Primacy of US dollar endures

Maybe I’ve been spending too much time watching World War III videos on YouTube, but I think it’s more likely the newsletter sellers and gold brokers are just tapping into some recent headlines to sell some fear about the imminent end of the U.S. dollar.

The U.S. dollar has maintained a privileged role on the world stage since the end of World War II, when it was established by international agreement as the primary currency to be utilized in settling international transactions. This agreement wasn’t any type of conspiracy or scheme to take over the world, it was rather a function of utility at the time. The world was in a state of physical ruin as a result of the war, and nations not in physical ruin were in economic ruin, except for one. The United States. So, it is no surprise the U.S. dollar was adopted as the world’s primary currency. In a way, it was a no brainer for the rest of the world.

The status of the U.S. dollar was further reinforced in 1973 when the United States struck a deal with the oil rich state of Saudi Arabia to price and trade oil in only U.S. dollars in exchange for defense assurances. Most of the remaining OPEC members followed the Saudis’ lead, and the “petro-dollar” was devised, further strengthening the reserve currency status. Once again, not so much a conspiracy, but more of a no brainer for the Saudis, as the U.S. military was by far the world’s most powerful then and now, and the Saudis needed the protection.

This status as the “reserve currency, petrodollar” certainly has extended benefits to the U.S. The policy enabled Americans to voraciously consume products from around the world, essentially exporting dollars in exchange for stuff, and perhaps most importantly it created continual demand for American financial assets (stocks, bonds, real estate and bank deposits) as dollar-laden foreign nations needed to store the dollars they earned in U.S. investments. Our government, in the meantime, has also taken full advantage of this scenario by borrowing a lot of these foreign-held dollars to help fund our entitlement state and military. All in all, however, from the biased perspective of an American, it seems like this reserve currency thing has worked out pretty well for the world.

So, has anything changed? Well, we’ve certainly abused the privilege a bit. With $31 trillion in national debt, and the ginormous expansion of the supply of dollars during the COVID crisis, there’s a lot of dollars out there, and when there are a lot of dollars out there they tend to be worth less, aka inflation. If inflation hurts here in the U.S., it’s positively brutal in dollar-holding foreign economies with less per capita income. Our government, in its efforts to maintain the international order, has also irritated a good number of foreign governments, which probably makes the need to hold dollars even more distasteful for them.

In order, however, for these annoyances to matter, someone would have to come up with a better alternative to use instead of the U.S. dollar. It’s extremely inefficient to conduct trade in multiple currencies, and the U.S. continues to be the largest market for most foreign exports. So, what would the alternative be?

The most common answer posed is the Chinese yuan, as there seems to be a strange quirk among those pitching paranoia about the reserve currency thing, that they also tend to be pitching paranoia about China taking over the world.

Some recent headlines have stoked this paranoia, as in the past few weeks China met with Saudi Arabia to discuss settling some oil sales in yuan and declared a “strategic partnership” with Russia to settle Russian oil sales in yuan. Scary? I think not.

First, the Saudis showed little interest in pricing oil in yuan, and even if they accepted yuan in payment for oil they would be crazy, in my opinion, to not immediately convert their yuan to dollars as soon as the check cleared. So, while yes, oil should probably be sold for yuan at some point, if the yuan is immediately converted to dollars on the backside, did the demand for dollars even change in the transaction? Doesn’t seem so to me.

Russia is another story altogether. With the crippling sanctions resulting from the Ukraine invasion, Russia is urgently trying to sell its sanctioned petro products to anyone who will take them, at steep discounts, in whatever currency is offered. I can’t imagine Putin oligarchs have any more use for Chinese yuan than you and I, but they’re desperate for currency of any sort and are in no way indicative of any changing reserve currency order.

The world may one day find an alternative for the U.S. dollar as the world reserve, but I’m willing to bet a bourbon it won’t be the yuan. There are risks inherent in our economy right now — interest rates are still in flux and the stock market is not showing any clear trend — but trying to manage and protect against the end of the U.S. dollar seems like more of a distraction.