Foreign Affairs (USA): the future of the dollar

In late March, global financial markets began to crumble amid the chaos caused by a pandemic of a novel coronavirus. International investors immediately began to seek solace in the dollar as they did during the financial crisis of 2008 and the Federal reserve had to make huge amount of dollars available for its global partners. Since the end of the Second world war has been 75 years, but the dollar still retains the primacy on the world stage.

The continued dominance of the dollar is quite remarkable, especially given the rise of emerging markets and the relative weakening of the U.S. economy in 1960 the share of the United States accounted for 40% of world GDP, and today only 25%. However, the status of the dollar will depend on the ability of Washington to brave the storm сovid-19 and to develop a strategy that will eventually allow the country to address the issues of its national debt and structural budget deficit.

The status of the dollar has value. The role of the dollar as the main global reserve currency allows the United States to pay lower interest rates on dollar assets than they would have had in other circumstances. Not less important is the fact that it allows the United States to have more significant trade deficits, reduces exchange rate risks and making American financial markets more liquid. Finally, it is advantageous to U.S. banks because they have better access to dollar funding.

The fact that the dollar has managed to retain such a high status for such a long period of time is a historical anomaly, particularly in the context of the growing power of Beijing. Currently, the Chinese yuan has the most potential to take over the role now played by the dollar. The size of the Chinese economy, prospects of future growth, its integration into the global economy and increasing attempts to internationalize the yuan point to the expansion of the role of the Chinese currency in the future. But in themselves these conditions will not be enough. And the widely publicized successes of China in the field of financial technologies — including the rapid development of mobile payment systems and recent pilot project in which the people’s Bank of China began testing a digital Renminbi — won’t change that. A digital currency that supports the Central Bank does not change the fundamental nature of the yuan.

Beijing will have to overcome many obstacles before the RMB can become a truly major global reserve currency. In addition to a number of radical measures it will be necessary to achieve greater progress in the transition to a market economy, improve corporate governance and create effective, well-organized financial markets, which has earned the respect of international investors that Beijing could remove restrictions on the movement of capital and to turn the yuan into a currency market.

Washington should clearly understand what really is at stake in his rivalry with China. The United States should maintain superiority in the field of financial and technological innovation, however, there is no need to exaggerate the impact of Chinese digital currency to the us dollar. First and foremost the United States must preserve the conditions that initially allowed the dollar to occupy a dominant position: it’s a dynamic economy, which is based on prudent macroeconomic and fiscal policies; transparent, open political system; a leadership position in world politics, economy and security. In short, the conservation status of the dollar will not depend on what is happening in China. It will almost completely depend on the ability of the United States to adapt its economy after the end of the pandemic Covid-19 so that it remain a model of success.

Competition of China in the field of financial technologies

Many of those who returned from China, talk with enthusiasm about how non-cash this country. From buying food in the shop around the corner to help beggars, — now all calculations in China are using smartphones and QR codes. The rows of ATMs in the past. Chinese companies increasingly compete with each other in the field of financial technology, and Chinese consumers are their main users.

These facts regularly, and impel experts on the idea that the dominance of China in the field of financial technologies will soon threaten the global status of the dollar. However, this should not be considered a serious threat because the United States is still among the leaders in the field of financial technologies. China was a pioneer in the financial technology field, he quickly adopted them and increased their scope. Chinese tech giants Alibaba and Tencent were the first to develop services that make digital transactions much more efficient and attracted a huge market of customers who do not have Bank accounts, primarily in rural China. The extent of use of their services was phenomenal. For example, in 2018, the volume of mobile payments in China reached 41.5 trillion dollars.

This success became possible primarily because of the existing financial infrastructure of China was outdated, and the state banking system is ineffective. Not less important is the fact that credit cards in China and has not caught on, so when smartphones have become cheap and ubiquitous, the opportunity to jump from an economy of cash payments to mobile banking.

No matter how “cashless” may now China, many Americans today can hardly remember the last time they used cash, not counting small purchases. Today, they can instantly transfer money from one Bank account to another without any loss. Such mobile payment services like Venmo and Apple Pay, work just as well, as Alipay and WeChat. However, the majority of Americans still prefer credit cards, because using them is as convenient as the use of mobile phones and the current financial system safe, efficient and reliable.

Chinese technology companies have accelerated the pace of innovation to meet the growing customer needs and to compensate for the inefficiency of the Chinese financial infrastructure. Moreover, they started to export their technologies to developing countries, whose emerging economy is in need of immediate widespread proliferation of smartphones and thus give Chinese companies an excellent opportunity to capture there market share.

The form and content of

Although the Chinese Central Bank could launch a digital currency already this year, the media often exaggerate the extent of the transformation will be its impact. Those who worry that the emergence of Chinese digital currency could mark the end of the primacy of the dollar, do not understand one thing: although the form of money may change, their essence remains the same.

Digital Renminbi will remain the Chinese yuan. No one invents new money. The symbols used in the calculations may change, but China’s ability to turn the yuan into a reserve currency will depend on the same set of factors applicable to the Issuer of the currency. And although the Chinese government insists on the use of digital Renminbi for transactions in the framework of its attempts to internationalize its currency, oil and other raw materials still are priced in us dollars.

The fact that the us dollar established as a global reserve currency, was hardly predetermined. The primacy of the dollar was the result of a combination of historical accident, geopolitical conditions prevailing after the Second world war, the policy of the US Federal reserve, as well as the size and dynamic development of the American economy. Today the “natural monopoly” of the us dollar may seem to be an integral element of the international system, but in the first half of the 20th century, the U.S. dollar and the British pound, in fact, had equal status as a reserve currency.

Over time, the international monetary system, most likely, again will give relatively equal weight to two or more reserve currencies. The main contender for this status is now the Chinese yuan, which has already become a reserve currency along with the yen, Euro and pound sterling. And if there is no disaster in the foreseeable future the Chinese economy will continue to move towards becoming the largest economy in the world. In addition, she will be the first major economy to recover after the crisis coronavirus.

Nevertheless, the fact that the Chinese yuan will become a reserve currency on a par with the American dollar, cannot be considered a foregone conclusion a fact. To achieve this status, China needs to reform its economy and create capital markets with such mechanisms, which can turn to Beijing a lot of political problems. The implementation of recent Chinese ambitions that required for such transformations, such as transformation of Shanghai into a global financial capital by 2020 — while he was suspended: financial centre simply cannot exist if there are strict instruments of control over the movement of capital and if the exchange rate is not determined by market mechanisms. The same can be said about the prospects of turning the yuan into a major reserve currency.

Although supported by the Beijing digital currency itself is unlikely to weaken the dollar’s dominance, it can accelerate the pace of internationalization of the RMB. In countries with unstable currencies such as Venezuela, digital yuan is a very attractive alternative to the local currency. Such Chinese companies like Tencent, which already has an impressive presence in the developing countries of Africa and Latin America, may further increase its presence and share in these markets through the use of digital yuan. This can improve the global status of the yuan and become part of the wider strategy of Beijing by projecting economic and political influence of China abroad.

Promoting innovation in the United States

While the United States is worth less to worry about the end of the era of the primacy of the dollar as a global reserve currency and more worried about the ability of the U.S. private sector to introduce new financial technologies. The idea of digital currency came to mind not only the Chinese, and it can promote not only the Central banks. Financial innovation in digital currency and mobile payments appear in the American private business.

Meanwhile, in these new technologies carry inherent risks. Without guarantees powerful data protection to implement this technology everywhere it would be difficult. Moreover, these new technologies can facilitate money laundering and other illegal financial activities, which also should cause some concern.

Silicon valley and wall Street have long led the campaign for financial innovation, new digital platforms for payments and new forms of money. If the fruits of these innovations will be implemented, us companies will be able to create the best, safest and most secure currency in the world, has a mechanism of protection against illicit financial activity. As a result, the increase of efficiency and reduction of transaction costs will bring significant benefits to consumers.

Thus, policymakers must find a balance between reducing the risks associated with the development of these new technologies, and support the ability of private American companies to innovate. The danger is that overzealous American regulators can raise the barrier of entry for American firms, forcing them to serve the interests of those who prefer digital financial transactions, not those who make choice in favor of the traditional banking or those who do not have accounts in banks — according to the world Bank, in the world of such people is about 2 billion, and most of them live in developing countries with weaker financial markets and unstable currencies.

Dollar supremacy begins in his homeland

It is worth emphasizing that the United States should seriously treat China as a strong economic competitor. But, if we talk about the superiority of the dollar, then the main risks stem not from Beijing but from Washington. The United States must support an economy that will the world to inspire a sense of security and confidence. If this is not done, then eventually the status of the dollar will be threatened.

The status of the dollar is a reflection of the fundamental health of the American political and economic systems. To protect the dollar, the us economy should remain a model of success and a role model. And this requires a political system that is able to implement the strategy, allowing Americans to achieve economic prosperity. This requires a political system that is able to maintain the fiscal health of the country. In the history there was not a single example of a country which has been for a long time to stay on top of in the absence of fiscal prudence. The political system of the United States must quickly respond to current economic challenges.

The economic policy of the United States abroad is also of great importance, because it affects the credibility of America and many defines its ability to effectively influence the course of world events. To maintain its leadership position, the United States should take the initiative to improve global norms and rules that govern trade, investment and competition in the field of technology to reflect the realities of the 21st century.

Washington also needs to remember that unilateral sanctions — possible due to the primacy of the dollar, entail certain costs. If you use the dollar as a weapon, it can push allies and enemies of the United States to the development of alternative reserve currencies — and perhaps even to join forces in the process. For this reason, the EU insists on the further expansion of the use of Euro in international settlements.

Similarly, the answer to the question of whether the RMB an important reserve currency along with the dollar, will be determined by whether China can restructure its economy. But if China successfully implements the necessary reforms, it will create an economy that will become more attractive for the export of American goods and services, and more favorable conditions for American companies operating in China. These changes will bring significant benefits to the United States.

The value of the national currency for its holders — is ultimately a reflection of major political and economic indicators of the country. How the United States will evolve in the coming years after the end of the coronavirus crisis, will be important tests. First and foremost, the United States should pursue a macroeconomic policy that will allow them over time to address the issues of national debt and structural budget deficit. They should not squander the foundations that support their economic strength and based on the spirit of innovation and efficient management. If Washington is to stay the course, we have every reason to trust the dollar.

Henry Paulson Jr. — Chairman of the Paulson Institute. From 2006 to 209 years he served as Secretary of the Treasury.