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Analysis
Dollar crisis on the horizon

Dollar crisis on the horizon

Washington will adjust to new multicurrency order

by Joergen Oerstroem Moeller in Singapore

Wed 6 Jun 2018

When a reserve currency is overstretched, creditors demand a rise in the country's bond yields. When that proves insufficient, they ask the government to make it cheaper to buy the reserve country's goods. This is what happened in the US in the 1970s and preceded its abandonment of the gold standard. There is a considerable risk that, under President Donald Trump, this will happen to the dollar. Creditors may hold dollars for a while, but are likely to engineer a fall in the real effective exchange rate.

In the short term, this does not mean much for the future of the dollar as a reserve currency. There is a lack of a genuine alternative. In the medium and long term, the analysis is less comfortable for the US.

Countries hold currency so that they can purchase goods and services and invest in foreign corporations, real estate or financial assets. Logic dictates they choose the currency of the largest and strongest economy that offers the most valuable goods, services and assets. The conclusion is straightforward: the propensity to hold another nation's currency in reserve is almost directly proportional to that nation's share of global GDP. In relation to banking, a global reserve currency's collateral is its share of global GDP. The smaller the outstanding amount of dollars compared to its share of global GDP, the more secure it is to keep dollars in reserve.

The outstanding amount of dollars that are claims on future US production is rising. The US's capability to deliver the products that the rest of the world is interested in buying is falling. When these two trends intersect, there will be a dollar crisis.

This process is already underway. Gazprom Neft, Russia's third largest oil producer, has for three years settled its crude sales to China in renminbi. In March 2018 news broke that Beijing is planning a pilot project for the second half of the year to pay for imported crude oil with renminbi instead of dollars. The two countries allegedly selected for the pilot are Russia and Angola, with rumours that Saudi Arabia and the United Arab Emirates may become involved. If this venture is successful, it will act as a spur to similar schemes for other imports and primary products.

China needs primary products, while exporters of such products need capital goods for domestic investment. China offers those goods – the US also does, but to a lesser extent. So why should these trades continue to be made in dollars? Furthermore, a system where money can be printed without restrictions, as has been the case in the US since it renounced the gold standard in the 1970s, has not instilled confidence in politicians and central bankers. Some commentators have proposed reintroducing a link to a fixed asset; this time not gold, but minerals or other primary products.

The emergence of a multicurrency or multi-asset international payments system will take time. It doesn't portend a collapse of the global payments system, but does point to a redistribution of global wealth. The seigniorage harvested by the US as the world's banker will gradually fall, narrowing the room for manoeuvre in US economic policy, which for the last 70 years has had the greatest influence on markets globally. As the power of the dollar wanes, the US will be pressured to adjust to a world economy vastly changed since 1945.

Joergen Oerstroem Moeller is Senior Research Fellow, ISEAS Yusof Ishak Institute, and a former State Secretary at the Danish foreign ministry. This is the second of two articles on the future of the dollar. The first was published on 5 June.

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