Stanley Druckenmiller, a billionaire US investment manager, issued an ominous warning, predicting that the dollar will lose its dominance as the world’s reserve currency within 15 years. He is far from alone in his hears about excessive US demand, a more inflationary climate, and the resulting currency weakening. The shaky equity markets over the previous two weeks have been exacerbated by such concerns.
The dollar has defied forecasts of its destruction for at least four decades. However, Druckenmiller’s views on currencies should not be ignored lightly. The warning comes amid a long-running retreat from the dollar as the world progressively moves toward a multiple-server currency system. There were hints that the dollar’s supremacy was eroding even before the coronavirus epidemic and the exceptional economic conditions it had created. The advantage is fading, according to the latest IMF figures as nations that trade with and borrow from the eurozone increasingly prefer to maintain euro reserves. China and the renminbi are not through this process. Nonetheless, the deterioration has been slow.
The credibility of anti-inflationary policies is on the line
When it comes to reserve currency status, incumbency offers significant benefits, partially due to inertia but also due to network effects. The more people who utilize the dollar, the more beneficial it becomes to the rest of the world. And also, the global economy’s leadership does not change hands frequently.
However, everyone agrees that the most serious danger to reserve currency status during peacetime is economic and financial mismanagement. And with the Federal Reserve abandoning its length of dedication to tightening policies in preparation for inflation and President Joe Biden “going big” on fiscal policy, fears that inflation may stabilize the currency are growing, at least in certain quarters. The Fed’s anti-inflationary reputation, which it has earned at such a great price over the last 40 years, may now be questioned, prompting international investors to be concerned that the US may blow, reducing the joy of their treasury holdings.
One of the most basic characteristics of a reserve currency is that it is backed by a state capable of providing secure assets to international investors. For more than a century, the United States has done so, with the US treasury market providing the world’s safest shelter in times of crisis and the most liquid assets that are the simplest to trade.
The US dollar is also actively exchanged in the foreign exchange market, also known as forex and the daily volume is roughly, say, $6 trillion, which is a very significant number. However, the fluctuations and price volatility make it obvious that those who are involved in the market need to find the Forex trading strategy that works not only during economic growth but also during the turmoil.
Safety is eroding
Some investors are waiting for fresh doubts about the dollar’s position in the international financial system due to concerns about future inflation. The instability in the treasury market caused by the pandemic in 2020 has generated serious concerns about the market’s liquidity. With the market’s decline, these heavily leveraged funds’ solvency was jeopardized and their lenders pulled into their loans, compelling the hedge funds to liquidate. In consequence, a feedback loop emerged in which dealers’ failure to absorb purchases led to greeted price reductions, which in turn led to more sales and further price reductions.
Unstable politics is another danger to the dollar’s position as a reserve currency. Donald Trump highlighted previously unknown flaws in the US system’s checks and balances. The integrity of American democracy was under the question mark, with many in the Republican party, rejecting the election’s conclusion and the previous president inciting the attempted insurgency at the US Capitol.
This is hardly a promising sign for a reserve currency. Nonetheless, there is a case to be made for the current exceptional stimulus. The Biden administration aims to enable faster growth by pursuing a more aggressive fiscal policy that the US pursued after the financial crisis, which may lead to less toxic internal politics and a more stable underpinning for the currency.
Meanwhile, the international capital appears to be giving Biden a pass. Big holders of currency reserves, such as Japan and South Korea, are reluctant to abandon the dollar due to their security dependency on the US. China’s holding of US treasury securities fell from $1.2 trillion to $1.05 trillion between August 2017 and October 2020, according to US Treasury statistics. Despite the incoming administration’s continuance of most of Trump’s antagonistic approach to China, they climbed in monthly progression to $1.1 trillion after the win of Biden.
It took only ten years for the dollar to dethrone sterling as the world’s reserve currency, according to history. That represented the impact of the First World War on Britain’s economic and financial power. Given the unprecedented fiscal and monetary reaction to the epidemic, it is doubtful that the coronavirus will be as economically devastating as the military conflict. However, fiscal indiscipline and monetary debasement in the United States are two risks to the dollar to keep an eye on.