Financial media, academic work and analyst reports are replete with references to a multipolar international currency system, including discussions about the fate of dollar dominance and prospects for alternatives. But what is a multipolar currency system? There is no uniform definition, and this article does not seek to create one.
Analysts should be specific about what they mean by ‘multipolar currency system’. The literature includes a multitude of ideas about the meaning, including: multiple currencies playing significant roles in global finance and trade; a singular dominant currency system turning into two dominant or three to four actors; a system of decentralised settlement, regional blocs and diversified reserves; and currencies serving globally as a meaningful store of value, means of exchange or unit of account.
There is a strong case for arguing dollar dominance remains entrenched. The dollar’s share of global reserves is 57%. Private measures – the dollar’s role in foreign exchange transactions, international bank assets and liabilities, and securities issuance – underscore the dollar’s dominance. Given the depth, openness and liquidity of its capital markets and the role of Treasuries, the US is seen as providing the world’s safe asset. The dollar is a store of value, medium of exchange and unit of account.
But the dollar’s share of reserves has edged downward, falling from 70% in 2000. Is the dollar still dominant, or must its share fall to 49% before it is no longer deemed dominant?
Do we already have a multipolar system?
A case can also be made that a multipolar currency system already exists. The euro’s share of global reserves is around 20%. Its role in debt issuance has picked up. Invoicing of euro-area exports outside the area is heavily euro-denominated.
The renminbi accounts for around 2% of global reserves, but Chinese trade settled in renminbi is around 30%. Chinese officials speak of internationalising the renminbi, though capital controls, the lack of convertibility and other factors are impediments. China has developed a fledgling cross-border international payment system, offering clearing and settlement for cross-border renminbi transactions – though it is a work in progress. The renminbi is more a medium of exchange than a store of value.
Data from the International Monetary Fund and other sources point to growing store-of-value demand for other currencies – including Canadian, Australian and Singapore dollars, Swiss francs and select emerging market currencies. But demand is constrained by the small size of their capital markets. Gold demand has surged.
On balance, elements of a multipolar currency system are already present. The euro’s use with respect to trade and finance and the renminbi’s in trade settlement exhibit elements of regional blocs. Other countries with open capital markets and sound performance play marginal roles. Fragmentation may reinforce these trends. Multiple currencies play key roles in international trade and finance as stores of value or medium of exchange, even if these are more regionally based and not as strong as the dollar’s global role.
More important questions
The focus on whether a multipolar currency system exists or not may be misplaced. Analysts often suggest such a system could be highly disruptive, especially if precipitated by a move away from the dollar.
If it occurs rapidly because the US erodes the foundations underpinning the dollar’s global role by – as the US is now doing – being an untrustworthy ally, attacking the rule of law and Federal Reserve independence, and running unsustainable fiscal policies, the worldwide tremors could ultimately be highly disruptive. The falloff in the dollar’s global role in this case will be the least of America’s worries.
If in an increasingly idealised scenario, America runs sound policies and others open up their financial systems, the dollar’s role could gradually ease and the world economy might be better off.
The debate about whether the world is characterised by dollar dominance or a multipolar currency system is overly stark. Elements of both are present, and shades of grey better characterise the current system. Global economic and financial performance is a more important focus than questions about a multipolar currency system. Regardless, greater definitional and analytic clarity are needed.
Mark Sobel is Vice Chair and Chief Economist of OMFIF.
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