A Growing Challenge To U.S. Dollar Dominance

With the Federal Reserve’s recent interest rate hike, the U.S. dollar has been grabbing all the currency headlines recently. Traders are actively debating what the current pace of Fed tightening means for the dollar. So far, it doesn’t look good. The market was bracing for a more hawkish Fed, and that didn’t happen. Sure, the Fed hiked interest rates again – as most people expected – but they stopped short of predicting a faster pace of monetary tightening. Which is why the dollar dropped after the hike.

There seems to be no doubt this is an important development for the markets in the short term. This recent dollar weakness, for example, could provide support to precious metals in the near term as readers of the Daily Pfennig® newsletter know. But, there was another event this past week that could have a far greater impact on the U.S. dollar in the long term.

Who’s After The U.S. Dollar?
I recently came across this headline published by the South China Morning Post: “Moscow and Beijing join forces to bypass U.S. dollar in world money market.”1 You see, Russia and China have been working towards stronger economic ties for years.

Last year, for example, they agreed to issue bonds denominated in their own currencies in each other’s market. Russia is now preparing to issue its first bonds denominated in Chinese yuan.2

The latest sign of this cooperation happened March 16, when the Central Bank of Russia opened its first overseas office in Beijing. The local news called this “a small step forward in forging a Beijing-Moscow alliance to bypass the U.S. dollar in the global monetary system.”3

It appears as though this trend has been going on for quite some time with China and Russia leading the charge.

Not Everyone Is Happy With The U.S. Dollar
Because of its world reserve currency status, the dollar has had almost endless demand in international transactions for years. That has allowed the U.S. to borrow almost unlimited cash at low interest rates.4 And, it has played a key role in our standard of living. There’s no doubt the dollar’s status has been great for America.

But, the dollar’s influence on international trade isn’t necessarily beneficial to other countries. In recent years, the BRICS countries – Brazil, Russia, India, China and South Africa – have been taking small steps to reduce the primacy of the dollar in international trade.5 China has been leading this effort in recent years.

The International Monetary Fund (IMF) recently added the yuan to its list of reserve financial instruments. That means the Chinese currency is now an official reserve currency just like the U.S. dollar, British pound, euro, and Japanese yen.6

The Chinese Central Bank has also called for a new global currency to replace the U.S. dollar as the world’s reserve currency.7 In a research paper called “Reform the International Monetary System,” the Governor of the Bank of China said the U.S. dollar-based system has “inherent vulnerabilities and systemic risks.”8

In the same report, the bank’s leader proposed creating a new international currency that would essentially undermine the dollar’s power in the global marketplace. According to the Chinese Central Bank’s proposal, this new currency should be backed by a basket of currencies selected from the world’s governments and controlled by the IMF.9

Keep An Eye On This Trend
This recent development involving Russia and China doesn’t mean the U.S. dollar is doomed in the short term. For a currency to potentially threaten the reserve status of the U.S. dollar, it would need to have a liquid market. And, that’s what Russia and China are seemingly trying to do. They’re using their national currencies in foreign trade payments and issuing bonds denominated in local currencies. These could be important steps towards developing greater liquidity of their domestic currency markets. This is why we should keep watching this trend.

After decades of being the world’s reserve currency, it’s easy to take the supremacy of the dollar for granted. But, as I talked about today, countries like Russia and China are actively working to develop alternatives to the U.S. dollar, which could have important implications at home and abroad in the long term.

Do you think the moves by China and Russia pose a challenge to the reserve status of the U.S. dollar? Please share your views with us by visiting our blog and leaving your thoughts in the Comments section.

Until the next Daily Pfennig® edition…

Sincerely,

Mike Meyer
Vice President
EverBank World Markets, a division of EverBank
1.855.813.8484
everbank.com