The US Congress acted on
Hamilton's recommendations, with
the Coinage Act of 1792 that
established the dollar (symbol:
$; code: USD) as the basic unit
of account for the United
States. The word dollar is
derived from the Low Saxon
cognate of the High German
Thaler. They created a decimal
currency by creating the dime,
nickel, and penny coins, as well
as the dollar, half a dollar,
and quarter-dollar coins, all of
which are still minted in 2021.
Several forms of paper money
were introduced by Congress over
the years, the latest of which
is the Federal Reserve Note that
was authorized by the Federal
Reserve Act of 1913. The U.S.
dollar as a currency is
sometimes referred to as the
greenback by the financial press
in other countries, such as
Australia, New Zealand, South
Africa, and India, due to the
banknotes' historically
predominantly green colour.
In wartime, banks can have their
monetary reserves stolen, either
captured by the enemy or
appropriated by their own
country. In 1944, Allied nations
sought to create an
international monetary order
that sustained the global
economy and prevented the
economic malaise that followed
the First World War because
World War II has devastated
European and Asian economies
while leaving the United States'
economy relatively unharmed. As
European governments exhausted
their gold reserves and borrowed
to pay the United States for war
material, the United States
accumulated large gold reserves.
This combination gave the United
States significant political and
economic power following the
war.
Consequently, during WWII, banks
in England and France shipped
their gold to the US for
safekeeping. After the war, the
allies tried to create some
stability. In a small New
Hampshire town called Bretton
Woods, they hammered out an
agreement that made the US
dollar a worldwide standard. The
gold standard is a system in
which a country's government
allows its currency to be freely
converted into fixed amounts of
gold. “The dollar was pegged to
the price of gold, and foreign
currency was pegged to the
dollar,” “The US dollar was
crowned as the world’s reserve
currency. It was a stable source
of stored value, a medium of
exchange a country’s currency
might not have.” The
arrangement, which came to be
known as the Bretton Woods
Agreement, codified this
economic dominance of the dollar
and established that the central
banks would maintain fixed
exchange rates between their
currencies and the dollar. In
turn, the United States would
redeem U.S. dollars for gold on
demand. Countries had some
degree of control over the
currencies in situations where
their currency values became too
weak or too strong relative to
the dollar. They could buy or
sell their currency to regulate
the money supply.
The Bretton Woods agreement laid
the foundations for an
international monetary order
that created rules and
expectations for the
international economic system.
It created the International
Monetary Fund (IMF), the
predecessor of the World Bank,
and an international monetary
system based on fixed exchange
rates. It valued the dollar at
$35 per ounce of gold and the
remaining signatories pegged
their respective currency
relative to the dollar, leading
some economists to argue that
Bretton Woods "dethroned" gold
as the default asset. While
Bretton Woods institutionalized
the dollar's importance
following the war, Europe and
Asia faced dollar shortages. The
international community needed
dollars to finance imports from
the United States to rebuild
what was lost in the war. In
1948 US Congress passed the
European Recovery Program -
generally known as the Marshall
Plan – giving dollars to
European countries to purchase
imports needed to rebuild their
economies. The plan helped
European countries by providing
them dollars to purchase the
imports needed to produce
exports, eventually allowing the
countries to export enough of
their goods to obtain the
dollars necessary to sustain
their economies without reliance
on any Marshall-like plan. At
the same time, Joseph Dodge
worked with Japanese officials
and Congress to pass the Dodge
Plan in 1949, which worked
similarly to the Marshall Plan
in Europe, but for Japan rather
than Europe. But nothing lasts
forever, though. The Marshall
and Dodge plans' successes have
brought new challenges to the
U.S. dollar. In 1959, dollars in
circulation around the world
exceeded U.S. gold reserves,
which became vulnerable to the
equivalent of a bank run.
The New Deal
The New Deal was a series of
programs, public work projects,
financial reforms, and
regulations enacted by President
Franklin D. Roosevelt in the
United States between 1933 and
1939. Major federal programs and
agencies included the Civilian
Conservation Corps (CCC), the
Civil Works Administration (CWA),
the Farm Security Administration
(FSA), the National Industrial
Recovery Act of 1933 (NIRA) and
the Social Security
Administration (SSA). They
provided support for farmers,
the unemployed, youths and the
elderly. The New Deal included
new constraints and safeguards
on the banking industry and
efforts to re-inflate the
economy after prices had fallen
sharply. Its programs included
both laws passed by Congress as
well as presidential executive
orders during the first term of
the presidency of Franklin D.
Roosevelt. The programs focused
on what historians refer to as
the "3 R's": relief for the
unemployed and poor, recovery of
the economy back to normal
levels, and reform of the
financial system to prevent a
repeat depression. The New Deal
also produced a political
realignment, making the
Democratic Party the majority
(as well as the party that held
the White House for seven out of
the nine presidential terms from
1933 to 1969) with its base in
liberal ideas, the South, big
city machines and the newly
empowered labour unions, and
various ethnic groups. The
Republicans were split, with
conservatives opposing the
entire New Deal as hostile to
business and economic growth and
liberals in support. The
realignment crystallized into
the New Deal coalition that
dominated presidential elections
into the 1960s while the
opposing conservative coalition
largely controlled Congress in
domestic affairs from 1937 to
1964.
The New Deal coupled with the
mounting inflation, debt from
the Vietnam War and other
factors loosened the Bretton
Woods agreement. Eventually, the
United States chose to devalue
the dollar. During the early
1960s American officials largely
prevented the conversion of
dollars to gold with a series of
"gentlemanly" agreements and
other policies – which included
the London Gold Pool - but these
actions were not sustainable and
American officials became
increasingly concerned; the
danger of a run on U.S. gold
reserves was too high. With
Nixon's election in 1968 and
faced with this mounting debt
and extravagant domestic
spending habits, and a
persistent balance of payments
deficit, the Nixon
administration finally issued
Executive Order 11615 in August
1971, ending the direct
convertibility of dollars to
gold, essentially creating what
was referred to as the “Nixon
Shock,” the world saw the end of
the golden era and a free fall
of the U.S. dollar amidst
soaring inflation. Nixon added,
"We must protect the position of
the American dollar as a pillar
of monetary stability around the
world ... I am determined that
the American dollar must never
again be a hostage in the hands
of the international
speculators." This became known
as the Nixon Shock and marked
the dollar's transition from the
gold standard to a fiat
currency, making the dollar
floating, with no gold backing.
Who started the petrodollar?
The petrodollar was started by
the United States in an
agreement with Saudi Arabia in
the 1970s with the intent of
standardizing oil sales and
purchases in U.S. dollars.
Understanding Riyal and Saudi
Arabia's Economy
In 1932, the Kingdom of Saudi
Arabia, as a country, was formed
by combining the Kingdom of
Hejaz and the Sultanate of Nejd.
After its creation, Saudi Arabia
utilized a bimetallic monetary
system based on British gold
sovereigns and silver Riyals. In
1952, the monetary system was
reformed to use a single
currency. This currency, the
Saudi Riyal (SAR), was backed by
Saudi gold guineas equivalent to
the British gold sovereign until
1959 when a system based on fiat
money issued by the Saudi
Arabian Monetary Agency was
created, which is the Saudi
Central Bank.
The Riyal briefly rose to a
20-year high in 2007 when the
U.S. Federal Reserve slashed
interest rates in the wake of
the Great Recession and the
Saudi Central Bank chose not to
follow for fear of
hyperinflation. However, after a
few months, the Riyal returned
to its pegged rate of 3.75 SAR.
Because the Riyal is pegged to
the U.S. dollar, its only
correlation is to the
"greenback."
Saudi Arabia's economy is driven
largely by its oil and gas
industry. It produces almost 12
million barrels of oil per day
and nearly 12% of world output.
The country ranked as the
largest oil producer in the
decade from 2003 to 2012, after
which it fell to second place
due to surging oil production in
the United States. Saudi Arabia
remains the world's largest
petroleum exporter. With proven
oil reserves of about 337
billion barrels and relatively
low production costs, Saudi
Arabia should maintain its
position as a top-three oil
producer ((alphabetically)
Russia, Saudi Arabia, and the
United States) for the
foreseeable future. The
country's oil and gas industry
is controlled by Saudi Aramco,
which is controlled by Saudi
Arabia's Ministry of Petroleum
and Mineral Resources and the
Supreme Council for Petroleum
and Minerals. Saudi Aramco is
mostly state-owned but had an
initial public offering (IPO) of
1.5% of the company in Dec.
2019. Meanwhile, although
international oil companies do
not participate in oil
production in Saudi Arabia,
several partners with Saudi
Aramco in joint-venture
refineries and petrochemical
plants in the country, partners
include Exxon Mobil, Royal Dutch
Shell PLC, Sumitomo Chemical
Co., and Total S.A.
In 2016, there were talks of a
potential devaluation of the
Riyal. As oil prices plunged,
Saudi Arabia was receiving fewer
receipts from its oil exports.
Because oil is denominated in
U.S. Dollars, devaluation would
see them receive more Riyal for
each barrel sold. However,
despite the oil crisis, SAMA
refrained from shifting the peg,
and ultimately oil prices
rebounded off their lows to
alleviate some of the pricing
pressure. Saudi Arabia is a
member of the Gulf Cooperation
Council, and in 2010 there were
talks of a single currency for
the Gulf region. This has yet to
come to fruition, although the
topic has come up periodically
in the region since.
The Rise of Petrodollar
Petrodollars are U.S. dollars
paid to an oil-exporting country
for the sale of the commodity.
Put simply, the system is an
exchange of oil for U.S. dollars
between countries that buy oil
and those that produce it. The
was the result of the oil crisis
in the mid-1970s when prices
spiked to record levels. It
helped increase the stability of
oil prices denominated in U.S.
dollars. The term regained
notoriety in the early part of
the 2000s when oil prices rose
once again. Although, initially
referred primarily to money that
Middle Eastern countries and
members of the Organization of
the Petroleum Exporting
Countries (OPEC) received, the
definition has broadened to
include other countries in
recent years. After the collapse
of the Bretton Woods gold
standard, the United States
struck a deal with Saudi Arabia
to standardize oil prices in
dollar terms. Through this deal,
the petrodollar system was born,
along with a shift away from
pegged exchanged rates and
gold-backed currencies to
non-backed, floating rate
regimes. The petrodollar system
elevated the U.S. dollar once
again to the world's reserve
currency and, through this
status; the United States enjoys
persistent trade deficits and is
a global economic hegemony. The
petrodollar system also provides
U.S. financial markets with a
source of liquidity and foreign
capital inflows through
petrodollar "recycling."
How It Happened
Through bilateral agreements
with Saudi Arabia beginning in
1974, the U.S. managed to
influence members of the
Organization of the Petroleum
Exporting Countries (OPEC) to
standardize the sale of oil in
dollars. In return for invoicing
oil in dollar denominations,
Saudi Arabia and other Arab
states secured U.S. influence in
the Israeli-Palestinian conflict
along with U.S. military
assistance during an
increasingly worrisome political
climate, which saw the Soviet
invasion of Afghanistan, the
fall of the Iranian Shah, and
the Iran-Iraq War. Out of this
mutually beneficial agreement,
the system was born, which
cement the US-Saudi relationship
and the U.S.-Saudi Arabian Joint
Commission on Economic
Cooperation till today.
Benefits of the System
Since the most sought-after
commodity in the world, oil, is
priced in U.S. dollars, the
helped elevated the greenback as
the world's dominant currency.
With its high status, the U.S.
dollar enjoys what some have
asserted to be the privilege of
perpetually financing its
current account deficit by
issuing dollar-denominated
assets at very low rates of
interest as well as becoming a
global economic hegemony.
Petrodollars are oil revenues
denominated in U.S. dollars.
They are the primary source of
revenue for many oil-exporting
members of OPEC including
Nigeria, as well as other oil
exporters in the Middle East,
Norway, and Russia. Because
petrodollars are denominated in
U.S. dollars, or greenbacks,
their true purchasing power
relies on both the core rate of
U.S. inflation and the value of
the U.S. dollar. This means
petrodollars will be affected by
economic factors the same way
the U.S. dollar is affected. So
if the value of the dollar
falls, does the value of
petrodollars, and thus the
government's revenue.
Petrodollar Recycling
Petrodollar recycling is the
international spending or
investment of a country's
revenues from petroleum exports.
It generally refers to the
phenomenon of major
petroleum-exporting nations,
mainly the OPEC members plus
Russia and Norway, earning more
money from the export of crude
oil than they could efficiently
invest in their own economies.
The system also creates
surpluses of U.S. dollar
reserves for oil-producing
countries, which need to be
"recycled." These surplus
dollars are spent on domestic
consumption, lent abroad to meet
the balance of payments of
developing nations, or invested
in U.S. dollar-denominated
assets. This last point is the
most beneficial for the U.S.
dollar because it makes their
way back to the United States.
These recycled dollars are used
to purchase U.S. securities
(such as Treasury bills), which
creates liquidity in the
financial markets, keeps
interest rates low, and promotes
non-inflationary growth.
Moreover, the OPEC states can
avoid currency risks of
conversion and invest in secure
U.S investments. The recycling
system was also used to invest
surplus dollars into sovereign
wealth funds, the profits of
which were used to invest in
activities not related to oil,
reducing the nation's dependence
on oil. $711 Billion is the
global net oil export revenue
from OPEC members in 2018,
according to the U.S. Energy
Information Association.
However, countries like China,
which holds vast quantities of
U.S. debt, have voiced their
concerns in the past about the
possible dilutive effects to
their asset holdings should the
dollar depreciate. Nevertheless,
the privileges associated with
being able to run persistent
current account deficits come at
a price. As the reserve
currency, the United States is
obligated to run these deficits
to fulfill reserve requirements
in an ever-expanding global
economy. If the United States
were to stop running these
deficits, the resulting shortage
of liquidity could pull the
world into an economic slump. In
1960, Yale economist Robert
Triffin described the problem to
Congress: either the dollar was
not freely available and other
countries could not afford to
import American goods, or the
dollar was freely available but
confidence that the dollar could
be converted to gold would
disappear. However, if the
persistent deficits continue
indefinitely, eventually,
foreign countries will begin to
doubt the value of the dollar,
and the greenback may lose its
role as the reserve currency.
This is known as the Triffin
Dilemma, named after Robert
Triffin, the economist who wrote
of the impending doom of the
Bretton Woods system in his 1960
book, Gold and the Dollar
Crisis: The Future of
Convertibility. He pointed out
that the years of pumping
dollars into the world economy
through post-war programs, such
as the Marshall Plan, was making
it increasingly difficult to
stick to the gold standard. The
country had to achieve this by
instilling international
confidence through a current
account surplus while also
having a current account deficit
by providing immediate access to
gold.
The
Tiffin Dilemma
The Tiffin dilemma or Tiffin
paradox is the conflict of
economic interests that arises
between short-term domestic and
long-term international
objectives for countries whose
currencies serve as global
reserve currencies. This dilemma
was identified in the 1960s by
Belgian-American economist
Robert Tiffin, who pointed out
that the country whose currency,
being the global reserve
currency, foreign nations wish
to hold, must be willing to
supply the world with an extra
supply of its currency to
fulfill world demand for these
foreign exchange reserves, thus
leading to a trade deficit.
The use of a national currency,
such as the U.S. dollar, as a
global reserve currency leads to
tension between its national and
global monetary policy. This is
reflected in fundamental
imbalances in the balance of
payments, specifically the
current account, as some goals
require an outflow of dollars
from the United States, while
others require an overall
inflow. Specifically, the
Triffin dilemma is usually cited
to articulate the problems with
the role of the U.S. dollar as
the reserve currency under the
Bretton Woods system. John
Maynard Keynes had anticipated
this difficulty and had
advocated the use of a global
reserve currency called 'Bancor'.
Currently, the IMF's SDRs are
the closest thing to the
proposed Bancor but they have
not been adopted widely enough
to replace the dollar as the
global reserve currency.
In the wake of the financial
crisis of 2007–2008, the
governor of the People's Bank of
China explicitly named the
reserve currency status of the
US dollar as a contributing
factor to global savings and
investment imbalances that led
to the crisis. As such, the
Triffin Dilemma is related to
the Global Savings Glut
hypothesis because the dollar's
reserve currency role
exacerbates the U.S. current
account deficit due to
heightened demand for dollars
How the
Tiffin Dilemma affects
Currencies
By "agreeing" to have its
currency used as a reserve
currency, a country pins its
hands behind its back. To keep
the global economy chugging
along, it may have to inject
large amounts of currency into
circulation, driving up
inflation at home. The more
popular the reserve currency is
relative to other currencies,
the higher its exchange rate and
the less competitive domestic
exporting industries become.
This causes a trade deficit for
the currency-issuing country but
makes the world happy (foreign
official dollar reserves (FRODOR)
are an indicator relating
international liquidity to the
effect of foreign central banks
on U.S. monetary policy). If the
reserve currency country instead
decides to focus on domestic
monetary policy by not issuing
more currency, then the world
becomes unhappy.
Becoming a reserve currency
presents countries with a
paradox. They want the
"interest-free" loan generated
by selling currency to foreign
governments, and they need to be
able to raise capital quickly
because of the high demand for
reserve currency-denominated
bonds. At the same time, they
want to be able to use capital
and monetary policy to ensure
that domestic industries are
competitive in the world market
and to make sure that the
domestic economy is healthy and
not running large trade
deficits. Unfortunately, both of
these ideas, cheap sources of
capital and positive trade
balances, usually can't happen
all at the same time. Issuing a
reserve currency means that
monetary policy is no longer a
domestic-only issue, it's
international. Governments have
to balance the desire to keep
unemployment low and economic
growth steady with their
responsibility to make monetary
decisions that will benefit
other countries. The reserve
currency status is, thus, a
threat to national sovereignty.
The fall of the Petrodollar
System
A falling dollar hurt
oil-exporting countries because
contracts were priced in U.S.
dollars. Their oil revenue
dropped along with the dollar.
The cost of imports, denominated
in other currencies, increased.
With the decline in the
purchasing power of the
greenback, some nations started
to debate the benefits of the
petrodollar system. Countries
like Iran, Russia, and India
have considered shifting the
base value of their exports in
their currency rather than the
U.S. dollar. Recently also there
have been concerns of a shift
away from US dollars to other
currencies. Venezuela said in
2018 that it would begin selling
its oil in the Chinese yuan,
European euro, and other
currencies. Then, in 2019, Saudi
Arabia threatened to abandon
petrodollars if the U.S. moved
forward with a bill, called
NOPEC that would allow the U.S.
Justice Department to pursue
antitrust action against OPEC
for manipulating oil prices. The
No Oil Producing and Exporting
Cartels Act (NOPEC) was designed
to remove the state immunity
shield and to allow the
international oil cartel, OPEC,
and its national oil companies
to be sued under U.S. antitrust
law for anti-competitive
attempts to limit the world's
supply of petroleum and the
consequent impact on oil prices.
In short, the changing landscape
of the global energy market
could result in a de-facto end
to the U.S.-Saudi petrodollar
agreement.
Meanwhile, the U.S. is becoming
a major exporter of energy for
the first time since the 1960s.
Fracking changed that equation
and led to a new boom in oil and
gas production in the U.S. Total
U.S. crude oil production
roughly tripled in the decade
spanning from 2010 to 2020. Over
the same period, the amount of
total U.S. oil consumption
provided by imports fell
substantially. Fracking uses
horizontal drilling to access
shale deposits previously
unavailable through conventional
drilling methods. After drilling
into the earth, a high-pressure
water mixture - called fracking
fluid - is applied to the rock
to release the gas and petroleum
inside. From both a bottom-up
and a top - down approach, there
is significant evidence that
shale oil could be profitable at
a price level of $60 per barrel
but at $120 per barrel, fracking
is a very profitable business.
At lower prices, companies are
forced to weigh the cost of
expensive fracking compared to
less expensive extraction
methods. While falling oil and
gas prices leave producers
scrambling to cut costs,
fracking can survive below $50
per barrel due to new
exploration and production
methods. Already, some higher
cost wells have already been
shut down and the most expensive
oil produced in the United
States today comes from older
wells known as “stripper wells.
This, along with a strong
domestic energy sector that
focuses on exports, could help a
smooth transition away from the
petrodollar as energy exports
replace the capital inflows from
Saudi purchases of U.S. assets
and uphold global demand for the
U.S. dollar. An added advantage
for the United States is that it
will ensure domestic energy
security, which was the main
reason for the petrodollar
agreement in the first place.
Nevertheless, while it will not
happen overnight, a drying up of
recycled petrodollars could
drain some liquidity from
American capital markets, which
will increase the borrowing
costs (due to higher interest
rates) for governments,
companies, and consumers as
sources of money become scarce.
If the petrodollar collapses
there would be significant
economic fallout as this would
mean the dollar's value as the
world's reserve currency may not
hold, impacting the dollar
balances of a variety of
nations. However, if the
petrodollar was phased out
gradually and replaced with
another currency, such as the
yuan, markets may remain stable
but the dollar would lose
significant power. Many
countries favour the de-dollarization.
Another Reserve Currency
What would happen if another
currency, such as China's yuan,
were to become the world's
reserve currency of choice? The
dollar would likely depreciate
relative to other currencies,
which could boost exports and
lower the trade deficit. The
bigger issue, however, would be
an increase in borrowing costs
as demand for a constant flow of
dollars tapered off, which could
have a severe impact on the
ability of the U.S. to repay its
debt or fund domestic programs.
China, on the other hand, will
have to quickly modernize its
financial system, long lamented
for protecting its export-led
industries, through currency
manipulation. Demand for yuan
convertibility means that
China's central bank would have
to relax regulations relating to
yuan-denominated bonds.
The Prospects of the Yuan
becoming the World's New Reserve
Currency
China has long been the world's
second-largest economy, with the
largest foreign exchange
reserves and the second-largest
share in world trade. However,
its position in the global
economy has long been
recognized, but this recognition
has not been accompanied by the
international monetary
significance of the yuan.
Despite China's economic
significance, the political
importance and the voting power
in the International Monetary
Fund (IMF) cannot be compared to
that of the U.S. because the
U.S. has over 17% of the votes,
whereas China has 3.8 %. Owing
to that, the U.S., together with
its allies, gets to block
decisions and tailor global
economic policy. Striving to
establish the world's reserve
currency, China has been leading
comprehensive economic and trade
policies while strengthening the
yuan convertibility. As a
result, effective October 1,
2016, the yuan has become a
reserve currency in the basket
of special drawing rights along
with the dollar, the euro, the
yen, and the British pound.
China has been supporting the
IMF reform while establishing
new institutions aimed at
redefining the current
international policy under the
strong influence of the U.S.
There have been several analyses
on the channels of Chinese
authorities' actions and the
prospect of recomposing the
international monetary system
and reducing the global U.S.
influence, to identify whether
it is likely that the Chinese
currency will obtain the status
of the world currency.
China has been strengthening its
economic and political position
in international institutions
for years, not only by being
integrated into existing
institutions under the current
rules of the game but also by
creating new institutions and
changing the actors of the
global economic scene according
to its needs. The
internationalization of the yuan
is part of this process. China
hopes the yuan will weaken the
dollar's impact and take its
fair share as one of the world's
dominant reserves. The share of
the Chinese yuan in the world’s
foreign currency reserves is
about 1%, and it has come a long
way in a short time. The yuan
has made impressive progress in
international finance. Entering
the IMF currency basket is a
symbolic but significant step
because it has placed the yuan
in the upper echelon of foreign
currencies. It is unlikely that
the yuan will succeed in
replacing the dollar, especially
from the perspective of the
poorly developed financial
market and the capital account
closed. The Communist Party is
not an institution of trust
outside of China, and the fear
of losing their invested funds
by a single decision of the
Communist Party of China will
surely keep the investors away
from large-scale investments in
China's financial market.
Nevertheless, securities from
China are still attractive in
terms of higher yield, so a
certain level of interest in
them will exist. Unlike China,
the U.S. is called a haven and
is considered a lender of last
resort, which means that
financial assets denominated in
dollars, especially the U.S.
Treasury bonds, are most
reliable. To be considered safe,
assets must be the first choice
of panicked investors, and must
also have a high level of
liquidity. For a country’s
currency to be considered a
haven, such a country must have
trustful institutions.
Analyzed a bit further and
beyond the current moment but on
the wave of current realities,
China is trying to strengthen
its position in the world as
much as possible, although 20%
of its exports go to the U.S., a
market that is introducing taxes
on its products, which may lead
to a slowdown of China's
economic growth. The growth may
also be affected by the "fewer
workers, more pensioners" trend,
and it is therefore likely that
the consumption in China will
stagnate or decline. In 2013,
China reported 13.7% of the
population aged 60 and older (MPRA,
2013). According to the UN, a
society in which 10% or more of
the population is 60 and older
is considered an ageing society,
and a burden on social security
systems is typical for such
societies. In a situation with
volatile consumption and
exports, and hence economic
growth, pressure for
institutional reforms piles up
and, therefore, the ability of
China to internationalize the
yuan becomes questionable
because investors' trust in
currency requires trustful
institutions. It is unlikely
that the yuan will replace the
dollar as the global reserve
currency because there are many
limitations on its more
extensive usage and further
internationalization. However,
the yuan will likely come to and
remain at the level of other
currencies from the basket of
special drawing rights, and
hence at the upper echelon of
the world currencies
New International Monetary
System
There is another possibility for
reducing the pressures countries
face trying to maintain reserve
currency status: a new
international monetary system,
an idea floated for several
decades as a potential solution.
One possibility is the special
drawing right, a type of reserve
asset maintained by a global
institution, such as the
International Monetary Fund (IMF).
While this is not a currency, it
does represent a claim by other
countries on foreign exchange
assets. A more radical idea
would be to create a global
currency, a concept pushed by
John Maynard Keynes, with a
value-based either on gold or
the mechanizations of a global
central bank. This is probably
the more complex solution
available and does present
problems relating to
sovereignty, stability, and
administration. After all, how
can you hold an organization
accountable that is voluntary?
The Bottom Line
In the short term, the prospect
of a reserve currency replacing
the dollar is slim to none.
Despite the economic and
political problems facing the
United States, its "safe-haven"
status is hard to beat,
especially in light of the
plight of the euro. It is hard
to parse out what exactly would
happen if the dollar were to be
overtaken by another currency,
and it is equally difficult to
predict what budgetary and
austerity measures in Europe and
the United States will do to the
global economy in the coming
years.
The Rise of
Crypto currency like
Bitcoin
There is no doubt that
crypto currency is a
game-changer. But in the near
term, it will not replace the US
dollar. In the long term,
anything is possible. Bitcoin is
the digital currency that
utilizes crypto currency and it
is controlled by the
decentralized authority which is
not like the government-issued
currencies whereas the
Crypto currency refers to the
technology that acts as a medium
for facilitating the conduct of
the different financial
transactions which are safe and
secure.
This idea is intriguing on
several levels. In terms of
retaining value through thick
and thin, the ultimate reserve
currency cannot be printed (and
thus devalued) with abandon by a
government. Gold and silver have
served as the ultimate reserve
currency, as precious metals can
be traded for commodities and
services, provide collateral for
debt and serve as reliable
stores of value. While many
observers believe gold is still
the only reliable reserve
currency (or if you prefer, the
only reliable backing for
government-issued paper money),
it’s a worthy thought experiment
to ask if a digital currency
could also act as a reserve
currency.
Since there is no real-world
commodity backing the digital
currency, its value must be
based on scarcity and its
ubiquity as money. The two ideas
are self-reinforcing: there must
be demand for digital money to
create scarcity, and the source
of demand is the digital
currency’s acceptance as money
that can be used to buy
commodities, goods, services and
(the ultimate test) gold. It
follows that the first step in a
non-state-issued digital
currency becoming a reserve
currency is that it isn’t
created in quantities that dwarf
demand. If the digital currency
is issued with abandon, it
cannot be scarce enough to gain
any value. “If I own one quatloo
(our hypothetical digital
currency) and a trillion new
quatloos are issued tomorrow,
the value of my one quatloo will
decline to near-zero”.
The second step is its
widespread acceptance globally
as money, i.e. a store of value
and something which can be
traded for goods and services.
There is a bit of a built-in
conflict in these two
requirements. To be useful in
the $60 trillion global
economies, the quatloo must be
issued in size: there must be
enough of it around to grease
transactions large and small in
all sorts of markets. Using the
U.S. dollar as a guide (since
the USD is the primary reserve
currency), we can estimate that
a minimum of $1 trillion in
quatloos would be needed to
become a practical global
currency. To act as a reserve
currency, another trillion or
two would be needed, as nations
would hold these quatloos as
reserves. (Nations hold an
estimated $7 trillion in USD
reserves, about $3 trillion and
$1 trillion or so in yen, pounds
and other currencies.) But
issuing quatloos in these
quantities would remove any
scarcity value. Thus the issuer
of the quatloo would have to
carefully issue more quatloos
only when demand justified the
need for more monetary “grease”
for the global economy.
As a transactional form of
currency, bitcoin's limitations
are inherent. As a reserve
asset, bitcoin's possibilities
are limitless. One Satoshi could
equal $1, $10, $100... It is
infinitely scalable. It is also
likely ungovernable, adhering
only to the will of the people.
If governments attempt to reign
in bitcoin with regulation, a
new layer could emerge with
users bypassing the exchange
intermediaries (such as Coinbase)
with their wallets running on
their local hardware connected
directly to the network. This
was the way it was done in the
beginning. If governments target
the free will of the individual,
this too could backfire. It
might only drive fear that they
are attempting to salvage their
authority from the onslaught of
technology, driving bitcoin's
legitimacy.
We are living in one of the most
bizarre moments in history,
driven by the accelerating pace
of technology, an exponential
curve. Tech investors often go
by the idiom "if you're not
early you're late." Perhaps the
euphoria and excitement
regarding the tech bubble, that
humanity would be reshaped by
the transformative impact of
networks and computers, was not
wrong, just early. Though there
are certain "meme stocks" that
are in a phase of speculative
euphoria today, perhaps this
time it is very different in a
general sense, and things like
bitcoin will indeed be
transformative in the long run.
There are nations in the world
that would like to see the end
of the US dollar's dominance, as
it would shift the balance of
power in their favour. Some
central bankers would like to
see digital currencies, giving
them incredible new tools to
track, monitor, and implement
monetary policy directly. But
perhaps a new Bretton Woods
agreement has already happened,
and it was a group of
cryptographers and software
developers creating bitcoin...
“Giving the power of the central
banks to the masses”. If the
government can click a few keys
at the Federal Reserve and
create money, why can't the
people?
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