Ten years after the global financial crisis, we are still coming to an understanding of how profound a shock it was. The changes in political alignments within and across nations and the diminished public support for globalization continue. But one aspect of the financial system has not changed: the dominance of the U.S. dollar in the monetary system.
An article by Fernando Eguren Martin, Mayukh Mukhopadhyay and Carlos van Hombeeck of the Bank of England in the BOE’s Quarterly Bulletin documents the different international roles of the dollar. First, it continues to be the main currency in central bank reserves, with a share of about 70% of total holdings. Second, the dollar is used as an invoicing currency for many international transactions, such as commodity sales. Third, firms outside the U.S. obtain funding through dollar-denominated bank loans and debts.
The use of the dollar for finance has also been examined by Iñaki Aldasoro and Torsten Ehlers of the Bank for International Settlements in an article in the BIS Quarterly Review. They report a rise in the use of international debt securities, driven primarily by dollar denominated debt issued by non-U.S. residents. The increase in such funding is particularly noticeable in emerging markets economies in Asia and Latin America. This debt includes sovereign bonds issued by governments that sought to lock in low interest rates.
What about the alternatives? A report on the international role of the euro issued by the European Central Bank acknowledges the primacy of the dollar. An index of the global status of the euro developed at the ECB shows a decline in the last fifteen years, which may have stabilized in the most recent year. This includes a fall in the euro’s share of international debt securities. The report also notes that the deleveraging of Eurozone banks as they built up their capital ratios led these banks to reduce their cross-border lending.
Why does the dollar continue to possess a hegemonic status a decade after the crisis that seemed to signal an end to U.S.-U.K. dominated finance? Gillian Tett of the Financial Times offers several reasons. The first is the global reach of U.S. based banks. U.S. banks are seen as stable, particularly when compared to European banks. Any listing of the largest international banks will be dominated by Chinese banks, and these institutions have expanded their international business. But the Chinese banks will conduct business in dollars when necessary. Tett’s second reason is the relative strength of the U.S. economy, which grew at a 4.1% pace in the second quarter. The third reason is the liquidity and credibility of U.S. financial markets, which are superior to those of any rivals.
The U.S. benefits from its financial dominance in several ways. Jeff Sachs of Columbia University points out that the cost of financing government deficits is lower due to the acceptance of U.S. Treasury securities as “riskless assets.” U.S. banks and other institutions earn profits on their foreign operations. In addition, the use of our banking network for international transactions provides the U.S. government with a powerful foreign policy tool in the form of sanctions that exclude foreign individuals, firms or governments from this network.
There are risks to the system with this dependence. As U.S. interest rates continue to rise, loans that seemed reasonable before now become harder to finance. The burden of dollar-denominated debt also increases as the dollar appreciates. These developments exacerbate the repercussions of policy mistakes in Argentina and Turkey, but also affect other countries as well.
The IMF in its latest Global Financial Stability (see also here) identifies another potential destabilizing feature of the current system. The IMF reports that the U.S. dollar balance sheets of non-U.S. banks show a reliance on short-term or wholesale funding. This reliance leaves the banks vulnerable to a liquidity freeze. The IMF is particularly concerned about the use of foreign exchange swaps, as swap markets can be quite volatile. While central banks have stablished their own network of swap lines, these have been criticized.
The status of the dollar as the primary international currency is not welcomed by foreign governments. The Russian government, for example, is seeking to use other currencies for its international commerce. China and Turkey have offered some support, but China is invested in promoting the use of its own currency. In addition, Russia’s dependence on its oil exports will keep it tied to the dollar.
But interest in formulating a new international payments system has now spread outside of Russia and China. Germany’s Foreign Minister Heiko Maas has called for the establishment of “U.S. independent payment channels” that would allow European firms to continue to deal with Iran despite the U.S. sanctions on that country. Chinese electronic payments systems are being used in Europe and the U.S. The dollar may not be replaced, but it may have to share its role as an international currency with other forms of payment if foreign nations calculate that the benefits of a new system outweigh its cost. Until now that calculation has always favored the dollar, but the reassessment of globalization initiated by the Trump administration may have lead to unexpected consequences.
