"The absence of alternatives clears the mind marvellously.” – Henry Kissinger
It’s not everyday that Warren Buffett is left scrambling for an answer – that too by a 13-year-old. One of the highlights of last week’s Berkshire Hathaway shareholders’ meeting was when a precocious teenager asked the Oracle of Omaha a question which is currently vexing policymakers from Washington to Beijing – is the mighty US dollar losing its status as the global reserve currency?
Multiple countries, from China and Russia to Gulf and Latin American nations, are seeking to wean themselves off the greenback amid ratcheting up of geopolitical tensions and ‘weaponisation’ of the dollar.
Russia, badly hit by Western sanctions following the Ukraine war, and China, locked in an intense battle with the US for global hegemony, are leading this de-dollarization drive.
India too is promoting the use of rupees for settling cross-border trade, with mixed results so far.
But as Buffett told his young questioner, do not expect the dollar to be dethroned so easily. “We are the reserve currency,” he said. “I see no option for any other currency to be the reserve currency.”
Wheels of History
Demise of the King Dollar has been a recurring theme in global financial discourse. In the mid-1980s, at the peak of Japan’s economic miracle, the yen was supposed to counter the dollar’s dominance. In the 2000s, analysts wagered on the newly established euro to deliver the knockout punch. Currently, it is the turn of the Chinese yuan to be anointed as ‘the next big thing’.
But as data shows, it is incredibly hard to dislodge entrenched monarchs.
As per latest IMF data, the US dollar accounts for around 60 percent of the cumulative foreign exchange reserves of global central banks – far more than all its other rivals combined.
Yes, there has been a steady slide since early 1990s, when it was around 70 percent, but this represents an incomplete picture, according to analysts.
This is because during times of a weakening greenback, the dollar value of non-dollar assets in foreign exchange reserves rise. This leads to the share of dollar holdings ‘declining’.
Moreover, as the dollar falls in value, it encourages nations with large currency reserves to buy US Treasuries to keep their own currencies from rising too quickly and damaging their export competitiveness.
This is borne out by the increase in US Treasury holdings of a number of countries in recent times.
China's reduction in US Treasury holdings looks like a game of geopolitical one-upmanship, but experts said Beijing is simultaneously ramping up purchases of other US dollar bonds -- for example those issued by US government-backed entities like Freddie Mac. Taken as a whole, China has actually increased its exposure to US Treasuries and quasi-government assets, they added.
Not just that, the dollar was involved in about 88 percent of global forex transactions in 2022, making it the single most traded currency in the forex market, as per the Bank for International Settlements (BIS).
In contrast, the yuan’s share was around 7 percent (increasing from less than 1 percent 20 years ago).
What’s more, about half of global trade is invoiced in dollars, although the US itself accounts for just over a 10th of international trade. And these figures have hardly changed since 2019.
Also Read: Why the renminbi won’t take down the dollar
In a recent note, analysts at Goldman Sachs said factors like sanctions imposed on Russia, Brazil's plans to set up yuan clearing agreements, and speculation about the yuan's use in commodity trading show that countries are diversifying their currency holdings, but these are not enough to displace the role of the dollar in global trade.
This because a credible challenger to the dollar will need to have a host of supportive measures like capital market depth, accompanying legal framework, currency management systems etc.
"While that is a clear risk if the US abuses its 'exorbitant privileges', we see no evidence of that in the data so far (for example, even Brazil's rising share of Chinese Yuan reserves replaced Canadian Dollar, not the Dollar), and our strong view is that there is currently no real contender," Goldman Sachs added.
As former US Treasury secretary Lawrence Summers put it more colourfully: “Europe is a museum, Japan is a nursing home and China is a jail.”
Nixon Shock
Brazilian president Luiz Inácio Lula da Silva was at his oratorical best on a state visit to China last month.
“Every night I ask myself why all countries have to base their trade on the dollar,” Lula said in an impassioned speech Shakespeare’s Hamlet would be proud of.
“Why can’t we do trade based on our own currencies?” he remonstrated, drawing loud applause from the audience at the New Development Bank in Shanghai, known as the ‘BRICS Bank’.
“Who was it that decided that the dollar was the currency after the disappearance of the gold standard?” The question was perhaps rhetorical, because the answer is really not a secret.
The US dollar replaced the British pound sterling as the de facto global currency under the Bretton Woods Agreement of 1944, which laid the foundation of the post-World War 2 global financial architecture.
Delegates from 44 Allied countries agreed to maintain fixed exchange rates between their currencies and the US dollar, which in turn was linked to gold at a fixed rate of $35 an ounce.
The dollar’s ascendancy reflected America’s status as the world’s new geopolitical kingpin following the decimation of European powers in the war.
This system worked well for the next 25 years, but with global trade growing rapidly, US dollars flooded the world market, and many nations began redeeming their dollar holdings for gold, alarming the US administration.
On August 15, 1971, President Richard Nixon abruptly announced the end of gold convertibility, besides ordering a freeze on all prices and wages in the US to check soaring inflation.
The ‘Nixon Shock’ was a seminal moment in global finance, with many critics saying it was the genesis of exchange rate manipulation, macroeconomic volatility and weaponization of the dollar.
Some 50 years after the transformation of the greenback to a full fiat currency, its impact continues to be an intensely debated topic.
At a recent event, veteran banker Uday Kotak had raised quite a few eyebrows with his remark that the “biggest financial terrorist in the world is the US dollar", joining a growing chorus against the outsized role of the greenback in international finance.
However, nothing better demonstrates the lack of viable options currently than Kotak’s tweet the very next day.
“In a recent discussion on US$ I inadvertently used words ‘financial terrorist’ which I would like to correct. What I meant was that a reserve currency has disproportionate power, whether it is nostro account, 500 bps rate increase, or emerging countries holding $ for liquidity,” he clarified.
As a former US Treasury official is reputed to have told his global counterparts in the 1970s, the dollar is our currency but your headache.
The description, like the dollar’s dominance, remains valid to this day.
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