In recent years the position of the US dollar as the global reserve currency has been increasingly challenged in both the words and actions of international leaders. Disapproval of the unique benefits reserve status offers to the US have led to demand for change, yet viable challengers to that role have yet to arise.
The problem is not that the reserve currency is issued by the United States, the problem is that it’s tied to any state at all. So long as the reserve currency is issued by one or more nations and subject to manipulation for the purpose of serving political agendas, as has been the case throughout history, the very idea of a free market economy is impossible to achieve. Only recently through bitcoin has the notion of a currency that can be easily traded and is not tied to any central entity become a reality.
Subject to Politics
Data source: IMF COFER database
Issuance of national currency is inherently tied to the will of central planning authorities within that country. In the case of the USD, there are just twelve voting members of the Federal Open Market Committee responsible for US monetary policy. That means twelve people making controversial decisions, driven by the economic interests of a single country, control the value of 62% of the foreign exchange reserves of global banking institutions and the denominating asset underlying 85% of global foreign exchange transactions.
That committee has chosen to grow its balance sheet by $85 billion per month, to well above $3 trillion in total, by monetizing US Treasury and Agency debt. Accordingly, the long term outlook for the value of the USD will be subject not only to the supply of new money, but also bubbles caused by synthetic support for state-favored asset classes, and record high national debt.
Expensive for Other Countries to Accommodate
All trade is dependent on the involved parties agreeing on a means of value transfer. The seller has to be able to use the proceeds of the sale to finance the rest of their business operations, which presents friction when the buyer is in another country and uses a different currency.
As a result, the US dollar is often used as an intermediary currency for international trade since the depth of the derivatives markets in USD allows both parties to easily swap back to their home currency and hedge against exchange-rate risk. This drives demand for USD while costing both trading parties time and money to facilitate the swaps.
Not surprisingly, an increasing number of countries are setting up direct swap lines to facilitate trade without the need for an intermediary currency. Even oil trading, almost exclusively denominated in USD for more than 30 years, is now using alternatives.
Threatens Global Financial Stability
To maintain the status of reserve currency, the issuing nation needs to ensure there is ample liquidity in that currency outside of it’s own borders. Unfortunately, the means of doing this can lead to negative long-term negative effects on global financial stability.
One way for the issuer of the global reserve currency to maintain liquidity for trading and reserve holdings internationally is to use trade to put more of its currency out to others than it takes back in. Said otherwise, the nation issuing the reserve currency is incentivized to incur sustained trade deficits by importing more than it exports. While aiding currency strength in the short term by providing the necessary liquidity to maintain reserve status, deficits can add up to unmanageable debts and the related long-term potential for devaluation of the reserve currency. A borderless currency without ties to current account balances would be immune to this effect.
Data sources: St. Louis Fed, TreasuryDirect
A Global Shift Is Well Underway
The dollar is not the world’s first reserve currency and it almost certainly will not be the last. The same status has been achieved by an abundance of currencies over the last 2,500 years as their issuing nations gained and lost economic prominence. Accordingly, the fate of the global financial system is tied to the success or failure of individual nations and, as the chart below illustrates, the USD is approaching the average lifespan for this role.
Timeline of global reserve currencies. Source: J.P. Morgan Private Bank 2012 Outlook
The sentiment that the time has come for an alternative seems to be underlying the actions of financial decision makers internationally. The share of global reserves held in USD has fallen approximately 10% so far in the 21st century and calls for a replacement for the USD have been posed in recent years. China has repeatedly suggested removing the USD from reserve currency status, as has the International Monetary Fund.
One of the most popular alternatives discussed on the global stage is the IMF’s Special Drawing Rights (SDRs) – claims on a basket of currencies, the composition of which is determined by the IMF Executive Board. Given the propensity for intentional manipulation of important financial benchmarks and increasing contention caused by international monetary unions, the prospect of going further down path of consolidated power with the SDR is disconcerting. As would be expected, some countries are beginning to show visible angst towards the global fiat system in general and have begun repatriating large amounts of physical gold.
In a world of increasing global communication and trade, a nation-agnostic currency would solve many of the problems we’ve seen repeated throughout history and potentially ease the associated international tensions. An asset for which the value is determined solely by international demand, immune to influence from central planners, is a necessary step forward towards a free market.
Only recently have the technologies required to facilitate such an idea existed, so for the first time in history, the next shift in reserve currency could be to one not controlled by government(s) or banks. Bitcoin may not be the solution, but categorically speaking, there’s a strong argument that it’s a step in the right direction.
It ‘s not the first time in history for reserve currency to be nonpolitical, because gold serves as a reserve currency today and it is nonpolitical outside of governments and banks (although currently manipulated).
Gold serves as a value store, but it’s not a useful currency for transactions. To get it from one place to another is expensive and could take weeks.
Gold sucks as a reserve though. It’s heavy, can only be split feasibly to a certain level and is not difficult to counterfeit. It occupies meatspace, so it can’t be transferred as easily as a currency that exists only in cyberspace. Bitcoin rules in this arena.
All currency is political, gold or otherwise. It might be outside the control of states, but it’s political nonetheless.
The point about deficits is very interesting. The only reason the world still accepts dollars and loans the US money is because there are not enough better alternatives. There will be a tipping point though and it will be soon.
I wonder why PBOC is not buying Bitcoins today? The first mover advantage (for a country) would be huge.
Because the BPOC is so large and wealthy if it touch BTC with a ten feet pole it will make its exchange rate skyrocket.
It doesn’t need to buy, just to say they are buying or will buy.
The exchange rate would be 1.000 US$ tomorrow, if they told it now.
Nicely written article. Sounds like there are benefits all round in moving to a new global reserve currency free from manipulation by states. Gold was a fine currency, but it’s just not practical in today’s world. Bitcoin does appear like a big step in the right direction.
To maintain the status of reserve currency, the issuing nation needs to ensure there is ample liquidity in that currency outside of it’s own borders. Unfortunately, the means of doing this can lead
“To maintain the status of reserve currency, the issuing nation needs to ensure there is ample liquidity in that currency outside of it’s own borders. Unfortunately, the means of doing this can lead to negative long-term negative effects on global financial stability. ”
You’re saying that a reserve currency needs to have an ever-expanding supply, which is why the USD should not be the reserve currency. How exactly does this argument build the case for Bitcoin?
If you make an argument against the dollar, it does not automatically ensue that this argument is supportive of Bitcoin.
The concern in that quote is not monetary supply as much as monetary flow. If the US (or any nation issuing a reserve currency) runs a trade surplus, they are reducing the liquidity of their currency outside of their borders and making it less attractive as a common medium of exchange. As such, continuous deficits (outflow of currency) by the issuing nation are effectively necessary to maintain that status.
If the global reserve currency is not tied to a country then the notion of trade balances for its issuer doesn’t exist, meaning there is no entity at risk of financial destabilization due to the requisite sustained deficits.
The problem with a national reserve currency is it is used outside the country issuing it.
So, better is the currency (E.G. the supply never increase), this would lead to an appreciation of the value of the currency with time (like it is happening now with Bitcoin, as its user base grow).
As the value of the currency increase, the good and services produced inside the country become more costly (and the people more wealthy). So there is a reduction of exports and an increase of import.
On the other side, if the country increase the currency supply, it flow out of the country where it is requested. But, as the currency flow out, something must flow in: good and services from abroad, usually.
This imply that any government issuing a reserve currency if faced with the problem of become a net imported and have trade deficits. This also show the government can print a lot of money without raising too much prices inside the country, as the supply is taken away by foreigners. So the government have, in the short term, no negative effects from printing and positive effects from printing. Why not printing? In the reverse, if it do not print, its debts become more heavy.
If it had not printed, the people holding the currency would had more purchasing power and would had more incentives to buy abroad and, with time, they would had consumed this appreciation or invested it in some way. In the short term, many jobs would become uncompetitive (and these persons would be angry with the government), but the great majority would be wealthier.
Bitcoin go around this because the issuing of new currency units is distributed and the issuing schedule is fixed and can not be changed. So there is no political entity able to change the issuing of the currency for its own benefit (short term or long term).
BTW, the story usually and with the reserve currency being printed too much, losing its reserve status (because holding it become more a liability than an advantage) and returning home is a short time period. This lead to high and higher inflation (often hyperinflation) as the holders of the currency use it to buy everything available and/or exportable.
People, we all know that diff governments will come and go and they will all promise you something, and fail to live up to it. So lets not rely on this idea anymore that governments know whats best and that they will do whats best with our cash but rather lets promote the bitcoin in every way we can. this is the only way we can help it grow. Lets vote for it in anyway, like we do when we go to the voting polls for politicians. We cannot rely on banks like we used to. When they fail they must be bailed out. Why must human bankers make errors with our money. They should have been held accountable. Seems like the banks and governments work to keep people where they want them . Power to Bitcoin!!!
Yeah you right anybody ain’t promoting bitcoin is shooting democracy in the foot