The fading influence of the US Dollar in one chart
One of the benefits of running an Empire or being a global economic superpower is that your currency becomes sought after all over the globe and weaker countries try to explicitly or implicitly peg their currencies to yours. This has the advantage that the demand for government bonds of the superpower is high independent of the creditworthiness of the issuer. As a result, economic superpowers tend to be able to borrow more at lower cost than smaller developed markets or emerging markets and run a sustained current account deficit.
The IMF recently created a new global debt database that includes not only sovereign but also private debt. In their excellent introductory blog post they have created a beautiful infographic that clearly shows that the debt load of developed markets is systematically higher than the debt load of emerging markets and frontier markets. And within emerging markets, the emerging economic superpower China is able to sustain – at least for now – much higher debt loads than almost all other emerging markets. Similarly, amongst developed markets, the debt load of the US is much higher than for Spain or Greece (if private debt and sovereign debt is combined), yet nobody doubts the creditworthiness of the US.
In a related research paper from the Bank of International Settlement (BIS), Hiro Ito and Robert McCauley investigate the interlinkages of global currencies and show how the currencies in different countries are influenced by US Dollar, the Euro, and other leading currencies.
In 1968 the US Dollar was the dominant currency of the world and the Dollar currency zone accounted for c. 60% of global GDP. But it had serious competition from Sterling, which was influential in the UK and many of its former colonies. In essence, Sterling was the world’s second reserve currency commanding about 15% of global GDP and the German Mark the third (5% of global GDP).
Fast forward fifty years to 2017 and we can see that Sterling has basically lost all its influence as the UK has become an integrated part of the European Union. Today, the Euro influences c. 30% of global GDP. While the US Dollar still influences about 60% of global GDP, this influence has weakened substantially. The correlation between the US Dollar and many emerging market currencies has declined while the correlation of these emerging market currencies with the Euro and other major currencies has increased. The link between the Brazilian Real and the US Dollar has weakened so much that by now the correlation between the Real and the Japanese Yen is higher than the correlation between the Real and the US Dollar.
What these charts show is not only a gradual decline of the US Dollar and Sterling in their importance as global reserve currencies but implicitly also a gradual decline of the necessity of smaller economies to invest in US Treasuries or UK Gilts. And this trend should gradually increase the current account deficit of the US and the UK over time.
This trend is likely to continue if China is able to expand its economic clout. In their paper, the authors show that already today, the Chinese Renminbi has significant influence over the currencies of commodity producing countries. The authors estimate that about 30% of global GDP is influenced by the Renminbi. A continued rise of China and adoption of the Renminbi as a major global currency would lead to more demand for Chinese bonds at the expense of US Treasuries and as a result to a widening current account deficit for the US.
Currency regimes over time
Ito and McCauley (2018), Fidante Capital.