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Why the US Dollar is so Stong and how it Helps?America.?

This week on The Elite Edge it's all about the American Dollar.

In a special report on ‘America’s Economy, The Envy of the World,’ The Economist looks at why the US dollar continues to dominate the world. A summary of The Economist article “China’s Yuan is nowhere near replacing the greenback” below:

Historical Context:

• In 1973, the Bretton Woods system of fixed exchange rates collapsed
• This led to widespread skepticism about the dollar’s future
• The dollar was viewed as a “sick currency all over the world” according to an article in the New York Times
• Many predicted a declining use of the US dollar globally

The Dollar’s Resilience:

• However, these pessimistic predictions proved wrong, as noted by economist Barry Eichengreen, of the University of California, Berkley in his book “Exorbitant Privilege”?
• Despite America’s share of the global economy (measured by PPP) falling from 27% to 23% by 2000, the dollar remained strong

Two key factors maintained the demand for the dollar:

1. Global investors continued parking wealth in New York
2. Governments built up dollar reserves to defend their own currencies

In the 21st century the pattern has repeated itself. Despite predictions of the decline in the dollar’s status, it has remained the dominant world currency.?

• The dollar is used heavily in trade, cross-border investment, and forex transactions
• At market exchange rates, the US still represents 25% of the world economy, unchanged since 1990

Changes and Challenges

It’s not that nothing has changed.?

• According to IMF data, the dollar’s share of global reserves fell from 73% in 2001 to 59% as of now
• China has increased yuan usage in its trade invoicing. About 25–30% of its trade is done in yuan vs the dollar
• However, the yuan hasn’t gained significant global reserve status
• And most dollar reserve shifts have gone to American allied nations’ currencies (Australia, Canada, the Scandinavian countries)

Why Does Dollar Dominance Persist?

Researchers at the Federal Reserve concluded in 2023 that dollar dominance has remained stable for the past twenty years. The reasons for this are:

1. America offers a unique combination of favorable factors like:

• The Rule of law
• Deep, liquid markets
• An open capital account
• A strong legal system
• A store of value

2. While in contrast potential competitors to the dollar have their limitations:

• China has a controlled capital account that limits the amount of money that can be taken out of the country thus making investors nervous
• Europe has insufficient safe assets?
• No other currency offers comparable safety and liquidity vs the dollar?

?3. The Dollar Benefits from Network Effects:

• Greater usage creates more incentive for continued use
• Dollar’s liquidity makes it cheaper for currency trade

Economic Implications

Economic Benefits to the US:

• Cheap debt for the US government and for American firms?
• Results in more investment in the US economy as capital is cheap for US firms
• American buyers, companies and individuals benefit from a lower price on foreign goods and services?

Potential Risks:

• Economists talk about a “New Triffin dilemma” where the growing appetite for dollars encourages more US debt
• America’s growing indebtedness could gradually erode the dollar assets’ safety
• No viable alternative currency exists at scale
• American goods and services are more expensive for the rest of the world?

Future Outlook

• The dollar’s dominance is likely to continue because the global economy would struggle without a liquid, safe, and plentiful reserve asset

In Conclusion

The dollar’s “exorbitant privilege” benefits the US through cheaper debt. However, it also benefits the world by serving as a liquid, safe and plentiful store of value. Its loss would have serious global consequences.