Cryptocurrencies and China Imperil the Reserve Currency Status of the US Dollar
In his book Denationalisation of Money, F.A. Hayek argued that governments have never devoted their power to providing proper money over time. They “have refrained from grossly abusing it only when they were under such a discipline as the gold standard imposed.”1 The gold backing of the US dollar as the global reserve currency was lifted in the early 1970s, and paper currencies, so-called fiat currencies, have since become the norm. Following this decision, the paper currencies have dramatically lost value against gold (figure 1). Since the turn of the millennium, this process has substantially accelerated.
Figure 1: Gold Price in US Dollars
For the past twenty to thirty years, the Federal Reserve and other major central banks have been steadily lowering interest rates and purchasing large amounts of government bonds as well as other assets such as corporate bonds and asset-backed securities. This has undermined the confidence in the US dollar and the euro as the world’s leading reserve currencies. A flight into tangible assets has set in, such that stocks, real estate, and precious metals have risen sharply in price. Competitors for the “exorbitant privilege” (Giscard d’Estaing) of the reserve currency have appeared, as those who issue the global reserve currencies benefit from virtually unlimited borrowing opportunities and immense profits from money creation.2 The competition has three dimensions.
Firstly, decentralized private digital currencies have emerged in contrast to the public monopolies on creating money. Anyone can create (mine) the pioneer bitcoin, but the supply is credibly limited. The exchange rates to paper (fiat) currencies float. Unlike the fiat moneys, which are based on the traditional banking system, payments are cryptographically legitimized and do not require a central intermediary. Other cryptocurrencies (decentralized or centralized) such as ether, ripple, tether, and dogecoin have been created (“altcoins”), but they are considered only more or (mostly) less equal to bitcoin in terms of credibility. The sharp increase in the value of cryptocurrencies measured in fiat currencies (figure 2) indicates that—despite strong fluctuations—many people trust in their store-of-value function.
Figure 2: Price of a Bitcoin in US Dollars
Secondly, a consortium of private companies around the internet giant Facebook intends to join in the competition for the money monopoly. In contrast to many cryptocurrencies, diem (formerly libra) is to be pegged to the US dollar (or the euro).3 It is therefore referred to as a “stablecoin.” The credibility of this peg is essential for the credibility of stablecoins, akin to bank deposits and money market fund shares.4 The popularity of Facebook could provoke a rapid spread of diem. The advantage of diem could be that international payments require no intermediaries and are cheaper. Especially for many people in developing countries who do not have a bank account, diem could be attractive. If one day the currently announced fixed exchange rate were to be relaxed in favor of a gradual appreciation path, the incentive to exchange US dollars or euros for diem would be great. Part of the seigniorage of the Federal Reserve, the European Central Bank (ECB), and other central banks could then go into the pockets of Facebook and Co.
Thirdly, competition for the exorbitant privilege also seems to have emerged among paper currencies. Up to now, all major central banks had expanded their balance sheets in tandem with the Fed, such that competition among fiat currencies was de facto suspended. Yet China, which has long resented the US dollar’s reserve currency status, may now back out of this arrangement.5 Many trade and financial transactions in East Asia are settled in US dollars, and the currencies of the East Asian countries are still pegged to the greenback. Whenever the Fed expands the money supply through purchases of US government bonds, the central banks in East Asia are compelled to buy US dollars. In this way, they help finance US government spending—e.g., expensive bailouts on the financial markets. Ronald I. McKinnon spoke of a quasi-unlimited credit line for the US, which is increasingly viewed with suspicion in East Asia (“the unloved dollar standard”).6
Figure 3: China’s Holdings of US
Article from Mises Wire