The world’s financial system is in a precarious state. For the first time in many decades, the long-term stability of the U.S. dollar is being questioned.
President Donald Trump’s on-going trade wars and threats of tariffs against virtually any nation which has the temerity to question his judgement or fails to act in a fashion he approves makes investors nervous — understandably.
For the entire period since the end of the Second World War, the U.S. dollar has been the preferred way to hold wealth and the preferred medium of exchange for international trade. Based in a country governed by the rule of law, home to some of the world’s largest financial institutions, with deep and diverse financial markets, it stood virtually alone among currencies.
That position afforded the U.S. immense power.
Particularly after it dropped the greenback’s link to a fixed price for gold back in the 1970s, the U.S. really was exempt from concern about trade deficits. Those deficits provided dollars for nations and individuals to hold as safe and a highly liquid form of wealth. In essence the U.S. dollar became the world’s currency.
But Trump’s disruptive actions have changed all that. Holding dollars now has a level of risk associated with it and the big question becomes: If not the U.S. dollar, what currency do you hold as a store of value?
There are really only three candidates to become a new reserve currency: the Euro, the Japanese Yen and the Chinese Renminbi. But each has major deficiencies.
While the Japanese economy is strong and important, it is not growing. Japan’s population is stagnant and likely to shrink in the coming decade and its financial institutions, while large and solid, are nowhere near as important as those in the U.S. Moreover, Japan is a close ally of the U.S. and is vulnerable to great pressure from Trump, particularly in matters of defence.
The Euro is an even more complicated problem. First, the major financial centre in Europe is London even though the UK is not a member of the Euro group. Moreover, the future of London’s position is uncertain, at least until the question of Britain leaving the European Community is settled. If it does leave, and especially if it is without an agreement, then certainly a new European financial centre will be formed. Exactly where is the big question. Germany and France would vie to host a major financial centre.
But perhaps Amsterdam might be chosen to prevent one of the two biggest economies cementing a dominant position.
Furthermore, the Euro itself, while it has a central bank, also has a multitude of countries that issue Euros and their fiscal rectitude varies greatly. Italy, in particular, is in a very precarious position with both massive debt and a massive budget deficit. But, to allow Europe to act as a centralized power would require the Euro states to surrender sovereignty and that is not going to happen any time soon. So the long-term vitality and stability of the Euro is in question.
The Chinese Renminbi could aspire to be an international currency, given the sheer size of the Chinese economy and its extensive trade with the rest of the world. But that is highly unlikely in the foreseeable future owing to the fact that its government does not adhere to a transparent rule of law. The sanctity of contracts is far from certain and how China regulates foreign investment and trade is far from predictable. Thus holding wealth in the form of Renminbi is risky and as long as that is the case, it will not become a major international reserve currency.
The International Monetary Fund might be able to assume a role. It already does to some degree but the ability to create reserve finds would require revision to the treaty establishing it. It is doubtful that Trump would agree to any revision that would diminish in any way the power the US holds within the organization.
So the world is faced with a seemingly unsolvable problem and, as a consequence, world trade and economic growth will slow appreciably over the coming years. Unless, of course, Trump is defeated in the next election.
David Bond is a retired bank economist who resides in Kelowna.