The Global Life Vest; The U.S Dollar Domination During the Pandemic

By Udheesh Gaddipati

Since President Nixon’s departure from the 1944 Bretton Woods Agreement, the U.S Dollar has remained the world’s reserve currency as the majority of foreign exchange reserves are predominantly made up of dollars. Today, over half of all international financial transactions, and upwards of 40% of all debt, is dollar denominated. 

However under the specter of anti-American sentiment, countries have started to push back against the dollar’s prominence. Mark Carney, Governor of the Bank of England, argued in August of 2019 that the dollar’s dominance ought to end, as continued reliance on it could spark “liquidity traps of ultra-low interest rates and weak growth,” adding that “while the world economy is being reordered, the U.S. dollar remains as important as when Bretton Woods collapsed”. 

Consequently, various currencies have begun to challenge the dollar for its status as the world reserve currency. Attempting to usurp the dollar in the futures and commodities market, China signed its first crude oil futures contract denominated in the yuan. Simultaneously, global circulation of the Euro has doubled in the last 20 years.

However, these efforts to thwart the dollar haven’t manifested into significant change. China’s petro yuan ambitions came to a swift end as institutional investors questioned the efficacy of China’s state owned oil market and voiced concerns of the Renminbi’s lack of liquidity. Moreover, the Eurozone’s share of the global economy has shrunk from 25% at its inception to 15% today, and is predicted to fall under 10% as emerging markets continue to grow. Further, Eswar Prasad, Senior Professor of Trade Policy at Cornell, asserts that although the dollar’s share as the world’s reserve currency shrank (only marginally), its share of outstanding international debt securities increased 19% from 2007 to 2018, while the Euro’s share dropped from 31% to 22%. Prasad also notes that from 2012 to 2019 the dollar’s share of cross-border payments rose by 10 percentage points while the Euro’s share has declined by 10 percentage points and the Renminbi’s share has fallen to under 2%.

While the dollar’s hold on global financial markets remains to be challenged, anti-dollar sentiment has all but disappeared as the Fed’s actions have heavily reinforced the dollar’s ethos in the wake of the pandemic.

On March 16th, the coronavirus shock sparked a mass sell off of U.S Dollar denominated/backed securities, with the DOW  plummeting nearly 13%. Market volatility spiked to a record high as investors and multinational corporations struggled to liquidate safe haven assets, like Treasuries, to free up cash and brace themselves for possible economic hardships. Simultaneously, companies and governmental entities were unable to access the lending and repo markets, which they rely on to make payroll and build schools. The accumulation of these market reactions sparked a massive dollar shortage around the world as central banks struggled to lend greenbacks to match demand. 

Fortunately, the Federal Reserve quickly came to the rescue, rekindling and expanding “U.S. dollar liquidity swap lines” to various central banks. The Fed began exchanging foreign currency for Greenbacks at a fixed rate to more than 14 Central Banks while opening other programs to lend dollars out to foreign money markets. In total, the Fed lent over $450 billion to central banks worldwide. 

The result was a global calm as the Federal Reserve prevented the mass selling of assets and U.S backed financial instruments keeping crucial markets (like international repo, debt, and bond markets) functioning. As the Fed reaffirmed their position to do whatever they could to foster market stability, safety premiums for holding the dollar encouraged people to hold onto their assets. These swap lines were critical for international banks as the dollar was made cheaply and readily available to firms and investors without the need to sell safe haven assets. Furthermore, the swap lines stopped a chain sell-off which could have dominoed into a global financial meltdown. The Bank of England – once critical of the dollar – changed their tune in the wake of the Covid crisis as Andrew Hauser, the Bank’s top markets official, commended the Fed’s swap lines, arguing that they “may be the most important part of the international financial stability safety net”. 

More importantly, the Fed’s commitment to keeping the dollar liquid, has given investors faith in the dollar’s credibility; as such, investors have flocked back as a central authority – the Fed – committed to keeping U.S backed assets from collapsing, reaffirmed this position. Not only has this given the U.S incredible leverage to determine internal policies of foreign central banks (by making swap lines conditional on their actions), but also resulted in the dollar nearly trading at pre-pandemic highs.

The Dollar Driven Economic Recovery

As the United States’ relatively weak economy slowly starts to recover, the cheaper dollar (driven initially down by lower interest rates, and the Fed’s fund rates drop) has encouraged foreign entities to convert their currency into the dollar to buy dollar denominated assets

In fact, oversea investors now own 16 percent of the U.S. corporate equity market as multinational investors have bought over $187 billion of shares during the three months after the March drop, making them the biggest buyers of U.S stocks and further expanding the dollar’s reach. Additionally, central banks have expanded their dollar reserves due to increased ease of acquisition as the dollar weakens.

This activity spearheaded recovery processes around the world as a falling dollar made Emerging Market (EM) assets viable alternatives to dollar backed investments. U.S Companies have also benefited greatly from the dropping dollar, as, according to Goldman, a 10% fall in the value of the dollar against a basket of trade-weighted currencies is expected to increase 2020 earnings per share by about 3%. Additionally, gold, copper, and other dollar denominated commodities have seen huge price hikes. 

The Federal Reserve’s public dedication to stabilizing and increasing the liquidity of the dollar at all costs has now made the dollar’s role as the world’s reserve currency ever so permanent, as the dollar regains ground lost to the Yuan and the Euro in the last decade. □


Work Cited

  1. Cover image by Udheesh Gaddipati
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