Many people, including some experts, think the US dollar's status as a major global reserve currency is in danger. Because of US deficit spending and debt. But the other options out there have worse problems than the USD.
Dollar Doomsayers Are Wrong—Again
The dollar’s status as the global reserve currency is in grave danger—at least that’s what a growing chorus of pundits and observers are saying. The U.S. government has embarked on a debt-driven spending spree as the country grapples with the COVID-19 pandemic and its economic repercussions. This explosion of U.S. borrowing, combined with more “money printing” by the Federal Reserve, has led mega-investors, hedge fund managers, economists and elite financial institutions to sound the alarm in recent months. ...
America’s fiscal and monetary policy efforts to prop up the economy amid the pandemic, these doomsayers argue, are doing long-term damage to the dollar. Further “debasement” of the currency will lead to rising inflation, dollar depreciation and ultimately a collapse of global confidence in its stable value. When that happens, they warn, global investors will flock out of the dollar into other, more stable currencies—a list that usually includes the Chinese renminbi, also known as the yuan.
Over the past decade, the global appeal of the yuan has improved. Yet, China’s currency remains something of a bit player. That may change in the next decade, but investors will likely be cautious about becoming overly exposed to the “redback,” for reasons that have little to do with finance and much to do with politics.
In the months following the global financial crisis of 2008, predictions of the dollar’s demise were also rampant, and China seemed open to seizing on the moment. Zhou Xiaochuan, then chair of the People’s Bank of China, publicly criticized global dependence on the dollar. China appeared to be embarking on a range of policies that would encourage global investment in its currency, effectively giving the world’s investors an alternative to the dollar.
In reality, while China talked a big game, actual progress on improving the yuan’s attractiveness was slow. For years, the biggest hindrance was Beijing’s unwillingness to fully open Chinese financial markets to international investors. Until 2015, foreign central banks interested in purchasing yuan-denominated bonds had to request permission from the Chinese government to access the country’s financial markets. Even when such permission was granted, investments were capped according to an assigned quota.
Over the past five years, however, reforms have picked up some steam. For example, investment quotas for central banks were scrapped in 2015. Two years later, in an effort to improve transparency and increase investor confidence in its financial products, Beijing allowed oversees credit rating agencies to rate the quality of Chinese bonds. Then in 2019, under pressure from Beijing, Morgan Stanley Capital International, a major financial index provider, added a bevy of Chinese stocks to one of its key benchmarks, the Emerging Markets Index, prompting a flood of foreign investment into Chinese equity markets.
Foreign investments in yuan-denominated assets have ballooned significantly over the past five years. Bond holdings alone are up more than threefold since 2015, and up 50 percent in 2020 alone. Economic incentives are clearly behind such moves. For example, the yield on a 10-year Chinese government bond is about 2 percent higher than for a corresponding 10-year U.S. government bond—a sizeable spread in today’s world of ultra-low interest rates.
In the long run, the dollar is likely to outlive predictions of its demise not because of its inherent attractiveness, but because of its competitors’ flaws.