The future of the dollar
US, WASHINGTON (ORDO NEWS) — At the end of March, global financial markets began to crumble amid the chaos caused by the pandemic of the new coronavirus. International investors immediately began to seek solace in the dollar, as they did during the 2008 financial crisis, and the US Federal Reserve had to make a huge amount of dollars available to its global partners. 75 years have passed since the end of World War II, but the dollar still retains its leadership on the world stage.
The continued dominance of the dollar is quite remarkable, especially given the rise in emerging markets and the relative weakening of the US economy — in 1960, the United States accounted for 40% of global GDP, and today only 25%. However, the status of the dollar will depend on Washington’s ability to survive the Sovid-19 storm and develop a strategy that over time will allow the country to resolve issues with its national debt and structural budget deficit.
The status of the dollar matters. The role of the dollar as the main global reserve currency allows the United States to pay lower rates on dollar assets than they would otherwise. Equally important, this allows the United States to have more significant trade deficits, reduce exchange rate risks and make US financial markets more liquid. Finally, it is beneficial to American banks, as they have enhanced access to dollar financing.
The fact that the dollar has managed to maintain such a high status for such a long period of time is a historical anomaly, especially in the context of the growth of Beijing’s power. At present, the Chinese yuan has the greatest potential to take on the role that the dollar now plays. The size of the Chinese economy, the prospects for future growth, its integration into the global economy and the increasingly active attempts to internationalize the yuan point to the expanding role of the Chinese currency in the future. But these conditions alone will not be enough. And China’s widely publicized success in financial technology — including the rapid development of mobile payment systems and the recent pilot project under which the People’s Bank of China began testing the digital renminbi — will not change that. Digital currency
Beijing will have to overcome many obstacles before the yuan can become a truly major global reserve currency. In addition to a series of radical measures, he will need to make more progress in the transition to a market economy, improve corporate governance and create effective, well-organized financial markets that will earn the respect of international investors so that Beijing can remove restrictions on capital flows and turn the yuan into a market currency.
Washington must clearly understand what is really at stake in its rivalry with China. The United States needs to maintain its leadership in financial and technological innovation, but there is no need to exaggerate the impact of Chinese digital currency on the US dollar. First of all, the United States needs to maintain the conditions that initially allowed the dollar to take a dominant position: it is a dynamically developing economy based on reasonable macroeconomic and fiscal strategies; transparent, open political system; leadership positions in world politics, economics and security systems. In short, maintaining the status of the dollar will not depend on what is happening in China.
China’s financial technology competition
Many of those returning from China enthusiastically talk about how cashless this country has become. From buying food in a shop around the corner to helping beggars, now all payments in China are carried out using smartphones and QR codes. The ranks of ATMs are a thing of the past. Chinese companies are increasingly competing with each other in the field of financial technology, and Chinese consumers are their main users.
These facts regularly suggest that China’s dominance in financial technology will soon jeopardize the global status of the dollar. However, this should not be considered a serious threat – in addition, the United States is still not far behind in the field of financial technology. China was not a pioneer in the field of financial technology; rather, it quickly adopted them and scaled up their application.
Chinese technology giants Alibaba and Tencent were the first to create services that make digital transactions much more efficient, and have attracted a huge market for customers who do not have bank accounts, especially in rural China. The scale of the use of their services turned out to be phenomenal. For example, in 2018, the volume of mobile payments in China reached $ 41.5 trillion.
Such success was made possible primarily because the existing financial infrastructure of China was outdated, and the state banking system was ineffective. It is equally important that credit cards in China did not take root, so when smartphones became cheap and ubiquitous, it became possible to jump directly from the cash economy to mobile banking.
No matter how “non-cash” China is now, many Americans today can hardly remember when they last used cash, except for small purchases. Today, they can instantly transfer money from one bank account to another without any loss. Mobile payment services like Venmo and Apple Pay work just as well as Alipay and WeChat. However, for the most part, Americans still prefer credit cards, because using them is as convenient as using mobile phones, and the existing financial system is safe, effective and reliable.
Chinese technology companies have accelerated the pace of innovation to meet growing customer needs and offset the inefficiency of China’s financial infrastructure. Moreover, they began to export their technology to developing countries, whose nascent economies need to immediately distribute smartphones everywhere and thus give Chinese companies a convenient opportunity to capture market share there.
Form and content
Although the Chinese central bank could launch a digital currency later this year, the media most often exaggerate how transformative its impact will be. Those who worry that the emergence of the Chinese digital currency could mark the end of the dollar’s primacy do not understand one thing: although the form of money may change, its essence remains the same.
The digital yuan will remain the Chinese yuan. No one invents new money. The symbols used in the calculations may change, but China’s ability to convert the renminbi into a reserve currency will depend on the same set of factors that apply to the issuer of that currency. And while the Chinese government insists on using the digital renminbi to trade as part of its efforts to internationalize its currency, oil and other raw materials are still priced in US dollars.
The fact that the status of a global reserve currency was assigned to the American dollar was hardly predetermined in advance. The primacy of the dollar was the result of a combination of historical coincidence, geopolitical conditions prevailing after the end of World War II, the policy of the US Federal Reserve, as well as the size and dynamic development of the American economy. Today, the “natural monopoly” of the American dollar may seem an integral element of the international system, but in the first half of the 20th century, the American dollar and British pound, in essence, had an equal position as reserve currencies.
Over time, the international monetary system is likely to again give relatively equal weight to two or more reserve currencies. The main contender for this status now is the Chinese yuan, which has already become a reserve currency along with the yen, euro and pound sterling. And if no catastrophe happens, then in the foreseeable future, the Chinese economy will continue to move towards becoming the largest economy in the world. In addition, it will be the first large economy to recover from the coronavirus crisis.
Nevertheless, the fact that the Chinese yuan will become the reserve currency on a par with the US dollar cannot be considered a predetermined fact. To achieve this status, China needs to reform its economy and create capital markets with such mechanisms that could turn into a host of political problems for Beijing. The implementation of recent Chinese ambitions, which required such transformations, such as turning Shanghai into a full-fledged global financial capital by 2020, has so far been suspended: a financial center simply cannot exist if the country has tight instruments for controlling capital flows and if the exchange rate is not determined by market mechanisms. The same can be said about the prospects of turning the yuan into a leading reserve currency.
Although the Beijing-backed digital currency alone is unlikely to weaken the dominance of the dollar, it can accelerate the pace of internationalization of the renminbi. In countries with volatile currencies, such as Venezuela, the digital yuan is a very attractive alternative to the local currency. Chinese companies such as Tencent, which already has an impressive presence in the developing countries of Africa and Latin America, can further increase their presence and share in these markets through the use of the digital renminbi. This could enhance the global renminbi status and become part of Beijing’s large-scale strategy to project China’s economic and political influence abroad.
Promoting Innovation in the United States
So far, the United States should worry less about the end of the era of the primacy of the dollar as a global reserve currency and worry more about the ability of the US private sector to introduce new financial technologies. The idea of digital currency came to mind not only to the Chinese, and not only central banks can promote it. Financial innovations in digital currencies and mobile payments are emerging in American private business.
Meanwhile, these new technologies carry internal risks. Without guarantees of powerful data protection, implementing these technologies everywhere will be difficult. Moreover, these new technologies can contribute to money laundering and other illegal financial activities, which should also cause some concern.
Silicon Valley and Wall Street have long led the campaign to create financial innovation, new digital platforms for settlements, and new forms of money. If the fruits of these innovations are brought to life, American companies will be able to create the best, safest and most secure currency in the world, equipped with mechanisms to protect against illegal financial activities. As a result, increased efficiency and reduced transaction costs will bring significant benefits to consumers.
Therefore, policymakers need to strike a balance between reducing the risks associated with the development of these new technologies and supporting the ability of private US companies to innovate. The danger is that overly zealous US regulators can raise the entry barrier for US firms by forcing them to serve the interests of those who prefer digital financial transactions rather than those who opt for traditional banking or those who have no accounts at all in banks, according to the World Bank, there are about 2 billion such people in the world, and most of them live in developing countries with weaker financial markets and volatile currencies.
Dollar supremacy begins in his homeland
It is worth emphasizing that the United States needs to take China seriously as a strong economic competitor. But speaking of the superiority of the dollar, the main risks come not from Beijing, but from Washington itself. The United States is committed to supporting an economy that inspires a sense of security and confidence throughout the world. If this is not done, then over time the status of the dollar will be in jeopardy.
The status of the dollar is a reflection of the fundamental health of the American political and economic systems. To protect the dollar, the US economy must remain a model of success and a role model. And this requires a political system that is capable of implementing a strategy that allows Americans to achieve economic prosperity. This requires a political system that is capable of supporting the country’s fiscal health. In history, there was not a single example of a country that could manage to stay on top for a long time in the absence of financial prudence. The political system of the United States must respond quickly to current economic challenges.
The economic course of the United States abroad is also of great importance, because it affects the authority of America and largely determines its ability to effectively influence the course of world events. To maintain leadership, the United States must take the initiative to improve the global norms and rules that govern trade, investment, and technology competition to reflect the realities of the 21st century.
Washington should also keep in mind that unilateral sanctions – possible due to the primacy of the dollar – entail certain costs. Using the dollar as a weapon could push the allies and opponents of the United States to develop alternative reserve currencies – and even possibly join forces in the process. It is for this reason that the European Union is insisting on further expansion of the use of the euro in international payments.
Similarly, the answer to the question of whether the yuan will become an important reserve currency on a par with the dollar will be determined by whether China can rebuild its economy. But, if China successfully implements the necessary reforms, it will create an economy that will become more attractive for the export of American goods and services, and more favorable conditions for American companies operating in China. These changes will bring significant benefits to the United States.
The value of the national currency for its holders is ultimately a reflection of the country’s main economic and political indicators. How the United States will develop in the coming years after the end of the coronavirus crisis will be an important test. First and foremost, the United States should pursue a macroeconomic policy that will allow them to resolve issues with national debt and structural budget deficits over time. They should not recklessly waste those foundations that support their economic power and which are based on the spirit of innovation and good governance. If Washington adheres to this course, we will have every reason to trust the dollar.
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