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Thursday, 27 May 2021

The end of times for the USD?

It’s Groundhog Day: There’s talk of the USD’s dominance being under threat as the global reserve currency. We know, we’ve talked about this possibility what seems like two dozen times before — and the world has speculated that the USD would exit stage right for at least forty years. But there are new indications that now it’s for real, says the Financial Times. Among those indications is a warning from bn’aire US fund manager Stanley Druckenmiller — who correctly anticipated Brexit — that there is excess USD demand coinciding with inflation and a weaker USD.

The risk of a USD demise has been compounded by conditions created by covid-19, but the signs appeared before the pandemic, the salmon-colored paper says. For one, global central banks have been relying less and less on the USD as their foreign currency, with an IMF survey finding that USD accounted for the lowest share of central banks’ reserves in 25 years. This downward trend makes sense when we consider that the USD was the most dominant foreign currency when it was also the world’s most dominant industrial producer; now, the US does not account for the lion’s share of global production, making it logical for the USD to take a backseat as a reserve currency.

Altogether, the USD’s dominance is unquestionably declining. But there are still threats that could make the situation even worse: economic and financial mismanagement; insufficient liquidity in the US government bond market, which therefore undermines USD’s status as a safe haven asset; and more dysfunctional politics like we saw with Agent Orange, who wreaked havoc in the US political system and exposed “unexpected weaknesses.”

So, where do we go from here? There are some — including IMF Chief Economist Gita Gopinath — who believe that traditional currencies, such as the EUR and RMB, can take over the USD with some “old-fashioned development of institutions to improve the eurozone’s architecture and resilience, and stronger domestic institutions and further liberalization of markets in China.”

Others are speculating that the USD’s successor is going to be a synthetic hegemonic currency that would be “provided through a network of digital currencies issued by central banks.”

This hypothesis is far from novel: There’s been chatter for years that digital currencies could swoop in and take the USD’s place as the global reserve currency, partially because they are faster and cheaper than conventional money. Central bankers, including former Bank of England Governor Mark Carney, have said that Central Bank Digital Currencies — a digital token or instrument that can be used for payments or a stable asset and is part of central bank-controlled money supply — not only could, but should replace the USD as the world’s reserve currency.

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