. 274-279, https://archiv.wirtschaftsdienst.eu/jahr/2015/ 4 / the-development-banks-of-the-emerging-countries-and-the-multilateral-financial-architecture / (27.9.2018).
The future of the US dollar
In the official reserve holdings of the central banks, the US dollar had a share of 62% worldwide in the first quarter of 2018, followed by the euro with 20% and the Japanese yen and the British pound with less than 5% each. The Chinese renminbi had a share of less than 1.5% .1 In the global transactions on the foreign exchange markets, which add up to a total of 200%, since two currencies are involved in each transaction, the US dollar had a share of 88% in 2016 , the euro of 31% and the yen of 22%. In 1995 the US dollar was 83% here and 90% in 2001. The development of the renminbi is noteworthy.While its share was 0% in 2001, it was able to achieve a share of 4% in 2016.2 In global cross-border credit relationships, the US dollar had a share of 50% in the first quarter of 2018, followed by the euro with 29% .3 In March 1999 the share of the US dollar in cross-border bank debt and securities was 45% and the share of the euro was 30% .4
The development of the country shares in world gross domestic product (world GDP) is interesting: measured at current prices, the USA had a share in world GDP of around 24% in 2017, followed by China and the European Monetary Union (EMU) with 16% each %. The reduction in the US share of world GDP is not dramatic. In 1970 it was 28%. By contrast, China had a much smaller share of world GDP in 1970, at just 0.8% .5
Overall, there have been no major shifts in the dominant international role of the US dollar over the past 30 years. It is noteworthy that overall the euro does not play a greater international role than the sum of the national currencies that were replaced by the euro in 1999 with the start of EMU. The renminbi increased its role but has so far been insignificant as an international currency. Another question is the future roles of the US dollar, the euro and the renminbi. In order to answer this question, the factors that make a national currency an internationally relevant currency should be named.
What makes a currency international?
The asset protection quality of a currency is of decisive importance for its international role.6 This includes a whole bunch of factors:
- A low current and expected inflation rate is fundamental. Expectations include trust in a country's institutions that are responsible for low inflation. Currencies with international functions serve as a safe haven in an uncertain global economy. High inflation rates destroy money's store of value.
- Equally important is the role of international currencies as the standard of value for cross-border credit. Empirical evidence shows that only a very small number of the around 160 currencies currently in existence in the world enjoy sufficient trust to serve as an international store of value and as a standard of value for international loans.
- A stable exchange rate is relevant for the asset protection quality of money. Ideally, the exchange rate of a currency with international functions is stable and should not depreciate under any circumstances. Exchange rate fluctuations not only increase uncertainties, they also disrupt the international functions of money. A strong devaluation of the world reserve currency devalues international liquidity compared to other currencies, while a strong revaluation increases the real debt burden of the debtors who are indebted in the international currency but do not do business in this currency. In that sense, the pound sterling was extremely functional under the gold standard with its fixed exchange rates prior to World War I.
- A currency with international functions must be convertible. Only in such a case can investors invest and withdraw money in the currency as they wish. Investors will also expect a friendly climate towards the wealthy. If there is fear of arbitrary restrictions, a currency will not take on any international functions.
- The size and diversity of a currency's asset market are also important. For example, even large investors must be able to withdraw money from an international currency without any noticeable effect on the exchange rate. In spite of Switzerland's stability and wealth-friendly policies, the Swiss franc only takes on minor international functions.
- The international political role and not least the military strength of a country are just as important for the international role of its money. A country can only be a safe haven if it is militarily strong. International claims of a small country against a militarily superior neighbor are difficult to collect when in doubt. It works the other way around.7 A gunboat policy is not absolutely necessary; economic and political pressure are sufficient.
- Finally, it must be borne in mind that there are strong network effects with currencies, which reinforce and stabilize the use of widely used money. This implies that the transition from one internationally dominant currency to another cannot be expected to take place smoothly.
US dollars and euros
If the US dollar is valued against the background of the above criteria, it becomes clear that of all the currencies currently in existence in the world it has the best prerequisites to be the dominant currency. The inflation rate in the US has been at a relatively low level for decades. There is no country on earth that offers the combination of full convertibility, a large asset market and high freedoms for the wealthy to the same extent. And in the political and military fields, no country can seriously compete with the US in the foreseeable future.
In Europe, the future of EMU is fraught with uncertainties. In order to create a long-term stable currency area, further integration steps would be necessary, which would have to go in the direction of state formation for EMU. What would be necessary would be a separate fiscal role for the EMU center, stronger transfer mechanisms, harmonization of the tax and wage formation system and a strengthening of the European Parliament.8 Such steps are rather unlikely in the short and even medium term. At the political level, Europe does not speak with one voice and there is no European army. These weaknesses in EMU make it unlikely that the euro can achieve the same relevance as the US dollar.
However, there are also risks for the US dollar. A US protectionist trade policy is not conducive, but it is compatible with the international role of the US dollar. Before the First World War, there were high tariffs in all countries, without this having harmed the international role of the then reserve currency, the pound. The problem is, if US President Trump is seriously pursuing a policy aimed at eliminating the US current account deficit or even creating a surplus, trade restrictions would not be the appropriate means, as they ultimately only affect the structure of trade. In order to eliminate the current account deficit, international capital movements must be regulated. Because the USA, as a world reserve currency country, is confronted with high capital imports from private and central banks. In countries whose currency plays an international role, this tends to lead to the currency becoming overvalued and current account deficits to develop. If the international movement of capital were restricted and the USA were to pursue an aggressive policy of undervaluation, this would have negative consequences for the international role of the US dollar. The US current account deficit was a very high 6% of US GDP in 2006, but fell to 2.4% of GDP in 2017.9 There is currently no need for the US to pursue an aggressive current account reduction policy.
In addition, the US is realizing a number of advantages from the international role of the US dollar. You can borrow in domestic currency abroad; they realize seigniorage profits, that is, profits from the fact that the US dollar is held on a large scale worldwide as cash or interest-free as a bank deposit; internationally important goods such as oil are invoiced in US dollars; international payment transactions are largely handled by US companies; and they get welfare gains from a strong currency. However, the overvalued currency also creates losers, especially among unskilled workers. Because it first lets the labor-intensive and technologically less demanding productions migrate abroad. If US President Trump wanted to join a mercantilist policy traditionally pursued by Germany, China and Japan, the global economy would have a problem, and this would also damage the role of the US dollar.
The renminbi as an international currency
China is pursuing strategies to internationalize the renminbi. An attempt is being made to conduct Chinese foreign trade in renminbi. Traditionally, a German importer of Chinese goods, for example, exchanges euros for US dollars and then US dollars for renminbi. In recent years, China has concluded so-called swap agreements with a number of countries, including Germany, in order to conduct foreign trade directly in Renminbi. Under these agreements, the Chinese central bank and the central bank of the swap partner provide short-term liquidity that allows trading in one of the two partner currencies.
China has managed to have around 50% of its foreign debt denominated in renminbi.10 This shows that the Chinese currency has built more confidence than many other currencies. It can also be assumed that a considerable part of the lending within the framework of China's engagement in Africa and within the framework of the “Belt and Road” initiative, which opens up a network of infrastructure projects and new economic zones in Southeast Asia, South Asia and Central Asia and trade with Europe should intensify, is denominated in Renminbi. China has recently started to process its own oil imports in renminbi. This breaks the US dollar's monopoly in this area.11 After all, China is building a worldwide payment system under its own direction. All of these efforts are reinforced by the trade war with the United States. However, the renminbi does not currently play a relevant role as a value standard for international loans with third countries and as an investment currency for international liquidity.
In the medium term, the renminbi is not yet ready to take on extensive international functions. The currency is not convertible, so that the institutional prerequisites for a comprehensive international function are already missing. A quick introduction of convertibility is not to be expected, since the Chinese financial system is not prepared for such a step and the entire Chinese economic model has so far been largely based on a largely state-controlled financial system.12 China's political and military power is also still at a lower level than that of the USA.
China will further strengthen the role of the renminbi in its own foreign trade and lending and possibly try to create its own currency bloc, but the renminbi will not become a serious competitor of the US dollar in the short to medium term.
The future of the monetary system
The future monetary system is likely to be dominated by the US dollar for a long time, albeit with decreasing strength. Due to the internal problems of EMU and the lack of the political and military dimensions of a world currency, the euro will hardly be able to displace the US dollar. However, there are serious risks to the future stability of the monetary system.
The USA cannot be expected to subject its economic policy to the requirements of the stability of a world currency. National interests and internal economic conflicts can lead to economic policies that exploit and / or destabilize the international role of the national currency. For example, flexible exchange rates contradict the functional conditions of an international monetary production economy. Because with international loans and the maintenance of international liquidity, exchange rate fluctuations such as inflation and deflation have an effect. However, it may be in the interest of the USA to use the exchange rate as an economic policy instrument.
In the long term, the global economy can get into an unstable scenario that could look like this: The USA pursues a nationally oriented economic policy that has little focus on the stability of the US dollar. At the same time, there are alternatives to the euro and, in the long term, the renminbi. If there are different international investment currencies, then the wealthy can and will jump from one currency to another depending on the economic policies pursued by the countries and expectations. Portfolio shifts can then lead to severe exchange rate turbulence and disruption. This would be a scenario in which no country in the world provides a good, internationally stable currency. For this reason, John Maynard Keynes brought the idea of a supranational currency, the bancor, into play, at least for the banks' reserve holdings and mechanisms of currency stabilization and limitation of current account imbalances. Such a step, however, requires intensive international cooperation and strong international institutions. 13
- 1 International Monetary Fund: Currency Composition of Official International Exchange Reserves, Washington, various years.
- 2 Bank for International Settlement: Triennial Central Bank Survey, Basel 2016.
- 3 Bank for International Settlement: Locational Banking Statistics, Basel 2018.
- 4 Bank for International Settlement: Quarterly Review, International Banking and Financial Market Development, Basel, August 1999.
- 5 Trading Economics, September 2018. Calculated in purchasing power parities, the GDP of the USA and China in 2018 are close to each other.
- 6 H. Riese: Theory of Inflation, Tübingen 1986, p. 237 f.
- 7 On October 4, 1849, British naval infantry occupied the port of Trujillo in Honduras in order to collect a claim from the Honduran government in the amount of US $ 100,000. On April 27, 1895, British naval units occupied the Corinto customs house in order to collect financial claims from the Nicaraguan government.
- 8 H. Herr, J. Priewe, A. Watt (Eds.): Saving the Euro: Redesigning Euro Area economic governance, Social Europe, 2017, https://www.socialeurope.eu/wp-content/uploads/2017/ 06 / EURO-web.pdf (September 17, 2018).
- 9 Federal Statistical Office, 2018, https://www.destatis.de.
- 10 In June 2015, China had a gross foreign debt of US $ 1.68 trillion, 49% of which was denominated in Renminbi, see J. Rong: Does China’s External Debt Pose a Major Risk ?, Best Minds, October 14, 2015. In June 2018, the U.S. gross foreign debt was $ 19.18 trillion. Of this, only 6.8% are denominated in foreign currency, cf. Department of Treasury, Resource Center, 2018.
- 11H. Zschäpitz: China breaks the dollar dictation with oil, in: Welt from 5.9.2018.
- 12 H. Herr: The Rise of China to an Economic Great Power - Successes and Challenges, in: M. Linke, T. Sablowski, K. Steinitz (Eds.): China: Societal Development and Global Effects, Manuscripts New Series, Rosa Luxemburg Foundation 2015.
- 13 H. Herr: International Monetary and Financial Architecture, in: E. Hein, E. Stockhammer (Ed.): A Modern Guide to Keynesian Macroeconomics and Economic Policies, Cheltenham 2011, pp. 267-293.
International currency system: US dollar, global currency or a "Chinese system"?
The international financial system represents the order of international financial relations and in this respect reflects the respective dominant economic ideas and power relations. It therefore maps on the international level what functions as the monetary order on the national level. In the German case, the national monetary order has been transferred to the European Monetary Union (EMU) with statutory framework conditions. In comparison, the international monetary system is not so clear-cut. It starts with the fact that, in purely formal terms, there is no international monetary system that is legally binding like a national monetary system. Rather, it is a mixture of regulated ingredients and habits. The core of what is regulated is still the International Monetary Fund (IMF) with its processes, such as the monitoring of its member states and the international financial markets. Unlike until the end of the Bretton Woods system in the 1970s, which dictated fixed exchange rates, 1 the rules for exchange rates are no longer fixed. Here the countries are free to decide and the exchange rates are flexible.
In fact, however, most central banks intervene in their currency markets with various instruments and thus try to influence exchange rates.2 The majority of central banks intervene directly on the currency markets, in most countries capital controls apply and even in monetary policy (setting the key interest rate) the 3 If the exchange rates are influenced so often (with or without success), can we still speak of a system, of an order of international financial relations? 4 In any case, it is obvious that countries today are very free to choose their exchange rate regime or the degree and structure of their international capital movements. Nevertheless, there are some elements of order in the international financial system, either deliberately brought about or grown. The first area includes the IMF, but this also includes the meetings of the G20 group of states and the entire area of financial market regulation, which is handled by the Bank for International Settlements (BIS) in Basel.
US dollars as the key currency
The outstanding element of the international financial system that has evolved is the US dollar as the key currency.The characteristics of a key currency can be determined from a few indicators:
- Reserve currency: In fact, around 60% of global currency reserves are still held in US dollars. This share is by far the largest, ahead of the euro with around 20% and other, less important currencies.
- Exchange: "Smaller" currencies are always exchanged first into a key currency and then, if necessary, into another smaller currency. This avoids countless small bilateral markets for minor currencies, which would be quite illiquid due to the small number of transactions, while the concentration of trading in a minor currency on exchange with a key currency bundles all transactions. Once again, the BIS statistics show beyond any doubt that the US dollar dominates by far in this respect as well.
- Issue currency: A key currency is used as the issue currency on international capital markets. Accordingly, private or public issuers do not only borrow in local but also in an international currency. Again, it is the US dollar that dominates in this function compared to the euro, yen or other currencies.
Why the US dollar?
The US dollar is the reserve currency because the USA is the dominant economy in the world. After the Second World War, the US dollar took over this role from the British pound. At this point the US economy had reached its relatively greatest weight in the world economy. It was also particularly productive, had a stable financial sector (unlike in the 1920s) and was quite open to foreign trade (not least because of the war economy). Furthermore, the USA had accumulated the essential state gold reserves at its central bank through the war. After all, the USA dominated politically as the winner of the war, the greatest military power and the only nuclear power. In this situation, the US was the natural linchpin of the world economy.
All of these reasons in favor of the US dollar as the reserve currency still apply today, but much less so than at the end of the Second World War.5 For example, if one takes the value added of the economy as an indicator, it becomes apparent that the USA has been in is about to descend continuously. This is the result of the previously underdeveloped countries catching up. After 1945 these were Europe and Japan, then the Newly Industrializing Countries (NICs, such as South Korea) were added in the 1970s, and in the last few decades other developing countries, including China in particular, have caught up a lot. If one calculates the US share with exchange rates adjusted for the lower fluctuations with purchasing power parities, the US weight is from around 35% (1950) over approx. 22.5% in the mid-1980s to a good 15% ( 2017) decreased (see Figure 1).
Importance of individual countries for the world economy
Source: IMF Data Mapper: GDP based on PPP, share of world, https://www.imf.org/external/datamapper/[email protected]/WEOWORLD/USA (October 2nd, 2018).
As a result, today - if one reevaluates the situation - one would think less of a single reserve currency than of a group of currencies which together make up the reserve currency. Basically, Keynes had already planned exactly this in his draft for the design of the Bretton Woods system, only at the time it corresponded to British interests, but not to the weighting of world economy and world politics. Over the decades, criticism of US currency dominance has tended to grow louder
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