Digital currencies to end USD reserve?

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Macro Afternoon

Via Doubleline:

If launched, central bank digital currencies (CBDCs), as I have recently warned, will put at risk the independence of monetary policy and what little is left of fiscal discipline within their borders of circulation.1 Central banks are not stopping at the replacement of money as we have known it. In conjunction with their developmental work on digital currencies proper, monetary authorities are devising a new structure for electronic payments to sweep aside the decades-long framework for payment settlements, both domestic and international. The world’s central banks and the Bank of International Settlements (BIS) envision a network of multiple cross-border payment systems featuring direct bilateral exchanges in the world’s different currencies. Such a regime would discard the decades-long mediation through the world’s reserve currency, the U.S. dollar. This paper examines implementation plans for cross-border payment systems and the threat this new global order would pose to the dollar and its status as the world’s reserve currency.

King Dollar: A Brief History

The dollar has stood as the world’s reserve currency since taking that crown from the British pound in 1944. In July of that year, delegates from 44 nations met in Bretton Woods, N.H., convening the United Nations Monetary and Financial Conference, where they reached a series of agreements for the post-WWII international monetary system. The dollar formed the monetary linchpin of the new order. Participating nations pegged their currencies to the U.S. dollar and in exchange received the privilege to redeem dollars in gold from the U.S. (the world’s largest holder of gold reserves) at the congressionally set rate of $35 an ounce. This started a period of “exorbitant privilege” for the U.S., to quote former French Presidents Charles de Gaulle and Valéry Giscard d’Estaing. Ever since then, thanks to the dollar’s reserve status, the U.S. can run a balance-of-payments deficit without the need to adjust domestic policy in order to settle its international trade bill. Because most international trade is transacted in dollars, which I explain in more detail below, in the most-extreme cases, the U.S. can print dollars to settle its balance of payment needs. All other nations must purchase dollars to fund their imports, and one way to attract foreign capital is with high real interest rates (interest rates above the domestic rate of inflation). On the margin, tighter monetary policy slows growth and compresses imports while attracting foreign capital. The U.S. doesn’t face that trade-off thanks to the dollar’s privileged status as the world’s reserve currency.

By the end of the 1960s, rising inflation and a surplus of overseas dollars had made dollar-gold convertibility unsustainable, and President Richard Nixon unilaterally canceled it on Aug. 15, 1971.3 The “closing of the gold window” effectively doomed the system of fixed currency exchange rates elaborated at Bretton Woods. By 1973, the regime of fixed exchange rates gave way to free-floating exchange rates. Despite de facto nullification of Bretton Woods, the U.S. dollar has remained unquestioned as the world’s reserve currency. Most of the world’s trade is transacted in dollars, with the majority of commodities traded in dollars. According to the International Monetary Fund, the dollar plays a dominant role in global invoicing. Through April 2020, the BIS reported, “The US dollar retained its dominant currency status, being on one side of 88% of all trades. The share of trades with the euro on one side expanded somewhat, to 32%.” The Japanese yen ranked third, with the currency being used on one side of 17% of all trades.4

The grumblings of French heads of state and other critics notwithstanding, a reserve currency is useful. (Figure 1) It facilitates global transactions, investments and international debt issuance, and interest payment and repayment by acting as a common denominator accepted by all countries. However, new conditions might be converging to depreciate the dollar in the forex markets and even one day topple its crown as the world’s reserve currency. In that event, the past of the British pound might not be prologue for the dollar. If central banking and the BIS dethrone King Dollar, I suspect no single currency will seize the crown of reserve currency. Instead, cross-border payments would be mediated by a conglomeration of bilateral arrangements.

Admittedly, for countries outside the U.S., such a system offers a very positive, even compelling feature: All countries would be able to settle their import bills in their own currencies, a privilege afforded predominantly to the United States and, to a lesser but noteworthy extent, the 19 countries constituting the eurozone and Japan. Even these countries, however, are obliged to settle payments for certain non-U.S. imports, notably oil and other commodities, in dollars.

SWIFT and Usurpers in the Wings

A key to the longevity of the dollar’s reign as the world’s reserve currency is its occupation as the principal medium of exchange by the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the dominant provider of cross-border payment settlements. On May 3, 1973, which is to say, around the time fixed-rate forex regimes gave up the ghost, SWIFT was founded in Brussels with the support of 239 banks in 15 countries. Today, according to its website, the company connects more than 11,000 banks, securities organizations, market infrastructures and corporations in 200 countries. With the propagation of blockchain and cryptocurrency technologies, SWIFT faces fair and inevitable competition from new players in the private sector as well as older competitors in the business of the settlement of cross-border payment orders. SWIFT has been updating its infrastructure as well. In January 2017, the company rolled out its global payments innovation (gpi). In 2019, cross-border transfers via gpi exceeded $77 trillion, accounting for 56% of all cross-border payments for that year and 65% of SWIFT’s total cross-border payments, making gpi by far the most-used messaging system for international payment in the world.

Whatever its resilience or vulnerability to private-sector challengers, SWIFT’s dominance faces a serious threat from outside the private sector – namely, the central banks, coordinated by the BIS. In a recently issued paper, the BIS and cosignatories, including the U.S. Federal Reserve Board of Governors and the European Central Bank, stated, “Central bank innovation is an opportunity for cooperation. Simultaneous research and exploration of CBDC by central banks could inform ways to improve cross-border payments.” The BIS has been spearheading research into “faster, cheaper, more transparent and more inclusive cross-border  payment services [which] would deliver widespread benefits for citizens and economies worldwide, supporting economic growth, international trade, global development and financial inclusion.” The BIS has acknowledged that, despite technological advances in creating a new cross-border payments infrastructure, some of these central bank initiatives “are still in their design phase and others remain theoretical.” In a working paper published by the BIS, authors Raphel Auer, Giulio Cornelli and Jon Frost wrote, “Central banks are considering multiple technological options simultaneously, current proofs-of-concept tend to be based on distributed ledger technology (DLT) rather than a conventional technological infrastructure.” However, the landscape is quickly changing as more central banks scale up research into payment systems.

We have already started to see movement on these initiatives. China and Russia have already rolled out competing settlement systems to SWIFT, and both are looking into more bilateral settlement capabilities with their trading partners. In 2014, Russia implemented an alternative to SWIFT called the System for Transfer of Financial Messages (SPFS). SPFS was seen as a response to the U.S. using its dominance in the global financial system to implement sanctions on Russia, its companies and individuals. In 2015, China launched its Cross-Border Interbank Payments System (CIPS). Stung like Moscow by U.S. financial sanctions, Beijing is encouraging its financial sector to make the switch from SWIFT. As more central banks work on their own settlement systems, Russia and China have shown that implementation can be a realistic goal.

“Uneasy lies the head that wears a crown.”

I foresee several big implications of the implementation of a new global payments system based on the bilateral regimes, all of which would put structural pressure on the dollar.

First, such a decentralized global payments system would take the world a big step toward removing the need for the dollar, or for that matter any other currency, to remain as the world’s reserve currency. Cross-border counterparties would settle payments in bilateral transactions in their own currencies, bypassing the dollar as an intermediary. The U.S. imports much more than it exports. These large current-account deficits create the need to have foreigners put their excess savings into U.S. assets to help stabilize the dollar. If foreign savings cease flowing into the U.S., the dollar will depreciate unless the import-export imbalance is corrected. (Figure 2)

Second, global central banks would no longer need to stockpile dollars and instead could diversify their foreign exchange (FX) reserves to a mix more commensurate with the countries with which they trade and conduct financial transactions. Dollar debt remains a large source of financing for many countries around the globe, but sovereign, corporate and other institutional borrowers have already begun to move some of this external financing into other denominations such as the euro and the yen.

Third, disintermediation of the dollar in cross-border payments could erode the greenback’s central role in pricing commodities and invoicing global trade. This would reduce a structural buyer of dollars. Outside the U.S., central banks have been forced to build up their dollar FX reserves in order to prevent a disorderly sell-off if exporters do not repatriate their dollar profits. In addition, in a reversal of norms in place since Bretton Woods, non-U.S. central banks might look to increase their holdings of gold relative to their dollar reserves. Central banks might increase the portion of their reserves allocated to gold, whose finite supply could help reduce debasement fears with respect to infinitely creatable CBDCs.

The End of a Single World Reserve Currency?

With the exception of two world wars in the first half of the 20th century, the world’s financial systems since 1815 have calibrated their international payments and banking reserves to a single reserve currency, first the British pound and the U.S. dollar since 1944. The nearly 80-year absence of viable alternatives has left Americans complacent about the dollar’s perpetuity as the world’s reserve currency. Outside the U.S., however, central banks and governments appear to foresee a future untethered from the dollar. The technology for such a delinking is here or soon will be. Central banks will possess the infrastructure to match their FX reserves to the currency mix and weightings of their balance of payments – and one day displace the dollar without the need to crown a new reserve currency.

Policymakers continue to steer intently into the uncharted waters of central bank digital currencies and decentralized global payment systems. Despite most of these initiatives still being in their theoretical design phase, global coordination among central banks will speed up their development and potential implementation. Armed with these currency and payment technologies, the world could rescind the exorbitant privilege the U.S. has enjoyed as printer of the world’s reserve currency and place structural pressure on the dollar to depreciate.

The choice of bilateral currency settlements is strategic not economic. Hence this paradigm is more likely to end in currency blocks that overlay strategic alliances than they are the end of the USD per se.

This seems to be the basic direction for all Cold War 2.0 geo-economics. We’re seeing the development of regional technology, trading and now currency blocks.

It will become increasingly difficult for all nations not to pick sides as this world develops.

Houses and Holes
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  1. New Bretton Woods, IMF_sub_USDigital gets best of both worlds. Bonded bond domination AND advantage; german dishing off marks status for euro. We are all greek now, pass the parsley stalks.

  2. The ‘digital’ element could mean cheaper to transact and remove the banks as ticket clippers. Central bank accounts for citizens and MMT. But what of Cryptos?

  3. pfh007.comMEMBER

    It is only a matter of time before the private bank monopoly on trading in electronic central bank liabilities is terminated.

    It is an idea that is well past its use by date.

    Though we can expect that the spruikers for western banking and their useful idiots will deny this until their last breath.

    It is obvious that the citizens of a country should be able to deal directly in electronic central bank liabilities of the public central banks.

    If that upsets the banks business models well tough bitties. They should discuss their grief with the horse and buggy industries and the makers of fax machines.

    Don’t forget that the Eurodollar market is massive and is essentially a massive exercise in shadow banking anchored in the US banking system that evades any real form of regulation.

    The history of the Euro dollar market is very interesting but how it works is even more so. It essentially depends on the private US banks as the entry point and exit point to the market.

    It may have significant problems if private banks lose their central place in western monetary systems.

    The Chinese motivation for a CBDC is a bit different. They are seeking to undermine the effectively private ‘coins’ in the form of credit on Wechat etc. They don’t really like this ‘private’ approach plus they could offer access to BOC CBDC to selected good friends offshore who might find it very attractive to be able to settle transactions outside of the US banking system including the Eurodollar system.

    This article on Vox (apologies to Stewie gives and insight into why the western status quo are watching CBDC with degree of trepidation)

    The international dimension of a central bank digital currency

    Massimo Minesso Ferrari, Arnaud Mehl, Livio Stracca 12 October 2020

    The majority of central banks around the world are working on their own digital currency. This column argues that central bank digital currencies would not only have domestic macroeconomic and financial implications for the issuing economy, they would also have implications for the rest of the world. In particular, the unique characteristics of a central bank digital currency, if used internationally, would create a new ‘super charged’ uncovered interest parity condition which would induce stronger international linkages in a quantitatively relevant way.

    • You are excused – Vox do occasionally carry interesting articles not as drenched in their Globalist viewpoint and on this occasion you managed to find one 🙂

    • Jumping jack flash

      This goes back to the concept of currency. You can use anything as currency, but there are obvious and necessary rules about what will actually be accepted for completing a transaction.

      My currency is cowrie shells, but I can’t buy a haircut with them, I need to exchange them for the accepted currency first, and the exchange rate is pretty bad.

  4. Everyone to get their own blockchain assigned at birth… least we will be able to vote from home, but some Josef Stalin type will still be counting the blockchains coming in.

    • There only needs to be one public blockchain, just like there only needs to be one internet HTTP protocol. The blockchain that will succeed is the one that can carry the most data and process the most transactions at the cheapest price, while remaining the most stable from a protocol perspective – ie no dev’s constantly tinkering with the base code.

      As far as digital currencies go – the prototype is already here. There are any number of stable coins already being traded across various blockchains, USDT, USDC, etc. Once again, in this space the blockchain that is most efficient at carrying these digital tokens will be the one that wins the blockchain war.

      • Polkadot and Quant provide interoperability between many blockchains. And this is where Polkadot is seen as taking over many functions from Etherium, plus it’s much much cheaper and can do many time over trasactions per second.

        • Polkadot, Chainlink – they are all solving problems that are rendered obsolete by a single public blockchain. The inefficiency that is created by requiring different blockchains to talk to each other, instead of just being on a single blockchain, represents a transactional cost, or system ‘grit’, and for micro transactions at the dust level these costs matter greatly.

          Very few use cases exist for ANY single use blockchains to exist, and those that do exist will exist just as well, and cheaper, on a public blockchain. Many of the real use case apps that can benefit from a blockchain (if not sustain one by itself) are already porting over to BSV; Peergames, UNISOT Geospoke,
          to name just a few, eg:

          Already there are tokens now on BSV that are far cheaper and far easier to transact in than the ECR20 tokens. For example, they’ve just tokenised the value of Crypto held in the locked Crypto exchange OBEX:

          Apparently you can take a bet on the creditworthiness of OBEX and that they’ll be able to unlock their wallets, by buying the tokenised crypto stock of users of the OBEX who have it trapped in the exchange – currently they are trading at 70% of face value.

          The chain that will win is the one that delivers the lowest cost transaction that meets all the legal requirements to qualify as a recordable, legal transaction.

          Sending a billion dollars from one side of the world to the other for $8.30 transaction charge, which is what someone was skyting about in the BTC world the other day, isn’t anything new – people have been able to send billions of dollars around the world for years…. but sending 1c to the other side of the world? That is completely new, and plays into the actual discussion around central bank digital currencies.

          These central bank digital currencies will come, but they won’t come on their own blockchain – why would they need to? The template for they will functionally look like and work already exists as the stable currencies that are traded as tokens on existing blockchain networks, such as BTC’s omni and on Ether, and now BSV…. ultimately it becomes a game of economics with the most efficient blockchain the winner.

          • I think that there are people who have far greater ambitions with this than economic efficiency……….economics is about to disgrace itself once again in the time honored manner and will be stood in the corner for a while. This is going to be about control, whether it remains centralised or we localise……..personal blockchains will bind us to the centre in a way few will think about.

          • For those interested in a little history around Blockstream.


            No one has interposed themselves more effectively into the efficiencies that BTC Blockchain could have delivered more effectively than Blockstream, who have also mastered the art of the ‘sidechain’ which is effectively what Polkedot or ChainLink offer in respect of linking other blockchain solutions.

            They all derive their value from solving an inefficiency, in Blockstream’s case one that it creates by its arbitrary data cap, and in Polkedot or ChainLinks case, as a result of the inefficiency created by Blockstream, making it necessary to develop other blockchains for solutions (side chains) rather than on BTC chain solutions.

  5. How well will a blockchain based currency stack up when the central revenue services demand all tax is paid in the sovereign currency instead.

    Personally I think blockchain based currencies are a fantasy with the people that back it not fully understanding the inflation / deflation rivers in an economy.

    My Theory is something like this

    The issues in blockchains is there is only so many coins that can be determined. Once that occurs the pool no longer grows and we then get into a weird issue where you have to keep splitting coins up in order to make it usable……

    For example looking at just Bitcoin, but the example stands up for any blockchain style digital currency.
    there are 2.5T USD in circulation and only 21 Million Bitcoins available which makes the straight replacement cost of each coin to be about 120,000 USD per coin.

    The majority of transactions are currently in the $2 to $20 range so each coin has to be divided up to allow this transaction rate to occur. Its possible to divide a bitcoin into 100Million peices BUT the overheads of transactions increase with this division increase.

    Add to that the fact this 2.5T USD is only whats in circulation, there is large amounts of USD stored in Reserves and Debt etc, where actual currency is not actually kept, but the promise it will be repaid in the CURRENCY.

    Bitcoin means the approach of transacting in a way that equates to shifting and adjusting balances means this is no longer possible so you have to add the approximate $7T USD held in reserves to the 2.5T. So for arguments sake lets say the actual $ to Bitcoin value transfer is really $450000… and now Only 1/4 of this is actually in circulation meaning the slicing up of Bitcoin is now focused in the transacted 1/4 of the pool, creating a deflationary scenario.

    Now as this 1/4 keeps being carved up and used, driving deflation the value of bitcoins held in reserve sky rockets due to the 3/4 to 1/4 leverage… So it becomes a really attractive proposition to sit on the coins, Making the pool smaller and as a result making it worse until the entire system grinds to a halt. And the only way to reset is to create a new currency almost instantly devaluing the current one and then rinse, repeat…

    Every blockchain style currency holds the same issue.

    • Jumping jack flash

      “And the only way to reset is to create a new currency almost instantly devaluing the current one and then rinse, repeat…”

      If this is true, then the obvious advantage of a pure digital currency is that this can happen almost instantly, and as many times (a day) that it needs to.

      • If it happens too regularly then there is no confidence in any currency and each reset would result in more consolidation of wealth with those who have it….

        • Jumping jack flash

          Of course. My point was that with digital it can theoretically be sped up to ludicrous speed, and algorithms/AI can manage all those minor details like booms, busts, crises, etc, and maintain the status quo. We could theoretically have several booms and busts in a day, and nobody would be any the wiser except everyone gets paid in currency revision 34-A7H2 in the afternoon, and through the magic of blockchain this is all managed seamlessly when we want to buy a haircut.

  6. Jumping jack flash

    You can trade in any currency you like, you can make any currency the “reserve” currency, but as far as I’m aware the OPEC deal with Saudi Arabia still stands that to buy OPEC oil you need to use USD. Everyone needs oil, so everyone needs a stash of USD. It is mighty convenient to just use USD for general trade, otherwise you’d need to buy a load of currency to trade in (the “reserve” currency) and then still keep a stash of USD to buy oil with.

    Unless they change it, and then look out S.A, you’ll suddenly find yourself “liberated”, or taken over by the Russians.

    • boomengineeringMEMBER

      That’s one of the reasons for the Gulf War, they wanted to trade in gold rather than USD, the yanks didn’t like that one bit.

  7. Well … I’m not sure. The US is the global hegemon by virtue of the fact that King Dollar is the world’s reserve currency. Once the King Dollar is dethroned and becomes “just another currency” the US will struggle to be as dominant militarily as it has been. Certainly their ability to fund such a vast military (1000 bases around the world and the largest nuclear arsenal) will be severely compromised.

    I’m not sure they would willingly go down this road.

    • Jumping jack flash

      You’re right.
      They’ll still have their petrodollar of course all other things being equal, so everyone will still need to buy at least some USD while they need OPEC oil, but in general their currency and their benefits from it would definitely be affected.

      And the US still has plenty of big sticks to enforce their wishes on the earth, or so they say.

    • – Those (about) 1000 military bases outside the US are paid for by the rest of the world. So, the world is fuinding the costs of their “occupation” by US troops. Anyone who knowledge of Balance of payments issues knows how that funding mechanism works.

        • – Australia also spends A LOT OF money for US made weapon systems.
          – Again: If you have knowledge of Balance of Payments then you’ll know in which corner of the (US) financial system you must look/at what 2 financial metrics you must watch (relative to each other).
          – The US consumer is actually suffering under those US “military adventures” outside the US as well. Not only as a result of higher taxation but also under the (increased) outflow of USDs. An “increased” outflow of USDs means that e.g. the price of oil (in USD) is higher than without those “military adventures”. It’s hard to get a decent estimate on how much more the US consumers is paying more for gasoline as a result of those “foreign military adventures”. But I think it’s a reasonable guess is that the US consumer pays somewhere between say 30 to 80/90 cents more for a gallon of gasoline. So, bring all the troops home and the price of gasoline will go down as well.

  8. When they can tax people, project force, and not be able to be repudiated by government I’ll stop belly laughing. Same as any other major currency with any wealth and army. Utterly ridiculous.

  9. – The USD will be no longer the world’s reserve currency when the US starts to run (chronic) Trade Surplusses. What the USD will be replaced with is still up in the air.

      • – When US domestic demand collapses. We saw that in 2008 as well. The US went through the GFC and US consumers (dramatically) reduced their consumption/spending > shrinking US Trade Deficit / US Current Account Deficit.
        – Again, when you have knowledge of Balance of Payments issues you know in which corner of the US financial system you have to look.
        – Speaking of which: 2 US financial metrics were (relative to each other) in favour of the US between say 1995 and 2008/2009. After the year 2008 these 2 financial metrics (again: the key here is relative to each other) actually were (again) (very) detrimental for the US.
        – And the Trump administration has made this (relative) “detrimental” situation (much) much worse. Think: “growing” budget deficits + tax cuts. Yes, the US federal budget deficit “increased” in 2020 as a result of the COVID-19 “problems”. But even in 2017 through 2019 the US budget deficits went “ballistic”. And I DO NOT only blame the Republicans. The Democrats were als lining up when the Trump administration was doling out those (corporate) taxcuts. But these “growing” (federal) budget deficits are a REAL danger for the US economy & the USD as a reserve currency. The MMT idiots say that deficits don’t matter but these guys seem to don’t have any knowledge of (International) Balance of Payments issues.

  10. The most fascinating thing the US treasury is considering is opening a digital account for each US citizen and depositing freshly minted Digital USD dollars.

    Nothing special EXCEPT these don’t sit in a bank account. The reside in a ledger held by the Treasury which credits you with these $.

    I find it fascinating to consider how this would interface with the fractional reserve banking model where every new $ is the result of credit expansion and only credit repayment of write off ever destroys $.

    If we extrapolate this then all dollars if digital could sit outside of bank deposit accounts. IF banks wanted you to desposit your digital $ so they could on-lend them they’d have to attract you to them using interest rates that by default won’t be negative.

    None of this stops (and nor is it intended to stop) digital currency debasement however. Seniorage won’t be going away until we are exchanging with non-CB digital currencies with fixed supply, like BTC for example.