The dollar continues to appreciate. It gained 5% this year against a Swiss franc, yet very strong during the pandemic.
Its role is more dominant than ever. A change in trend is unlikely. It is all the less so as in history a passing of the baton is slower than one might think. These are the conclusions of a long study of exchange rate regimes since the Second World War (“Rethinking Exchange Rate Regimes”, CEPR, November 2021), carried out by such renowned economists as Carmen Reinhart, Kenneth Rogoff, of Harvard, and Ethan Ilzetzki, of the London School of Economics. The first two were the authors of This time it’s different. Eight centuries of financial madness and Carmen Reinhart is none other than the chief economist of the World Bank.
The dollar rules the current “non-system”
The dominant position of the dollar is the main feature of the current monetary system, according to the authors. Rather, in their opinion, one should speak of “non-system” to characterize the situation after the end of the fixed exchange rate regime in August 1971. This supremacy is manifested in the invoicing of exchanges, in the issuance of bonds and in demand from central banks or sovereign wealth funds as well as from private investors. In the 1970s, half of the countries, accounting for 70% of global GDP, had the dollar as a benchmark. This proportion has increased further for three main reasons.
First of all, the fall of the Soviet Union led around twenty countries to take the greenback as a reference, and some of them the euro.
Then, inflation hit countless countries at the end of the last century, leaving them without monetary anchors. But as soon as the latter managed to control the rise in prices, most took the dollar as a benchmark.
Finally, the rise of Asia, in the wake of Chinese liberalization measures, has further strengthened the role of the American currency since this block of countries had taken the dollar as a reference. The increase in their share in economic exchanges has therefore increased the supremacy of the greenback.
Who is talking about laissez-faire?
Today, according to the authors, two-thirds of countries have a fixed or quasi-fixed exchange rate regime. Only 3% of countries have a truly floating exchange rate and the rest an intermediate status. We are far from the monetary laissez-faire imagined after the end of the Bretton Woods agreements.
The most surprising, in the eyes of the authors, is the increase in the share of trade in dollars of Germany, Europe’s largest economy, as well as of the United Kingdom. “This progression has occurred despite European economic integration, despite the euro and the increase in intra-European trade volumes and despite the fact that trade between Europe and the United Kingdom is four to four. five times more important than with the United States ”, note Reinhart, Rogoff and Ilzetzki. Almost 70% of British trade with the rest of the world was billed in pounds sterling in the 1970s. This proportion has fallen to less than 50% today.
The dominance of the greenback is also striking as the currency used for financial assets: 50% of bonds are in dollars, 30% in euros and the rest in the currency of the issuer. The American currency is omnipresent in the financial debt market. US corporate bonds outnumber those of European corporations by five times. It is true that, historically, bank debt is more popular in Europe.
“In search of safe assets, the dollar is also in the lead,” write economists. The United States represents half of the debt market of industrialized countries at the end of 2020. The share of European states corresponds to a quarter of that of the United States.
Competitive and geopolitical advantages
The implications of this situation are considerable, in the eyes of the three economists. A dominant currency offers exorbitant privileges, according to the authors. Both the US state and private companies can borrow at lower interest rates than competitors. US SMEs can even borrow easily abroad, while the reverse is very unlikely. The greenback is, moreover, better protected against the risk of strong currency fluctuations due to its position as monetary leader.
The American advantage is finally geopolitical. As the trade is done in dollars, it is easy for the United States to impose sanctions, as we have seen with Iran. The United States also has potentially critical access to data and information on transactions in its currency.
Everyone is talking about the rise of China and the renminbi. The size of the economy of the Middle Empire is expected to exceed that of the United States in 2040. Its currency may be the reference currency in 2100 but, according to the authors, for the moment its growth is very limited. China is even strengthening the US currency. The authorities mainly borrow in dollars. Moreover, leadership changes are rare and often linked to a serious geopolitical event, such as an armed conflict.