As the U.S. fights China to retain its position as the world's preeminent economy, there is one arena in which it reigns supreme: currency markets.
While the rise of China and many of its Asian neighbors has seen the U.S. share of global exports fall from 21.6% in 1948 to 8.5% in 2018, the dollar is still involved in almost half of all currency transactions.
Greenbacks make up about 63% of foreign currency reserves held by central banks, compared with an average 57.1% over the past quarter century. That compares with 20.7% for euros and 1.9% for the Chinese renminbi. The British pound, from which the dollar took the crown of global reserve currency following WWII, made up just 4.43%.
Apart from securing bragging rights over its rivals, the dollar's role as the grease that smooths the wheels of global commerce grants the U.S. extraordinary power, described in the 1960s by then-French Minister of Finance Valéry Giscard d'Estaing as an "exorbitant privilege."
That "privilege" can be seen in higher returns on U.S. assets, lower borrowing costs and unprecedented control over the global financial system, which the U.S. government has used, and continues to use, as a weapon to punish what it considers errant countries, such as Iran and Russia.
"While I see the administration's enlisting of the dollar's exorbitant privilege as a weapon encouraging efforts to explore [alternatives], absent some full blown conflict, I don't see institutions dumping the dollar," said Barry Eichengreen, professor of economics at the University of California, Berkeley and author of Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System.
End of empire
The dollar has been the dominant currency in global trade since the 1930s, usurping the pound sterling, which crumbled in significance along with the British Empire. But it was not until the late 1970s that the pound lost its status as the world's reserve currency as the international monetary system slowly weaned itself off sterling.
However, the dollar's status is not guaranteed. The U.S. has pushed the limits of its privilege in recent years, allowing its fiscal deficit and debt to balloon to previously unheard-of levels, while its use of the global financial system against its adversaries has seen many of them look for ways to operate without recourse to the dollar.
In 2014, Beijing and Moscow signed a 150 billion yuan central bank liquidity swap line agreement to get around American sanctions. Iran is locked out of the SWIFT global payments systems, while Russian banks, including Gazprombank OJSC and Vnesheconombank, and energy companies Rosneft Oil Co. PJSC and PAO NOVATEK have suffered transaction bans with U.S. entities.
In response to the U.S. pulling out of the Obama-era nuclear accord with Iran, other signatories to the agreement, the U.K., France and Germany, devised Instrument in Support of Trade Exchanges, a system for processing payments while avoiding cross-border financial transactions that could fall foul of the U.S. But the system only applies to humanitarian products such as food and medicine, much to Iran's displeasure.
The euro, the world's second most prevalent currency in global trade since its launch in 1999, and the Chinese yuan, which represents the world's second-largest economy, are the leading pretenders to the dollar's throne, but both have major obstacles to become an accepted international benchmark.
Euro's rise and fall
More than a decade ago, markets were watching closely for signs that the dollar was losing favor among reserve managers at central banks as the euro gained strength against a U.S. currency beset by concerns about the subprime crisis. Even the world of hip hop got involved, with rapper Jay-Z flashing wads of €500 notes in the 2007 video to "Blue Magic."
However, the euro peaked at $1.6038 on July 15, 2008, and ended the year at about $1.39 as it became clear that the financial crisis was global. It was trading at $1.1155 at 6:07 a.m. ET on May 21.
That same year, former U.S. Federal Reserve Chairman Alan Greenspan said it was "absolutely conceivable that the euro will replace the U.S. dollar as reserve currency, or will be traded as an equally important reserve currency."
The eurozone debt crisis has since put paid to any ambitions the single currency may have had to take the dollar's crown. The euro also plays a different role globally to the dollar.
Whereas the Fed had the capacity to print dollars when liquidity dried up during the global financial crisis, the ECB is confined by its strict mandate to target inflation of 2%. To achieve greater internationalization, the European Commission would have to change the ECB's mandate, "assuming wider international responsibilities, such as extending swap lines during crises," said Rongrong Huo, executive director at Investec Asset Management.
After peaking at 28% of global reserves in 2009, the euro represented 20.7% of central bank coffers at the end of 2018.
Also weighing on the euro's chances of posing a serious challenge to the dollar is the fact that almost all trade transactions involving the single currency feature at least one eurozone country, whereas 80% of dollar-denominated imports never enter the U.S., according to the Bank for International Settlements.
The euro area also runs a large current account surplus with the rest of the world, totaling €184 billion in 2018, according to Eurostat. That does not lend itself to large currency outflows, instead draining euros from international markets.
Eichengreen expects the euro to gain traction, particularly with those countries on its periphery, which trade more with European countries than the U.S. Similarly, as the yuan develops, he expects Asian countries to wean themselves off the dollar.
However, the yuan has thus far disappointed those who predicted that China's currency would match the meteoric rise of its economy and take a more global role. Despite being used in a growing amount of trade, the government's tight control of the yuan's movement in and out of China and the looming specter of intervention mean it plays a relatively small international role.
China's yuan officially became a world reserve currency October 1, 2016, and represents 10.92% of the IMF's special drawing rights, the third-biggest share after the dollar and euro.
However, its share of global central bank reserves is considerably smaller, at 1.89% at the end of 2018, up from 1.23% a year earlier, IMF data shows.
While the yuan ended its peg to the dollar in 2005, its exchange rate is not allowed to float completely freely and instead trades within a 2% band around a reference price published daily by the People's Bank of China. Capital controls also limit investors' ability to move yuan out of China at will.
A lack of liquidity and depth in Chinese capital markets is a major hurdle to overcome, according to Sergey Dergachev, an emerging markets portfolio manager at Union Investment. China needs more comprehensive bankruptcy laws and improved corporate transparency, but Dergachev expects that it will take 10 years for Chinese corporate debt markets to open up fully.
Still, China's structural shift away from an export-oriented economy to a consumption-led model continues to boost yuan liquidity in global markets.
"As China's current account deficits become more frequent, it may have to run down foreign assets or borrow more from abroad to pay for its consumption," said Huo. "China would naturally prefer to borrow in its own currency rather than incur foreign debt. As a result, China has an incentive to continue with the internationalization of the yuan and reduce reliance on the dollar."
China's position as the biggest importer of commodities has also given a push to efforts to challenge the dollar's supremacy in the trade of raw materials. Oil companies in Russia, Iran and Venezuela — all subject to U.S. sanctions — have begun accepting yuan as payment for Chinese imports, while China has launched petro-yuan futures on the Shanghai International Energy Exchange.
The emergence of U.S. shale as a major contributor to global oil supply — the U.S. became the world's biggest oil producer in 2018 — and the commitment of Saudi Arabia, the biggest oil exporter, to trade crude in dollars following an agreement with the U.S. in the 1970s, mean the U.S. currency's dominance of commodity markets is unlikely to decline any time soon.
"[Chinese] markets are volatile, ability to move money across borders is still limited, there's not an enthusiasm that I can detect from investors to park all their money in Shanghai," Eichengreen said. "The dollar is still the least dirty shirt in the pile."