The U.S. dollar’s reserve currency status is being tested

PITTSFIELD — For more than three-quarters of a century, the U.S. dollar has functioned as the world’s reserve currency. That status is now being questioned by various countries.

Back in 1944, delegates from 44 allied countries met in Bretton Woods, N.H. to develop a system to manage foreign exchange that would not disadvantage any country. The delegation decided that the world’s currencies would be pegged to the U.S. dollar, which was in turn pegged to the price of gold.

The gold peg worked until it didn’t. The deficit spending needed to finance the Vietnam War and the Great Society domestic programs caused the U.S. to flood the financial markets with paper money. That created enormous concern for countries holding dollars. The future stability of the dollar was in question, which led to an enormous rush to convert dollar reserves into gold. The demand for gold so outstripped the available store that President Richard Nixon was forced to de-link the dollar from gold, which led to the floating exchange rates that exist today.

The U.S. greenback is essentially the default currency in international trade and a global unit of account. As such every major firm, treasury, and central bank hold a large portion of their foreign exchange in dollars. Central banks, for example, hold around 59 percent of their reserves in U.S. dollars. Since most holders of dollars want a return on these balances, they usually put those dollars in U.S. government bonds in world financial markets.

However, in recent years many foreign countries perceive that the United States is no longer the oasis of stability it once was.

In terms of its social, political, and economic status, there is much to worry about. The Trump years of putting America first (at the expense of others), U.S.-sponsored tariff trade wars, social unrest, the Jan. 6 insurrection, and the ongoing divisions and attacks on U.S. institutions have convinced many nations that they must somehow insulate themselves from further U.S.-generated risks.

Last month, Brazil, for example, which is the largest economy in South America, decided to bypass the dollar altogether in its trading relationship with China. China is Brazil’s largest trading partner with a record $150.5 billion in bilateral trade last year. The two nations will be able to exchange their currencies directly, thereby reducing costs, promoting even more bilateral trade, and facilitating investment, according to the Brazilian Trade and Investment

Promotion Agency.

Efforts are already underway by several other countries to do the same thing. The “BRIC nations” — Brazil, Russia, India, China, and South Africa — are discussing ways to drop the dollar in their trade relationships. Saudi Arabia, the United Arab Emirates, India, and Iran also want to cut the U.S. dollar out of the oil trade. Like most commodities, oil and gas are traded in U.S. dollars. As such, energy prices usually move in tandem with the rise and fall of the dollar. For energy-importing nations, a rising dollar and rising oil prices are an unnecessary double whammy.

China, our largest competitor, has been working for years to expand the use of its currency, the renminbi (yuan) in international trade. The Russian invasion of Ukraine, and China’s aggressiveness toward other countries in Southeast Asia like Taiwan, Japan, Vietnam, etc. are dividing the world into two opposing camps. The U.S. and Europe’s use of dollar-denominated trade, tariffs, and sanctions as a political weapon are forcing countries like Russia to use the Chinese currency as a haven.

Future Ramifications

The ramifications of these moves could, over time, have a serious impact on the U.S. equity and bond markets. More than 50 percent of sales and earnings of the S&P 500 Index are generated overseas. Foreign abandonment of the dollar would also result in the sale of U.S. Treasury bonds, which force interest rates higher and bond prices lower.

But don’t confuse a weakening dollar with the end of the dollar’s status as the world’s reserve currency. While these threats to the dollar are real, I doubt I will see the dollar relinquish its reserve currency status in my lifetime. The U.S. dollar trades in long cycles of approximately 15 years. Over the last five cycles, the average change of the value of the dollar from high to low was a 50 percent decline in the global purchasing power of the dollar relative to a basket of currencies. A currency’s decline is never in a straight line.

Several currency traders believe the peak of the dollar occurred in October 2022. If so, we are now six months into the next bear cycle for the dollar. The strength of a currency is dependent on the underlying strength of the country that issues it. In the U.S., skyrocketing deficits, inflation, out-ofcontrol spending, plus a host of other problems could explain the decline in the dollar we have seen in the recent past. There are similarities between today and the 1970s.

The way I see it, the real threat to the long-term status of the dollar is entirely in our hands. A worsening of the internal divisions within our country, continued avoidance of climate change, further declines in education, the continued disappearance of a skilled labor force nationwide, and erosion of trust in our institutions, political and otherwise, could convince more countries over time to devise workarounds in their use of the dollar.

Rather than address the root cause of our problems, we continue to look for stop-gap measures like tariffs, immigration curbs, and more mega-billion-dollar government-sponsored programs in the private sector. And then there are the efforts of the misguided minority in Congress.

Three GOP Congressmen recently introduced a Gold Standard Bill that would repeg the U.S. dollar to a fixed weight of gold bullion to stabilize the dollar. Ghosts of Tricky Dick!

About all that would accomplish would be a meteoric rise in the price of gold and the stocks of gold mining companies in places like — you guessed it — Arizona. Since two of the three congressmen are Arizona Republicans, it doesn’t take a rocket scientist to figure out who would benefit from that move.