Demise Of The Dollar Is Greatly Exaggerated – Credit Suisse Paper

Editorial Staff

24 January 2023

The US dollar is unlikely to be as dominant a currency in the long term as countries try to reduce exposures but there’s no immediate sign that the greenback will fall from its perch, according to a study by Credit Suisse.

Taking time away from short-term market gyrations and political controversy to ponder trends, the Credit Suisse Research Institute has issued a 44-page paper –The Future of the Monetary System. It scans developments going back to WW2, the rise and fall of Bretton Woods, the end of the gold link to the dollar in 1971, the rise of floating exchange rates, the advent of the euro in 1999, the rise of China, and rising worries about massive public debt, particularly after 2008.

Actions by the US, the EU and other groups to slap sanctions on Russia, as well as clashes with Beijing over trade, have put the role of the dollar as an anchor of the global financial system under the spotlight.

“Even in the absence of geopolitical and economic calamities, a further diminution of the role of the US dollar in global foreign exchange reserves is likely due to three factors: the diminishing need for FX reserves in a world of floating exchange rates, the active diversification policies of central banks, and the increased use of swap lines between central banks,” the paper said.

In recent years the importance of the dollar has been underscored by measures, for example, by Credit Suisse's rival, UBS, to switch to reporting its financial results in dollars rather than Swiss francs. That switch was justified because UBS books such a large amount of revenue outside Switzerland. UK/Hong Kong-listed HSBC reports in dollars, to give another case. And, as compliance officers at banks and other organizations know, any transaction in dollars puts one in the cross-hairs of the US Department of Justice – as seen in the case of scandal-hit soccer group FIFA, for example.

Inflation
“Like other countries, the United States is battling a burst of inflation, while the economy slows. Meanwhile, fiscal and external imbalances have worsened substantially. This situation is somewhat reminiscent of the 1970s, when trust in the US dollar was significantly undermined,” it continued.

“In addition, geopolitical tensions have escalated substantially in recent years. This combination raises the specter of a potential major pivot away from the US dollar. On balance, we believe this remains a fairly unlikely case for now and that a gradual evolution to a more multi-polar monetary system is more likely.”

Senior policymakers have criticized the existing system for decades, concerned that the dollar’s status as a global reserve currency, and the large US stock of public debt, are potential risks to the system at some point.

“History shows that it is not just periods of US dollar weakness that can cause problems in the rest of the world, but that periods of tight Fed policy and a strong dollar can be even more disruptive,” the paper said.

“Today, the US dollar represents slightly more than 60 per cent of global FX reserves at central banks, compared to more than 80 per cent in the early 1970s,” it continued.

The bank said there are no clear candidates to replace the US dollar as lead currency. The euro and Chinese renminbi don’t qualify as alternative currency “hegemons.” The paper added that the idea of a global currency is a mirage because there is not the intense level of cooperation to make it work.

“While the euro accounts for around 20 per cent of global foreign exchange reserves, behind only the US dollar, and is also freely tradable across borders – a key prerequisite for a lead currency – eurozone policymakers clearly do not strive for their currency to take on such a role. The absence of a fiscal union and common “safe” asset as well as a banking union are further disadvantages for it to take on a dominant role in the global monetary system,” the paper said.

“In contrast, China is one fiscal entity and its few large banks can be regarded as money centre banks. However, the renminbi lacks the third key characteristic which would qualify it as a competitor to the US dollar: international capital mobility. It seems unlikely that China will fully liberalize and open its financial markets for cross-border transactions and is the key reason why the share of renminbi in global FX reserves is still so small,” it said.