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75 Years After Bretton Woods, Is the Dollar's Dominance Assured?

State Street

August 29,2019

In the summer of 1944, while war devastated Europe and Asia, representatives from dozens of countries converged at a New Hampshire resort town to hammer out a new international economic and monetary order.

In the summer of 1944, while war devastated Europe and Asia, representatives from dozens of countries converged at a New Hampshire resort town to hammer out a new international economic and monetary order. This historic meeting would later be known as the Bretton Woods Conference, where delegates agreed to a number of provisions, including one that pegged national currencies to the United States dollar, while the dollar itself would be convertible to gold at a fixed rate. This arrangement, which became known as the Bretton Woods system, officially dethroned the British pound from its position atop the world's currency hierarchy, making way for the era of dollar dominance.

While the Bretton Woods system is no longer in existence, the dollar's dominance continues today, with “greenbacks” accounting for 62 percent of central bank reserves. What’s more, global trade is predominantly invoiced in USD. And as Bloomberg reported late last year, the dollar is also the leading currency for international loans and global payments.[1]

And yet, statistics notwithstanding, long-term trends and more recent political developments have some questioning how long the dollar's dominance will last. As we mark the 75th anniversary of Bretton Woods, we take a look at the factors affecting the dollar's current standing.

Incumbency

Much like politicians running for reelection, the dollar has an incumbent advantage: With so much of the world's business conducted in dollars, companies and countries are hard-pressed to move away from it. Right now, "not using dollars and not resorting to US banks can be costly and inconvenient," says Barry Eichengreen, a professor of economics and political science at the University of California at Berkley. However, as Eichengreen explained in his 2011 book "Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System," Britain’s economic problems in the 19th century led to the loss of its geopolitical power and ultimately the decline of British sterling as the global reserve currency, proving that incumbency isn’t everything. Keeping this historic context in mind, it's not unimaginable that major changes in the US economy could lead to the dollar's own decline.

Independent Stability

The dollar maintains a reputation as a reliable, accessible currency, which largely stems from the work of the Federal Reserve. "It fluctuates in very minor ways compared to other currencies, so it's a nice store of value," says Bill Maurer, the director of the Institute for Money, Technology and Financial Inclusion at the University of California-Irvine. "It's also accessible — we don't have currency crises that make it hard for people to get a hold of dollars." But according to H.W. Brands, author of "Greenback Planet: How the Dollar Conquered the World and Threatened Civilization as We Know It," the independence of the Fed has been challenged by the current political environment. "If foreigners come to believe that the Fed, which essentially controls the value of the dollar, is subservient to political administrations, then all of a sudden, the dollar becomes much less attractive."

Meanwhile, some high-profile Democrats have advocated for an unorthodox framework known as Modern Monetary Theory, which argues for low interest rates with inflation managed by Congress through the fiscal lever. In the long run, this policy mix could lead to “fiscal dominance,” whereby central bank policy is governed by the needs of the fiscal authority, and to a loss of confidence in the USD.

Competition (or Lack Thereof)

The euro and the renminbi are often mentioned as potential rivals to the dollar, but both have their drawbacks. The pending "Brexit" continues to roil the European Union, while China's 2015 economic crisis and questions about the convertibility of the renminbi are a source of worry for investors. "The United States no longer has the dominion over the world economy it once had, but America's principal competitors don't measure up," said Brands. "The dollar remains the currency of choice by default." However, countries may try to work around the greenback when politics get in the way. Most notably, after the US announced last year that it would resume sanctions against Iran, the governments of France, Germany and the UK created a payment system that would allow them to continue trading with Iran without using dollars.

Multipolar Potential

Even before the political developments of recent years, economists like Eichengreen were predicting that the dollar would lose ground in different parts of the world, as currencies like the euro and the renminbi, as well as those of India and Brazil become more powerful regional players. Less prominent currencies, meanwhile, have their own appeal. "Central banks and others are gradually diversifying away from the US dollar into the currencies of relatively small economies, like Canada, Switzerland and Australia," Eichengreen said. Altogether, it suggests a movement to a multipolar monetary system where the dollar remains an international currency, he said, but not quite the dominant force it is today.

Digital Currency

Crypto currencies like Bitcoin are widely considered too unstable to pose a real threat to the dollar. Libra, the forthcoming digital currency from Facebook, promises to be more stable thanks to management by a governing body, but skepticism from government officials and expected regulatory hurdles make it an unlikely challenger to the dollar, too.

But what about digital currencies backed by governments themselves? Last year, IMF Managing Director Christine Lagarde made headlines when she said that central banks should consider issuing digital currencies. Erik Townsend, the author of "Beyond Blockchain: The Death of the Dollar and the Rise of Digital Currency," has argued that governments would benefit from creating digital cash systems that make it easier to monitor transactions. Particular governments may be especially motivated to move forward with such systems, Townsend said on the podcast "Superinvestors and the Art of Worldly Wisdom." China or Russia, for instance, could team up with other countries to issue digital currencies to rival the dollar. "They have recognized digital currency technology as a potential tool of leverage that they could use in order to challenge the dollar's role as the world's global reserve currency," he said.[2]

For all the challenges facing the greenback, dollar doubters are still hard-pressed to predict exactly when the currency could lose its leading position. And during times of increased risk aversion, investors continue to flock to the USD as safe-haven flows pile into US Treasuries. In fact, even in the wake of the August 2011 US credit downgrade, US Treasuries rose in price and the dollar gained against the British pound and euro. Ultimately, only time will tell whether the dollar's winning streak will continue and for how long, and that uncertainty remains top-of-mind for many, even as Bretton Woods becomes an ever more distant memory.

 

 

[1] Coy, P. (2018, October 3). The Tyranny of the U.S. Dollar. Retrieved from https://www.bloomberg.com/news/articles/2018-10-03/the-tyranny-of-the-u-s-dollar

[2] Super Investors and the Art of Worldly Wisdom: #26: Erik Townsend On The Intersection Of Distributed Ledger Technology And Global Macro Investing [Audio blog post]. (2018, December 5). Retrieved July 31, 2019, from https://thefelderreport.com/2018/12/05/erik-townsend-on-the-intersection-of-distributed-ledger-technology-and-global-macro-investing/

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