Why Hasn't The Dollar Fallen?

The global financial landscape is potentially witnessing the initial stages of the dollar's decline as the dominant global currency. Central banks are increasingly diversifying their reserves, shifting from U.S. Treasury securities into gold and other non-traditional reserve currencies. This process is likened to a slowly melting iceberg, where large chunks eventually calve off all at once. Historically, the dollar has not always been the sole dominant currency in the United States. In the early history of the U.S., before the California gold rush, Spanish silver coins, known as "pieces of eight," were the primary medium of exchange. These coins, minted in large quantities in Spanish colonies like Mexico and Peru due to vast silver deposits, achieved global dominance. They circulated across continents, from the Americas to Asia, often outcompeting local currencies. This global reach was facilitated by extensive trade networks, including the famous Manila galleons that transported silver across the Pacific to Asia, where it was accepted for goods like silks and ceramics. The widespread acceptance of Spanish silver stemmed from its consistent quality and value, maintained by the Spanish crown's oversight of minting processes for centuries. While the exact logistics of cutting these coins into "pieces of eight" for smaller transactions remain somewhat unclear, it became a convention despite the inherent coordination challenges of uneven divisions. Another historical example of a long-reigning currency is the Byzantine solidus, a gold coin that served as a stable international currency for approximately 700 years, from around 500 AD to 1200-1300 AD. Its remarkable durability and stability earned it the moniker "the dollar of the Middle Ages." The solidus's longevity is attributed to the Byzantine Empire's fiscal prudence, which allowed it to maintain the currency's value without significant debasement, even when faced with numerous external threats. The rise of an international currency is typically contingent on two sets of preconditions. The first, widely studied by economists, relates to commercial and financial prowess. A strong economy with extensive international trade and developed financial markets, facilitating cross-border lending and borrowing, naturally exposes other nations to its currency. Liquidity in capital markets, making the currency easy to buy and sell, further enhances its value. The second set of preconditions, increasingly recognized, are political. These include a government that lives within its means, ensuring the currency holds its value over time. Checks and balances on arbitrary executive action, such as those present in the Roman Republic versus the later Empire, are crucial for inspiring domestic and international confidence in the currency. The rule of law and strong property rights are also vital. Furthermore, the strength of a country's alliances plays a role, as central banks prefer to hold currencies of trustworthy alliance partners, viewing it as a show of good faith. Military dominance, or security, is another key ingredient, commonly associated with international currency status. This encompasses both the ability to defend national borders and to protect trade routes. Historical examples like the Dutch and English East India Companies, which operated as paramilitaries to secure their trading interests, highlight this. While Florence's florin was an exception, achieving dominance through commercial prowess and innovative banking without significant military power, most other cases demonstrate the importance of security. The fall of an international currency often stems from debasement, military defeat, or an inability to keep pace economically. These factors can be interconnected, with military challenges leading to currency debasement to finance conflicts. Economic decline, as seen with Florence losing its textile competitiveness or Britain becoming the "sick man of Europe" by the mid-20th century, can also erode a currency's international standing, though with potentially long and variable lags. The current situation of the U.S. dollar, while still dominant, shows signs of decline, with its global market share as a reserve currency gradually decreasing. This transition is expected to be slow but could become violent if foreign confidence in the U.S. government erodes rapidly. The dollar faces multiple threats, many originating internally, including rising U.S. debt and political uncertainties. Unlike previous transitions where one or two clear threats existed, the dollar now faces challenges from various sides. The dollar's remarkable dominance since World War II, cemented by the Bretton Woods system, has persisted despite significant global structural changes and the collapse of Bretton Woods itself in the 1970s. Its unique characteristic in modern history is its long-standing persistence as a pure fiat currency, unpegged to gold since 1971. While the Dutch guilder had elements of a fiat currency in the 18th century, the dollar has supercharged this model. The idea of a global currency, like Keynes's Bancor or the IMF's Special Drawing Rights (SDRs), has historically struggled to gain traction due to the absence of a global government and the inherent geopolitical power dynamics. The Euro, despite its regional importance, faces limitations as a global currency due to the lack of a common fiscal policy and a unified source of high-quality treasury securities. Dollar dominance presents both benefits and costs for the U.S. Benefits include the convenience of international transactions in its own currency, lower interest rates on Treasury debt, and its role as a safe haven during global crises. However, the stronger dollar exchange rate, a consequence of its safe haven status, creates headwinds for U.S. manufacturers and exporters. While some argue that dollar dominance fosters excessive financialization and detracts from investment in manufacturing and education, these are likely secondary to other fundamental determinants of economic competitiveness. The loss of dollar dominance would mean increased complexity for imports and exports, higher interest rates (affecting mortgages), and the loss of the "automatic insurance" of safe haven flows during crises. Comparing the current situation to the 1970s, when many predicted the dollar's demise after Nixon closed the gold window, reveals both similarities and differences. While both periods saw political strains and inflation, the 1970s ultimately saw Congress and courts rein in executive power, affirming the rule of law. The current political climate and the greater strains with allies make this period distinct. Furthermore, the digital revolution is weakening network externalities, making it easier to trade and use different currencies, thus undermining the dollar's default advantage. China's renminbi, despite its economic prowess and growing trade and investment, is unlikely to become a global reserve currency due to political constraints. The lack of an independent central bank and the arbitrary nature of Chinese financial rules deter foreign investors. Western governments also view China as a geostrategic rival, making them hesitant to become dependent on its financial system, particularly given concerns about the weaponization of financial platforms. While the absence of a viable alternative at scale currently supports the dollar, it does not guarantee its continued dominance. A significant economic, financial, or political crisis in the U.S. could lead foreigners to abandon the dollar for gold, cryptocurrencies, or currencies of reliable "middle powers" like Canada, potentially leading to global financial dislocations. Gold continues to serve as a reliable store of value and a debasement hedge, present at both the inception and decline of international currency regimes. Central banks hold gold as a way to diversify reserves and as a collateral asset in financial transactions. In times of geopolitical uncertainty, nations may repatriate gold to safeguard it from sanctions, though this limits its utility in international payments. Bitcoin and other cryptocurrencies, while currently too volatile for widespread use as a medium of exchange, could potentially compete with or replace gold as a hard money asset due to their portability and other properties. However, the future of international monetary systems is more likely to be shaped by blockchain and distributed ledger technology, which will serve as new payment rails. What runs on these rails remains to be seen, with central bank digital currencies (CBDCs) and tokenized bank deposits considered more probable contenders than volatile plain vanilla cryptos or stablecoins, whose stability and fungibility are yet unproven. For investors, the key lesson from monetary history is that shifts in currency dominance are rarely smooth and come with disruptions. Diversification across a portfolio of assets is the best defense against such uncertainties, as there is no longer a single safe asset.