An interesting statistic (www.stansberryresearch.com) shows that since 1450, the currencies of Portugal, Spain, the Netherlands, France, and the United Kingdom have all served as the world's reserve currency, and each currency has dominated for between 80 and 110 years. According to this statistic, the US dollar has in fact served as the global reserve currency since 1920. So, if the pattern of history repeats itself, the dollar's global reserve status could be shaken around 2030. Once this happens, which currency will have the potential to replace the dollar?
In fact, the dollar was really recognized as a global reserve currency by countries around the world after the Bretton Woods Conference in 1945. After World War II, the Bretton Woods System I was formed. The biggest feature of the system is the so-called dual peg system, that is, the US dollar is pegged to gold and other currencies are pegged to the US dollar. Bretton Woods I has been successfully operating for two decades. Beginning in the second half of the 1960s, the system's problems became apparent. With the rapid recovery of the European economy and the Japanese economy after World War II, the absolute superiority of the US economy was gradually weakened. The "Trenifon conundrum" began to surface.
The "Trenifon problem" means that in order to sustain the global economy's demand for reserve currencies, the United States must continue to export dollars; but as the global dollar grows, other countries will have doubts about the ability of the United States to maintain the dollar's peg to gold. In fact, from the second half of the 1960s, some Western countries, represented by France, began to run gold with the US dollar. With the rapid decline in U.S. gold reserves, the Nixon administration announced in 1971 that the dollar would stop pegging to gold. The Nixon Shock is considered a sign of the end of The Bretton Woods System I.
The 1970s saw the global economy face an era of stagnation caused by two oil crises, a period of transition for the international monetary system. After the Jamaica Conference in 1976, the international monetary system gradually shifted to the Bretton Woods system II.
The biggest feature of Bretton Woods II is that the dollar, which has left the gold anchor, continues to act as a global reserve currency. Export-oriented emerging economies (Asian Tigers, Asian Tigers, and China, etc.) export goods to the United States in exchange for dollars, and resource-exporting economies (Middle Eastern countries, Russia, etc.) export resources to the United States in exchange for dollars, and these two types of countries will then reinvest a large part of the dollar as foreign exchange reserves in the safe assets of the United States (especially US Treasuries). In other words, under Bretton Woods II, the United States must have a large current account deficit and a capital account surplus, while the peripheral countries must have a large current account surplus and capital account deficit.
Under Bretton Woods I, gold is the source of stability anchoring the global monetary system. Under Bretton Woods II, the Fed's monetary policy credibility became a source of stability anchoring the global monetary system. The periphery believes that the highly independent Fed will implement responsible monetary policy based on stabilizing domestic economic growth and inflation, which will bring about the exchange rate of the us dollar and the price stability of safe assets of the US dollar.
After entering the 21st century, there was a significant current account imbalance in the world. In other words, Countries such as China, Germany, and the oil-exporting countries have accumulated large current account surpluses, while the United States has accumulated large current account deficits. Surplus countries have large claims from deficit countries. At the time, creditors such as China feared that once the U.S. government's external debt burden was overwhelmed, the United States might reduce the level of real foreign debt through a sharp depreciation of the dollar, which would cause heavy losses to global creditors.
After the outbreak of the subprime mortgage crisis, in order to cope with the crisis and boost the economy, the Fed implemented three rounds of quantitative easing in 5-6 years, surging the Fed's total assets from more than $1 trillion to about $4.5 trillion, and the resulting global liquidity flood greatly promoted the rise in global asset prices (especially the US stock market). Interestingly, however, during this period, the dollar index (i.e., the weighted average exchange rate of the dollar against other major developed country currencies) did not fall but rose. Especially after the European sovereign debt crisis hit the euro hard, the dollar's global reserve currency status has generally risen and then fallen since the outbreak of the subprime mortgage crisis, and has remained roughly unchanged.
In the wake of the COVID-19 pandemic, the Fed's quantitative easing policy intensified, raising its total assets from $4 trillion to $9 trillion in just two years. The U.S. stock market index is once again rising with the implementation of quantitative easing. The dollar index as a whole remains relatively strong.
In fact, whether after the subprime mortgage crisis or after the COVID-19 pandemic, the rest of the world has been very critical of the negative spillover effects of monetary policy in the United States. In order to boost domestic economic growth and maintain domestic financial stability, the Americans have implemented an extremely loose monetary policy, which has exacerbated global liquidity excess, pushed up the debt levels of emerging market countries and developing countries, and enhanced the financial instability of the latter. However, the Americans "do not care about the external floods." Once the recovery of the US domestic economy leads to an increase in inflation, the Fed will begin to contract monetary policy, and the continuous tightening of monetary policy will cause new negative shocks to peripheral countries.
While other countries have criticized the negative spillovers of U.S. monetary policy at home, the U.S. government has gone its own way. The international standing of the dollar has not been significantly weakened. One of the most important reasons is the lack of an opponent who is competitive enough for the dollar. Currencies such as the euro, the renminbi, the british pound, and the japanese yen will still be difficult to challenge the central position of the dollar in the short term.
However, the outbreak of the Russian-Ukrainian conflict in 2022 may exacerbate the transformation of the current international monetary system. After the outbreak of the Russian-Ukrainian conflict, developed countries represented by the United States imposed a number of financial sanctions on Russia, including the inclusion of some Russian banks in the SDN list, the exclusion of some Russian banks from the SWIFT system, and the partial freezing of Russia's foreign exchange reserves and gold reserves.
The biggest shock to the current international monetary system is that the United States and some European countries have frozen Russia's foreign exchange reserves and gold reserves, which has undermined the security of the world's most important safe asset to date (US Treasuries). As mentioned earlier, the Bretton Woods II system is based on the belief that current-account surplus countries such as China believe that U.S. Treasuries are the safest assets in the world and that the U.S. government will not fall into debt. But as the U.S. government has frozen dollar assets in Afghanistan and Russia this year, this means that the U.S. government no longer abides by market rules (even in name). Other countries' questioning of the dollar's safe assets will naturally shake the foundations of the current international monetary system.
For Countries such as China, Saudi Arabia, and India that hold large amounts of foreign exchange reserves but are not U.S. allies, this means that investing in U.S. Treasuries will no longer be safe in the future, and the U.S. government's reputation in global financial markets may be completely subject to its geopolitical considerations. Once U.S. Treasuries lose their status as the world's most important safe asset, the dollar's position in the international monetary system will undoubtedly decline significantly.
The reality of the United States joining forces with some European countries and Japan to sanction Russia this time vividly shows many countries that the diversification of assets within the United States and its allies alone cannot resist the systemic risk of multinational joint sanctions. So what other options are there? If internationally accepted credit currencies are no longer reliable, allocating a higher proportion of sovereign foreign exchange assets to physical assets, especially commodities, becomes a wise choice, especially for countries that rely heavily on commodity imports. The logic is very simple, since the purpose of accumulating dollar reserves is to cope with imports for a longer period of time in the future, since dollar assets have become less reliable, it is better to use them directly for importing commodities. This is the logic of Credit Suisse analyst Zoltan's view that the world will enter the Bretton Woods system III, and under the new international monetary system, the dollar and commodities will share the status of reserve currency.
The author believes that the outbreak of the Russian-Ukrainian conflict is likely to mean that the single reserve currency system formed since the establishment of the Bretton Woods system will be transformed into a multi-reserve currency system. Under the multi-reserve currency system, a multi-level global reserve currency may be formed. For example, the US dollar, euro, renminbi, british pound, yen and other currencies may share the function of international reserve currencies, of which the proportion of the US dollar may be significantly reduced, while the proportion of the euro and the renminbi may rise significantly. This fragmented reserve currency landscape certainly affects efficiency, but it matches the global supply chain system that has become fragmented since the COVID-19 pandemic. The pattern of global geopolitical conflict that could intensify after the outbreak of the Russian-Ukrainian conflict could strengthen the fragmentation of the international reserve currency.
All in all, under the multiple pressures of the great power game, the global epidemic and geopolitical conflicts, globalization may return, and economic and financial globalization may give way to regionalized and fragmented cooperation. This trend is reflected in the trade side, which is manifested in the regionalization and shortening of the global supply chain. This trend is reflected in the financial side, which may be manifested in the diversification of international reserve currencies and the fragmentation of the international monetary system.
(Zhang Ming is deputy director of the Institute of Finance of the Chinese Academy of Social Sciences, deputy director of the National Finance and Development Laboratory, and director of the China Chief Economist Forum)