Between the idea
And the reality
Between the motion
And the act
Falls the Shadow
The Hollow Men, T.S. Eliot
We’re going to again make ourselves unpopular with our stance on the future of the dollar, just as we did during the 2015 Greece bailout crisis. Then we were virtually alone in predicting that the negotiations would fail and that the plucky Greeks had no leverage against the Troika (the ECB, IMF, and European Union), meaning they’d have to accept the so-called IMF “memorandum”. In fact, the outcome was worse than anyone, even our site, predicted.
In the end, after Greece rejected a debt refinancing with an end-of-June drop-dead date, the ECB withdrew key support for the Greek banking system, putting it into crisis. Food, fuel and pharmaceutical shortages were starting when Greece accepted a worse deal than the one on offer in February.
Saying Greece would not prevail infuriated those who thought that more IMF “reforms” would do more damage and what Greece needed was debt writedown. We agreed that the Troika was administering bad economic medicine. But that had nothing to do with who would get their way.
What the Greece advocates reflexively rejected was that Greece had no way out of its debt yoke. Their fantasy was that Greece could exit the Euro, repudiate or at least denominae a lot of its debt, and gain competitive advantage by devaluing its currency.
That was a non-starter. Even at first pass, if I recall correctly, on the order 70% had been restructured and converted, so it was no longer governed by Greek law. So even if Greece could have launched its own currency, it would not have been able to redenominate or restructure its debt. And the non-Greek law debt would become more costly to service when the new drachma traded lower than old Euro-equivalent values.
An even bigger impediment was launching a new currency. Merely designing, printing and distributing new cash would take over a year. Even before getting to the bank IT issues, ATMs would need substantial overhauls either to handle a new currency or euros and the new currency.
And on the IT side, banks and payments processors would need to code for a new currency and also write routines for conversion into major currencies. And this isn’t just banks in Greece. This is all major international banks, currency traders, and payments processors. They don’t have any reason to hurry because Greece. Our IT experts said the coding would take at a minimum three years, and given how most bank IT projects roll, five to seven was more realistic. In the meantime, already desperate Greece would suffer massive capital flight if it announced it was exiting the Euro but was not able to make an immediate changeover.
That’s the 50,000 foot version. We spelled it out in much gorier detail over many posts.
Back to the dollar. It’s ironic that many of the anti-globalist and/or pro-Russians commentator pride themselves as being realists in their analyses of the war in Ukraine, with their discussions of the merits of particular items of Soviet v. Western weapons, ammunition consumption, logistics, recruitment and training. Yet they stay at the handwave level when it comes to the operations of banking and finance, despite the astonishing accomplishment of banks and payments processors delivering accurate statements of account, month in, month out, picking your transactions out of a flow of billions a day.
Yes, the dollar hegemony is past its sell-by date. The US acts as there is no risk of the dollar era ending, as witness its remarkable grab of hundreds of billions of Russian central bank assets (the actual number is now believed to be less, a lot of money looks to have slipped away). However, the fact that the countries outside the collective West would very much like to reduce the role of the dollar in international trade, investments, and financing does not mean it will happen any time soon.
First, let’s think at a high level about successor regimes. There are, broadly speaking, two ways this could go. One is that an existing currency could displace the dollar. We’ve seen that movie, with the dollar assuming the role of pound sterling. It took two World Wars and a Great Depression for that transition to take place. The second is to form some sort of new, non-national currency (some have suggested SDRs as a starting point).
As we’ll explain, for any non-national currency to be anything more than an intermittently-used gimmick, it will wind up impinging on the sovereignity of the states that participate. Is anyone willing to bet Eurozone 2.0 will be that much of a improvement on the original?
Back to the first option. A successor reserve currency would need to have a large enough economy with capital markets open to foreign investors with perceived-to-be-fair trading markets and well-regulated institutions. Foreigners who wind up holding the reserve currency will be subject to its rule of law of the reserve currency country, such as it is. Even if they simply keep it in cash at a bank in their country, it will need either to have a banking license in the reserve currency country or be a correspondent with one of its banks. And that correspondent agreement will be subject to reserve currency country law. If the foreign party would rather hold securities, the foreign party again has to be mindful of the integrity of securities regulation and the oversight of brokers and exchanges.
Ironically, the US model of highly efficient markets with investors having extremely weak governance rights helped support the US as reserve currency. The US could tolerate having foreign investors in public US companies so long as they did not buy a stake in a perceived-to-be-important player big enough to give a foreign owner influence. The US does meddle if that looks likely to happen.
The Euro was once seen as a potential competitor to the dollar, but its protracted post Global Financial Crisis banking/sovereign debt crisis, which was never fully resolved, put paid to that idea.
The Chinese renminbi is the logical successor to the dollar, but China does not seem willing to take the steps to have that happen. In the post-Bretton Woods regime, a country wanting to have its currency serve as a vehicle for transactions outside the country (as in independent of bi-lateral transactions with the country) needs to get in circulation outside its borders. That means running trade deficits. No way, no how is China willing to do that, since a trade deficit1 is tantamount to exporting jobs. Wage growth and high levels of employment are imperative to the legitimacy of the regime.
China would also need open capital markets, transparent regulation, credible measures to prevent bad practices like front running and insider trading, and at least a reasonable prospect that foreign investors who got into disputes with their bank or broker would be treated not much worse than locals when seeking recourse (as in officials and courts need to realize that giving foreigners too much of the short shrift is bad for business). But China has leaky capital controls for domestic investors and its less than fully open capital markets helped dampen capital flight when the dollar spiked after the Ukraine war started (admittedly the renminbi is also viewed more favorably than in the last capital flight episode in 2015-2017, when China had to intervene heavily to defend its currency.
But but but…you might say…China is going to create a petro yuan!
Really? They’ve been trying and have gotten nowhere. Yes, they might now make big bi-lateral trades with Russia and Saudi Arabia, so each wind up holding renminbi as a result of making big purchases from state-affiliated companies. Those big bi-lateral transactions do not suddenly turn the renminbi into a reserve currency.
The logic of this 2018 Forbes article, Why The Petro-Dollar Is A Myth, And The Petro-Yuan Mere Fantasy still holds. Key sections:
China’s recent introduction of yuan-denominated oil futures has attracted some fairly extensive press commentary….It is widely thought, for example, that oil somehow underwrites the global financial system and guarantees the U.S. dollar’s hegemonic status.
Let’s stop right there. Did you even know there were yuan oil futures? That means for the last four+ years, oil has been priced in yuan! In practice, has this made an iota of difference? No!
Back to the article:
But we should be clear: the Petro-dollar does not exist, and really hasn’t done in any meaningful way since the 1970s,2 therefore the “Petro-yuan” has no future. This is not to say that oil will never be traded in yuan, that is likely, but it is to say that trading oil in yuan will not suddenly transform the currency into the global reserve many claim is inevitable…
Since the 1980s, the dollar has been consolidated as the global reserve currency because of the strength and dynamism of the U.S. economy, and oil exporters have demanded to be paid in U.S. dollars because that’s the currency they prefer to hold on to. To do otherwise is to take on exchange risk. Exporters can, and routinely do, accept payment in whatever exchange medium they wish — tanks, planes and construction services — but their central banks demand dollars for reasons entirely unconnected to oil. Because the U.S. dollar is a hard currency, easily exchangeable, underwritten by the U.S. taxpayer, and founded upon decades of broadly consistent macro-economic policy management….
One can imagine another currency challenging it at some point in the future, but only on the basis of the openness of its underlying economy, and the depth of the capital markets denominated in it. And if the euro can’t do it yet, why does anyone imagine the yuan is up to the job?
Confirming that the receptivity to the use of the renminbi as a foundational currency is not remotely proportionate to the importance of the Chinese economy, in 2018, the renminbi represented only 1.1% of foreign exchange reserves held globally. China was trumpeting that its use had spiked by the end of 2021…to 2.79%. That still rounds to zero. If we see continued strong increase as a result of the US sanctions against Russia, then there might be reason to think the rise of the renminbi might be more than a glimmer in China’s and anti-globalists’ eyes. But the worries in China in early 2022 about capital flight suggests otherwise. Wake me when it happens.
The bad behavior of the US government in going sanctions-crazy against Russia, and its current inflation mess, as many can see clearly, has greatly increased the motivation to move away from the dollar. But despite its now many warts, it’s gone way up in value, reaffirming its attractiveness as a perceived safe haven currency for many users. So the dollar is still the winner in the beauty contest between Cinderella’s ugly sisters.
But what about some sort of joint currency? Please tell me how this does not wind up being Son of Euro.
The reason the dollar system works is that its payment systems players all connect, via agreements under US law, to US regulated institutions, with the intra-day payments that get closed out at the end of the day backstopped by the Fed.
For the Euro to have been created, you first had countries who had agreed to have the European Court of Justice be the final adjudicator. States agreed to fund solely in the Euro, which made them subordinate to the Eurozone since they could no longer issue their own national currencies.
That amounts to a big loss of national sovereignity. Pray tell, how do they go about setting up a new legal/regulatory regime to oversee the operation of this new currency regime and settle disputes? Remember, it would have to take precedence over national law with respect to dealings that involve regulated financial institutions in the new currency system. That seems to run afoul of the key aims of the new “fair world order” multipolarity project.
One might argue for having the new joint currency sit alongside national currencies. Ask Argentina or Russia circa 1998 or any country that was substantially dollarized how that works. If the new currency becomes well accepted, it may become preferred by locals to your currency, risking destabilizing capital flight at the worst moments. It could also become preferred for commercial and retail borrowing, again with the high odds of eventually producing a financial crisis when the home currency falls against the joint currency.
So the most likely outcome is we have to wait either for a monster dollar crisis,3 which BTW does not mean any successor regime will be ready for prime time, or for China to be willing to accept the cost of having at least a somewhat financialized economy (reasonably deep and active trading markets). I don’t see that happening soon.
We’ll turn to operational issues tomorrow.
1 Technically, it’s the current account deficit determines if and how much currency a country sends abroad. But trade and services are the largest component of the current account. Turning the mike over to Investopedia, “It is, in fact, possible for a nation to have a current account deficit when it does not have a trade deficit, but that is highly unusual.”
2 The article’s recap of 1970s deal is not accurate. The US was concerned about US purchases of Saudi oil and did not have the Saudis impose requirements on other countries. Because the riyal did not have any meaningful float outside the Kingdom, it would wind up initially holding dollars as a result of US oil buys (even if the US had to go through the form of acquiring riyals to tender, it could get enough only through the Saudi central bank, either directly or an in-country bank, and the result would be dollars in the Saudi banking system and oil to the US). The US worry was the Saudis might dump dollars and buy investments in other countries, further weakening the dollar and intensifying the energy and inflation crises.
3 China finally having its long-anticipated big blowup is possible too. No major economy has gone from being export/investment led to consumption-driven without having a major financial crisis. With either a big US or Chinese implosion, the next phase is likely to be a Depression-level collapse in trade and scramble to fix/regulate key institutions. The immediate focus would be domestic, to preserve savings and growth. So any concerted effort to implement a new international system would be likely to go on the back burner.