BackOpinion | Reports of the US dollar’s death have been greatly exaggerated
The covid crisis has reinforced the American currency’s domination for now and foreseeably ahead
PremiumWith China seemingly now in control of its covid-19 outbreak and its economy starting to rev up even as the US is still experiencing rising fatalities, some observers view the pandemic and its economic damage as the moment when the baton of global leadership passes from the latter to the former. With it, they see the end of dollar dominance. Yet, financial markets have hardly paid heed, and for good reason. The covid disaster has only reinforced the dollar’s dominance both now and in the foreseeable future.
According to John Authers, Michael Howell of CrossBorder Capital thinks that just as World War I precipitated the decline of the pound sterling and the arrival of the US dollar, covid-19 would herald the end of the dollar century and the beginning of the Chinese one (Will The Dollar Always Rule? Ask The Archduke’, 31 March 2020).
Confusing cyclical factors for structural factors is a mistake that many of us often make, and prophecies of the dollar’s demise reflect such a confusion. The US dollar can depreciate substantially, but this would not undermine its appeal as a store of value much because other currencies would be in far worse shape. The dollar endured one of the worst phases of weakness between 1994 and 1995. But, in the second half of the decade, it was the US that gave the world the hope of a technology wave and inflation-free, productivity-led growth. Yes, we know how that story ended. The problem is that it ended the same way everywhere else too.
A similar script played out in 2008. There are enough US-bashers in developing countries, with India no exception, who called it a North American crisis. To be precise, Canada was largely undisturbed. Its banking system was stable. It was not an American crisis but a global crisis. Debt and housing bubbles had burst everywhere. Some of the countries—again, India and China in particular—have been unable to shake off the after-effects more than a decade afterwards. The short point here is that no country, and certainly not China, had bothered to do the hard work necessary to prepare and present itself as an acceptable alternative global hegemon and thus see its currency displace the US dollar.
Currently, the structure of global balance sheets, with large dollar liabilities in emerging economies and falling dollar revenues from trade, means enormous pressure on businesses in the developing world at a time when capital is fleeing those markets.
Looking further down the road, the post-covid world is also likely to buttress the dollar’s dominance. Contrary to the view of many economists, the physical infrastructure and working age population are going to stay intact. As such, there is no reason to believe that aggregate supply will be permanently reduced. Indeed, academic research shows that pandemics, unlike wars, do not reduce supply, but instead lead to a long-term decline in real interest rates and returns on capital. While covid-19 seems to be different from past pandemics in that the fatality is disproportionately among the elderly, there are other good reasons why it will likely lead to lower real rates and lower returns. Over-extended leverage around the world means that the policy response of shutting down production has exposed the fragility of the global economy. Interlocked webs of financial commitments are stoking the potential risk of a cascade of defaults and financial instability. In an environment of weak global demand and persistent financial problems, the US as a buyer of last resort and the provider of a significant safe asset will remain in pole position. The dollar’s reign is not over by a long shot.
Geopolitically and geo-economically, the covid crisis will have weakened and not strengthened China. Global currency leadership is not going to be determined by the case fatality rate of covid-19 over two odd months. There is no basis to accept that China’s economy has emerged stronger. Published numbers are no proof of recovery. Fathom Consulting, an independent research and analytical firm in the UK, points out that China’s urban unemployment rate is understated, while its share of high-tech exports as a percentage of overall exports is vastly overstated. Just the other day, Luckin Coffee, a Chinese coffee company that touted itself as an alternative to Starbucks, saw its stock price plummet by more than 70% on allegations of fudged numbers.
The US dollar’s inevitability and indispensability were underscored when the Federal Reserve opened a facility last week to do dollar repurchases for emerging economies. Only that brought a semblance of stability to the battered currency and bond markets of several emerging economies.
In the final analysis, it is fair to say that the US has repeatedly abused its exorbitant privilege in the last 50 years and that the world would be better off without one country having that privilege. That requires another Bretton Woods kind of conference and a re- design of the international monetary regime. No country has the moral, economic and political stature to initiate and steer such a conference to a globally satisfactory outcome. The inertia of incumbency favours the US dollar for the foreseeable future.
V. Anantha Nageswaran & Srinivas Thiruvadanthai are, respectively, member of the Economic Advisory Council to the Prime Minister and Director of Research at Jerome Levy Forecasting Center. These are the authors’ personal views
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