A bipolar currency regime will replace the dollar’s exorbitant privilege

The writer is professor emeritus at the Stern School of Business, NYU and chief economist at Atlas Capital Team

The US dollar has been the predominant global reserve currency since the design of the Bretton Woods system after the second world war. Even the move from fixed exchange rates in the early 1970s did not challenge the greenback’s “exorbitant privilege”.

But given the increased weaponisation of the dollar for national security purposes, and the growing geopolitical rivalry between the west and revisionist powers such as China, Russia, Iran and North Korea, some argue that de-dollarisation will accelerate. This process is also driven by the emergence of central bank digital currencies that could lead to an alternative multipolar currency and international payment regime.

Sceptics argue that the global share of the US dollar as unit of account, means of payment and store of value hasn’t fallen much, despite all the chatter about a terminal decline. They also point out that you can’t replace something with nothing — as former US Treasury secretary Lawrence Summers put it: “Europe is a museum, Japan is a nursing home and China is a jail.”

More nuanced arguments point out that there are economies of scale and network that lead to a relative monopoly in reserve currency status, and that the Chinese renminbi cannot become a real reserve currency unless capital controls are phased out and the exchange rate made more flexible.

Moreover, a reserve currency country needs to accept — as the US long has — permanent current account deficits in order to issue enough of the liabilities held by non-residents as a counterpart. Finally, such sceptics argue that all attempts to create a multipolar reserve currency regime — even an IMF Special Drawing Right basket that includes the renminbi — have so far failed to replace the dollar.

These points may once have had some validity, but in a world that will be increasingly divided into two geopolitical spheres of influence — namely those surrounding the US and China — it is likely that a bipolar, rather than a multipolar, currency regime will eventually replace the unipolar one.

Complete exchange rate flexibility and international capital mobility is not necessary in order for a country to achieve reserve currency status. After all, in the era of the gold-exchange standard the dollar was dominant in spite of fixed exchange rates and widespread capital controls.

And while China may have capital controls, the US has its own version that may reduce the appeal of dollar assets among foes and relative friends. These include financial sanctions against its rivals, restrictions to inward investment in many national security-sensitive sectors and firms, and even secondary sanctions against friends who violate the primary ones.

In December, China and Saudi Arabia conducted their first transaction in renminbi. And it is not farfetched to think that Beijing could offer the Saudis and other Gulf Co-operation Council petrostates the ability to trade oil in RMB and to hold a greater share of their reserves in the Chinese currency.

It is likely that the GCC countries, as well as many other emerging market economies, may soon start accepting such Chinese offers given that they do a great deal more trade with China than the US. Also, there is a clear so-called Triffin dilemma in a currency regime in which the reserve country runs permanent current account deficits that will eventually undermine its reserve status as the growth in its international liabilities becomes unsustainable.

Critics question whether the currency of a country running a persistent current account surplus can ever achieve global reserve status. But China may in any case be moving towards a growth model less dependent on trade surpluses.

It is also an anachronism that the US, whose share of global gross domestic product has halved to 20 per cent since the second world war, still accounts for at least two-thirds of all so-called vehicle currency transactions. The current system makes emerging market economies financially and economically vulnerable to changes in US monetary policy driven by domestic factors such as inflation.

Finally, new technologies including CBDCs, payment systems such as WeChat Pay and Alipay, swap lines between China and other countries, and alternatives to Swift, will hasten the advent of a bipolar global monetary and financial system. For all these reasons, the relative decline of the US dollar as the main reserve currency is likely to occur over the next decade. The intensifying geopolitical contest between Washington and Beijing will inevitably be felt in a bipolar global reserve currency regime as well.