The main danger for the international status of the US currency is the situation inside the US. As former Finance Minister Henry Paulson warned, Washington will have to do something about the uncontrolled growth of the national debt and budget deficit. Otherwise, the dollar will lose its privileged position.
Because the US monetary unit plays the role of the leading world reserve currency, rates on dollar assets are low. This allows the country to sustain a large trade deficit, reduces economic risks, increases financial market liquidity, and provides US banks with expanded and priority access to funds.
However, former US Treasury Secretary Henry Paulson calls it a “historical anomaly” that the dollar has maintained this status for so long.
“Now, the Chinese yuan has the greatest potential. The size of the Chinese economy, growth prospects, integration into the world economy, and active efforts to internationalize contribute to the role of the Chinese currency,” Paulson said in an article published in the journal Foreign Affairs.
“The dollar’s superiority came only from a combination of historical events, geopolitical conditions after world war II, Federal Reserve policy, and the enormous size and dynamics of the American economy,” Paulson writes. He recalls that in the first half of the twentieth century, the dollar and the British pound were substantially equivalent reserve currencies.
Today, the “natural” of the dollar seems to be an integral part of the international monetary system. Still, over time, the former head of the US Treasury believes, the balance of two or more world reserve currencies will be formed again. The Chinese yuan is the leading contender, as it is already quoted on a par with the yen, Euro, and pound.
On the other hand, Paulson is convinced that China is not yet a threat to the stability of the US currency. Until China finally moves to a market economy, the yuan will not be able to become a truly global currency.
The problem is not in China
The dominance of the dollar raises more and more questions for the former Finance Minister, especially given the increase in the share of developing countries in global GDP and the decline in this indicator for the US: from almost 40% in 1960 to 25% now. But that’s not even the problem.
The future of the dollar, Paulson emphasizes, depends on Washington’s ability to build a strategy that will eventually solve problems with the national debt and structural budget deficits. We don’t have to talk about it yet.
The current owner of the White House has no equal in terms of the speed of increasing financial obligations. To the 19.9 trillion inherited from Obama, trump managed to add another five. And this despite the promise to liquidate the debt within eight years.
The US budget deficit is one and half-trillion dollars, and according to the calculations of the largest banks, in 2020, the difference between government spending and revenue will triple — to four trillion, the maximum since world war II. And the national debt has exceeded a record 25 trillion. Borrowing is growing faster than the economy. In 2019, GDP added 2.3% — about 850 billion dollars, and the debt — more than 1.2 trillion.
Analysts state: the situation is almost out of control. The ratio of total public debt to GDP jumped to 108%, whereas in 2006, in the run-up to the financial crisis, it was no more than 63%. According to the Institute of International Finance, if you add corporate, mortgage, and other debts, the amount will generally pull 330% of GDP.
Sell government debt
Fewer people are willing to lend to the debt-ridden economy. According to statistics from the US Treasury, in March, the flight of foreign investors from US debt — both private and public — was unprecedented. Over the month, international holders of treasuries dropped them by $ 256 billion, reducing the total portfolio to 6.81 trillion.
Of the 33 countries that are the largest creditors of the American economy, only Japan (by 3.4 billion), Switzerland (1.3), Taiwan (4.1), the Philippines (1.3), and Australia (1.8) increased their investment. Central banks of developing countries actively sold US Treasury bonds: they needed dollars to support falling national currencies against the background of the coronavirus crisis. Russia also reduced the portfolio of treasuries — from 12.58 billion to 3.8 billion.
The largest seller was Saudi Arabia — the Kingdom got rid of American securities for 25.3 billion dollars. In Brazil and India, the figures are slightly less — 21.5 and 21 billion, respectively.
Such a sell-off does not bode well for Washington since the one-and-a-half-trillion-dollar budget deficit is covered mainly by the sale of government bonds.
According to analysts, an unlikely but possible scenario of freezing investment in US bonds by several countries will deal a severe blow to the status of the dollar as a reserve currency.