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Dominant Dollar Bests Challengers

Beijing and Moscow have rarely had more reasons to rue the dollar’s global dominance. Yet changing the status quo will be difficult, and recent efforts to do so have yielded little.

The dollar isn’t only the primary reserve currency held by other central banks. It is also ubiquitous in trade and international capital markets, making it crucial to the stability of emerging economies. Last year a soaring dollar rattled the developing world by making dollar debt more expensive for foreign borrowers to service.

The dollar’s primacy boosts overseas demand for American assets, which some economists believe lowers U.S. borrowing costs. It also gives Washington the ability to cut countries and organizations off from the world financial system, because access ultimately requires links to U.S. banks.

That power rankles in Tehran, Beijing, Moscow, Brussels and elsewhere. Yet, after a drawn-out crisis in the eurozone, and a more recent slowdown in China, the dollar’s international pre-eminence looks safer than ever. Concerns that a U.S. administration with an America First platform would diminish the dollar’s global role haven’t been borne out, either.

“We have seen a resurgence in the dominance of the dollar in cross-border debt and a persistence in its role as a reserve currency,” says Catherine Schenk, an economic historian at the University of Oxford. That is a product not just of euro weakness and a slowdown in yuan internationalization, she says, but also of the dollar’s underlying advantages.

“In times of uncertainty like today, the liquidity of markets becomes even more important,” Prof. Schenk says.

As the pool of dollar bonds issued by non-U.S. governments and companies more than doubled between mid-2008 and last year, to $9.564 trillion from $4.299 trillion, international bonds in other currencies shrank to $5.672 trillion from $6.129 trillion, according to the Bank for International Settlements.

International use of the euro, once the dollar’s clearest challenger, has diminished since the eurozone sovereign-debt crisis raised the specter of default on debts previously believed safe. The euro’s share of global reserves shrank to 20.5% in the third quarter of 2018 from 28% in 2009.

China, meanwhile, has spent years trying to boost the international use of its currency, including by encouraging offshore yuan trading and by recently introducing yuan oil contracts.

It has had some successes, such as gaining a place in the International Monetary Fund’s basket of reserve currencies. But to make the yuan an international force, economists and investors have long maintained, Beijing must permit freer movement of money across its borders.

Instead, facing a flood of capital outflows in 2015-16, it clamped down on investment outside of China. And it is unlikely to make it easier to move money in and out of China now, as growth slows and U.S. tariffs pinch its manufacturers.

The data isn’t encouraging for Beijing. The offshore yuan bond market has shriveled in size, FTSE data shows, and the yuan’s share of global payments has receded, according to figures from the Swift banking network. Currency swap lines, which China extended across South America, Africa, Europe and Asia, have largely gone unused.

Beijing’s flagship Belt and Road Initiative, meanwhile, a $1 trillion program to fund infrastructure linking East Asia and Europe, is often compared with the U.S. Marshall Plan, the postwar aid program that helped rebuild Europe. But while that plan sated Europe’s desperate need for dollars for trade, Belt and Road borrowers don’t need or want much Chinese yuan.

According to research by Citigroup economists, Belt and Road contractors prefer to receive dollars, and all major recapitalizations of Chinese lenders funding the program have been done in dollars.

The dollar does face some challenges. Russia’s central bank sold or moved most of its U.S. Treasurys last year, official data shows, as part of an overt de-dollarization policy that includes closer links to China. And in the long term the yuan’s clout is likely to increase.

“There are still capital controls and questions about the credibility of the [Chinese] institutions, so it’s far-fetched to look at it as a reserve currency,” says Claire Dissaux, head of global economics and strategy at Millennium Global Investments in London. But she says use of the yuan is likely to grow, fueled by foreign investment in China’s vast bond market.

The yuan also will eventually gain some reserve-currency attributes, especially within Asia, says Arvind Subramanian, a nonresident senior fellow at the Peterson Institute for International Economics. The yuan is tracked by several regional currencies, he notes, largely because other export nations in the region don’t want to appear less competitive.

“The fact that China has become a big trader helps its case for its currency to become a reserve currency,” Mr. Subramanian says.

For the yuan to truly become a global reserve currency, as a 2011 book of his predicted would happen by the next decade, he says China must stabilize its economy and clean up its financial system.
Source: Dow Jones

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