How long will the dollar remain dominant?

Current issues related to economy, (responsible) investment, pension and income: every week an APG expert gives a clear answer to the question of the week. This time: chief economist Thijs Knaap on how long the dollar will remain dominant.

Before we zoom in on the role of the dollar, let’s take a look at Johannesburg. The so-called BRICS countries (Brazil, Russia, India, China and South Africa) are meeting there this week. The alliance between emerging economies in the “Global South” is sometimes seen as the counterpart to the G7, the alliance between the seven biggest Western industries. The term BRICS was originally coined by a Goldman Sachs economist to highlight the growth potential of these five economies. Since 1997, those economies - measured in dollars - indeed grew 10 times, compared to 2.5 times for the G7 economies.

Resistance

If that growth continues, the BRICS bloc will overtake the G7 countries economically at some point, Knaap said. “The question is what exactly that means, but at least it says something about their economic clout. And that’s where the shoe pinches. Because China’s economy constitutes 70 percent of the BRICS’ total GDP, but its economic growth has been very disappointing lately. In contrast, the U.S., which accounts for 63 percent of the G7’s total GDP, is now doing well economically.”

Then there is the question of how close cooperation is among the BRICS. “There is some talk that they have the future and may one day have a common currency, like the euro countries. But that’s never going to happen, if only because Beijing doesn’t want it.” What does bind the five countries is their distaste for institutions such as the IMF, the World Bank and the World Trade Organization (WTO). “These are basically international organizations, but many countries feel they are dominated by the West. In recent years, therefore, China in particular has established more or less competing organizations, such as the China Development Bank and the Asian Infrastructure Investment Bank. As a result, poorer countries no longer depend solely on the West for loans.”

Threat

To what extent do these developments now threaten the major role of the dollar? The Bretton Woods system established in 1944 included pegging the values of all national currencies to the dollar, which was the only currency exchangeable for a fixed amount of gold. Even when that system stalled in 1971, the dollar retained its dominant role. “The U.S. was the most powerful capitalist country by all accounts at that time, and so it was also assigned the most important currency. Once you hold that position, it is difficult for other countries to knock you off the throne, partly because of network effects. For example, there is a good chance that a plantation owner in Colombia and a fruit trader in Indonesia will use the U.S. dollar to settle a shipment of bananas.”

This gives the Americans an “exorbitant privilege”, as French Finance Minister Valéry Giscard d'Estaing once called it. Knaap: “After all, it costs them virtually nothing to print billions of dollars annually, while other countries have to provide products, services or their own currencies to get those dollars. In addition, dollar dominance allows the U.S. to act as the world’s police officer. Indeed, a bank trading in dollars soon has to deal with U.S. regulators. With that, they are also bound by, say, an embargo against a Russian arms dealer. These are the two main reasons why the question occasionally arises - especially outside the Western world - whether the global dominance of the dollar is still appropriate today. But economically it is perfectly explicable and ensures a stable financial system.”

Alternative

That dominance could not be lifted overnight, in any case. “For that to happen, the U.S. would have to stop being the most powerful country in the world, and that may take some time. Then there is the question of what currency can take over the dollar’s role. As we have seen, there will be no BRICS currency.” The only credible alternative is the Chinese renminbi, but there are some snags with that. “First, as a country, you’d be handing yourself over to Chinese oversight, which not everyone wants. Second, the U.S. has a huge trade deficit (in which case imports exceed exports, ed.), resulting in billions of dollars flowing around the world every year. China, on the other hand, has a huge trade surplus, so that currency circulates less among foreign traders.” To increase the role of their currency, the Chinese established their development banks, Knaap continued. “However, that is not going very fast. On top of that, American dollars are always freely tradable, while China still likes to keep control and has temporarily halted trade in its currency several times in the past. This is bad for confidence, although Beijing’s goal is to eventually free up trade in their currency completely. But it does mean there is no alternative to dollar dominance for now.”