Is the Dollar Standard Ending?

Last month, world governments learned that property rights do not apply to foreign exchange reserves.

In effect, the leaders of the world’s largest economy — with a gross domestic product surpassing $20 trillion in 2020 — seized the assets of a country with a gross national income per capita of $500. Data from the United Nations reveal that more than half of Afghanistan’s population wasn’t even alive on 9/11.

Two weeks after the seizure of Afghanistan’s assets, the West froze the assets of the Central Bank of Russia. The implications of these decisions will take time to understand fully. However, three immediate conclusions may be drawn.

First, exporters are likely to slow their acquisition of U.S. dollar reserves going forward. This would mark an important shift, particularly for the so-called ‘emerging and developing’ economies, which have represented the marginal demand for dollars since the Asian Financial Crisis.

Second, a declining demand for dollars should compel the United States to abandon its credit- and consumption-driven economy. In recent decades, exporters’ voluminous accumulation of dollars helped depress U.S. interest rates, effectively subsidizing American consumption and supporting asset prices. 

A contraction in dollar demand would likely reduce asset prices, eroding the collateral for a swathe of overleveraged businesses and expanding the funding gaps plaguing retirement systems in the process. The reduced need to ‘recycle’ exporters’ dollars could also diminish the outsized role of finance in the U.S. economy and its politics, while a weaker dollar could facilitate a rebalancing toward a revitalized manufacturing base.

Third, large exporters, most notably China, will be incentivized to recalibrate their own economies in favor of domestic demand and consumption-led growth. Though this has been a stated objective of Chinese policy for years, progress has been slow-going. The West’s recent asset freezes may reinvigorate this shift with a new sense of urgency.

Many people believe that a move away from the dollar as the world’s reserve currency remains unlikely. Commentators frequently point to the lack of a viable alternative with ample liquidity and an issuer that adheres to the rule of law. After all, the euro and the Chinese yuan constituted roughly 20% and 3% of global reserves last year.

However, the probability that countries will seek out an alternative has gone up considerably. The issue is not which countries have secure, investable assets that can absorb reserves today, but rather the countries that will create them over the decades to come.

Two possibilities merit consideration.

Prophesies decrying the eschaton of the dollar have proven rash and delusional. In a world where central banks’ property rights were observed, there was scant impetus for change. 

That world resides in the past. The decision to freeze central banks’ assets may have been justifiable, but expediency has its consequences.

First submitted to FT on 21 March 2022.

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