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The U.S. Dollar Is Unlikely to Lose Its Top Spot to Libra or the Yuan

The U.S. Dollar Is Unlikely to Lose Its Top Spot to Libra or the Yuan

(Bloomberg Businessweek) -- The U.S. gets perks from the dollar’s lofty status in international trade, starting with the ability to borrow more cheaply. So the dollar has long faced wannabe competitors. The euro was created partly to chip away at its dominance, and China has been pushing for the yuan to be used more widely. Neither currency has dislodged the greenback from its perch. According to data going back to 1989, the dollar hasn’t lost any of its share in central banks’ foreign currency reserves, in currency trading, or in the cross-border liabilities of banks. Its share of debt issued in foreign currency has grown.

The U.S. Dollar Is Unlikely to Lose Its Top Spot to Libra or the Yuan

Yet challenges keep coming. There’s digital currency, such as Facebook Inc.’s planned Libra, and President Donald Trump’s trade wars and isolationist policies, which have given other countries an extra nudge to seek alternatives. Europe is attempting to circumvent U.S. sanctions against Iran by establishing an alternative payment system that wouldn’t depend on dollars.

But currency watchers and economists say potential substitutes for the dollar all present bigger problems than the status quo. “The dollar doesn’t have to be great, it just has to be the least worst one,” says Paul Sheard, a senior fellow at Harvard and former chief economist of S&P Global. “China is still a communist country transitioning slowly. Europeans point out themselves that the monetary union is still a work in progress. It will take decades for either to get to a point to be real alternatives.”

The U.S. Dollar Is Unlikely to Lose Its Top Spot to Libra or the Yuan

Because of U.S. sanctions, Russian and Iranian central banks have partially moved away from the dollar in their holdings. Yet that’s done very little to tip the scales, especially as much of the diversification has come in the form of rising gold reserves. Europe’s special financial channel for trade with Iran is so far only for food and medicine—which U.S. sanctions already allow—and has failed to persuade Iran to stick to the nuclear agreement it struck in 2015.

Facebook, which counts almost a third of the world population as users, is a formidable force that has upended many legacy systems. Yet Libra at this stage sounds more like an alternative payment system than a new currency. Visa Inc. and Mastercard Inc. are among the project’s initial backers. And the value of the Libra coin will be based on a basket of traditional currencies. “You need state backing for any legitimate currency,” says Philip Suttle, a former Bank of England economist who now runs his own advisory firm. States are unlikely to let Libra become a freewheeling global medium of exchange, especially if it jeopardizes anti-money-laundering efforts. And Visa and Mastercard’s backing won’t last if the project runs into regulatory hurdles, according to Morgan Stanley analyst James Faucette.

Facebook executives faced skeptical U.S. lawmakers during hearings in mid-July. Sherrod Brown, a Democratic senator from Ohio, called the project “delusional,” adding: “Look at Facebook’s record. We would be crazy to give them a chance to experiment with people’s bank accounts.”

The U.S. Dollar Is Unlikely to Lose Its Top Spot to Libra or the Yuan

As for the euro and the yen, holding them has limited appeal now because bond yields and interest rates in the euro zone and Japan are so low—in some cases negative. And there’s an added problem in Europe: “There’s no central euro bond, making the continent’s bond market fragmented with lots of different issuers, more like the U.S. municipal debt market,” says Marc Chandler, chief market strategist at Bannockburn Global Forex.

The U.S. Dollar Is Unlikely to Lose Its Top Spot to Libra or the Yuan

The yuan is a relatively new challenger as China’s economy has grown rapidly to become the second-largest in the world. Its share in reserves, global transactions, and currency trading has been growing fast, albeit from a very low base. The International Monetary Fund didn’t even break out the yuan’s share in global foreign exchange reserves, including it in “other currencies” until 2016.

A big hurdle for the yuan is that China’s policymakers manage its value, which makes market players wary of it. “The yuan will definitely play a bigger role, but how much depends on how fast they’ll liberalize their currency,” says Fred Bergsten, the founding director of the Peterson Institute for International Economics.

Given all that, the biggest threats to the dollar would have to come from the U.S. itself. Policies that could lead to high inflation might erode confidence in the currency, according to former BoE economist Suttle. That could happen if Trump replaced the Fed chairman and packed the central bank with governors who’d follow his orders in his second term—or if the same happened under a populist Democratic president. “Fiscal expansion financed by the Fed could crash the dollar,” says Suttle.

But Congress would have to go along with both the Fed appointments and the budgetary expansion. The more likely scenario, Bergsten says, is for the euro and yuan to become more important in the next few decades, leading to a multipolar currency regime. Even so, the dollar will probably remain in first place. “If the U.S. screws up massively, Europeans and Chinese do the right things, with all three happening together, the dollar could lose its top spot,” Bergsten says. “That’s not an easy combination to get to.”

To contact the editor responsible for this story: Pat Regnier at pregnier3@bloomberg.net, Nick Baker

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