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Relax about USD reserve status. For me, the important point about this is the scale of shock needed to shift the system. We would need to see China with the largest or most imposing military presence and production worldwide. It would need to run huge current account deficits. And we’d need to see the epi-center of global financial markets shift to an opaque and sovereign risk-laden China. Tectonic hardly covers it.
Meyrick Chapman is the principal of Hedge Analytics and a former portfolio manager at Elliott Management and bond strategist at UBS. At FTAlphaville.
A famous Simpsons episode shows Homer selling his soul for a doughnut. Thinking he can outwit the Devil if he doesn’t quite finish it, Homer gleefully chants “I’m smarter than the Devil”. You can guess how it ends.
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It is as difficult to escape the dollar’s contractual reach in trade as it was for Homer to escape his promise to the Prince of Darkness. The greenback plays an outsized role in international trade, both in an absolute sense and relative to the US share of global output.
So dominant is the greenback that the end of dollar hegemony is a comically distant prospect. The Devil’s contract is here to stay.
A potted history of how dollarisation began helps frame the likelihood of de-dollarisation. After WWII the US was both the largest economy in the world and the only major economy to emerge unscathed. Choosing payment in dollars was the only rational response of international traders, as the economies of alternatives such as British pounds or French francs were badly damaged. In most cases, dollars were the first and only choice to inspire the trust of sellers.
Nor was it only commodity producers that adopted the dollar. As European economies recovered all of them aimed at generating dollar earnings through exports to America. The process of dollarisation emerged at the behest of non-American traders, rather than as a US government plan to embed its currency into the world economy.
All these benefits remain, despite the passage of nearly 80 years. Just because we have economies that rival the size of America doesn’t mean their currencies can rival the dollar. Impartial acceptance is key. In fact, over 80 per cent of all international trade is invoiced in dollars, according to the Federal Reserve.
Only Europe bucks the trend, and this is due to invoicing in euros within the eurozone. That is a big box of doughnuts. Even if some trade becomes redenominated into other currencies, the dollar is currently so dominant that it would have little meaningful effect for a very long time.
But who would re-denominate away from dollars? If it was attractive to do so, there is no reason why intermediate or manufactured goods should not already be invoiced in another currency.
The reality is that this hasn’t happened because the benefits don’t match the costs. In fact, the only sectors incentivised to re-denominate are those involving primary goods traded by geostrategic rivals of the US. But trade denominated in non-dollar currencies for entirely political reasons is certain to account only for a portion of total trade in any resource.
Total exports of agricultural and extractive commodities (mostly stuff we dig or pump out from the ground) amounted to $4.9tn in 2019 according to WTO and Unctad estimates. Total combined commodity trade amounts to about 20 per cent of the value of total exports. About 50 per cent of exports of agricultural commodities are actually from developed countries and about 35 per cent of extractive commodities.
Some developed countries may strive to replace commodity contracts with their own (or other) currencies. But this would simply amount to an accounting exercise and would probably barely affect the dominance of the dollar. For developing countries there may be some benefits from switching to renminbi, but the proportion of renminbi-denominated trade is likely to remain low, possibly forever.
Does the US benefit from dollarisation? Surprisingly, the advantages may be relatively modest. Dollarisation slightly increases the demand for dollars at the time of transaction. But trade is a flow, not a stock. All dollars are ultimately linked back to the US banking system, so once a trade is completed the dollars are free to circulate anywhere. The value of the dollar is barely affected.
And when compared to total international trade, and in particular total turnover of foreign exchange, the amounts are large, but not significant compared to total daily turnover.
So Saudi Arabia’s recent suggestions that it may switch some of oil contracts into yuan should be taken with a pinch of salt. And the excited talk that the dollar is losing its grip as a reserve currency misses the point.
Any switch away from the dollar would, in terms of economic impact, barely be measurable, even if it generates energetic headlines. And note that the Saudi proposal is only for “some” contracts to be redenominated. The announcement looks more like a geopolitical backslapping ruse than a serious threat to the dollar.
The dollar commands such widespread usage that only a multi-decade shift is likely to have any impact. No one is smarter than the Devil.