The Fed takes a long, hard look at the currency’s international role in the age of «geoeconomics», sanctions, and China’s renminbi. 

If you can beat them, join them. That might be one interpretation of the overnight speech by Federal Reserve (Fed) Governor Christopher Waller.

In introductory remarks made at a conference in Washington DC discussing the international role of the dollar, he took the hordes of US currency naysayers head-on by echoing widespread commentary that it was «destined for demise – potentially an imminent demise».

Still Here After All

But, in truth, it was just brief sophism calculated to elicit a reaction from his audience, as well as a clear prompt to get them thinking. 

«Such predictions have not materialized,» he went on, with a footnote referring to a similar speech made in February. «The dollar remains, by far, the most widely used currency across a variety of metrics, including as a store of value and a medium of exchange».

Continued Dominance

Although it was not clear at the time, that first speech seemed to herald a quasi-existentialist analytical exercise related to the role of the dollar as an international currency, likely in advance of the conference currently underway.

Although it might be because it was made in a far-off place (Bahamas) and a different context (climate change), Waller seemed way more convinced about the state of play then, noting that US currency formed 60 percent of global reserves, followed by the euro at 20 percent.

Trade Invoicing

He was even more emphatic at the outset of the year about its role related to trade and banking. For the former, the purview of commercial banks near and far, dollar trade invoices comprised three-fourths of exports in all regions, except Europe, where it was at about half if the eurozone was excluded. 

When it came to banks and financial markets, about 60 percent of all bank loans and deposits were in the US currency, along with 70 percent of bonds not issued in a home country currency.

No Digital Inflection

The same apparently holds in the digital sphere and decentralized finance, or DeFi, something finews.com has commented on at some length recently. 

According to him, the likelihood of Bitcoin and the like replacing the US currency seems slim given that 99 percent of all stablecoin market capitalization was linked to the dollar, implying that any expansion in use was only likely to strengthen its dominance.

The Renminbi Question

But we digress. The more recent speech seemed somewhat more circumspect by citing a conference paper examining what he euphemistically called «geoeconomics tensions», or, in other words, the US-China trade conflict.

Here he maintained that sanctions and «geopolitical distance» seemed to lower the dollar’s share in foreign exchange reserves while another paper that looked at sanctions and policies that directly supported China’s renminbi could «reduce the prominence of the dollar if these sanctions and policies are «long-lasting»».

Trivial Share

That seems to imply a more moderated view of the mainland’s efforts from that in February when he stated that there had been an increase in the share of reserves held by the renminbi - but that it remained «trivial» at about 2 percent.

Back then, he went through a laundry list of reasons to inveigle fence-sitters about the mainland’s currency, noting that it was it not freely exchangeable, but that there were strict capital blocks and limited investor confidence. He also went on to highlight the shortcomings of symbolic efforts to increase trade invoicing with Brazil and Saudi Arabia. 

Possible Changes Afoot

He was much more equivocal and salient about things now, saying: «Rising geopolitical tensions, sanctions against Russia, China’s efforts to bolster usage of the renminbi, and economic fragmentation all can affect the international use of the dollar, most visibly as a store of value and reflected in its use in official foreign exchange reserves.»

Even though it is laudable, from the point of view of governance and transparency, that the Fed is out there trying to piece together the dollar's manifold challenges in the future, it is still only one side of the coin, pun very intended. As part of that, the task of the conference was to get a better view of the just-as-wide implications for worldwide financial stability related to the US currency.

Safe-Haven Shocks

Recent large-scale events such as the global financial crisis and the pandemic directly transmitted shocks to the American economy as investors and governments sought to protect their assets during periods of stress, with an additional paper set out to take a closer look at that, and the effectiveness of the swap lines between the Fed’s international liquidity facilities and the swap lines of foreign central banks.

Here the finding seems to be that having those kinds of lines in place mitigates the appreciation of the dollar against other currencies and its consequences. «This evidence suggests that the central bank swap lines not only ensure that credit continues to flow to US households and businesses, but also that these swap lines have effects that enhance financial stability and, thus, the standing of the US dollar as the dominant global currency,»  Waller said.

Hong Kong’s Peg

There is one caveat to all this. For some reason, no one outside Hong Kong on either side of the looming «geoeconomics» or «geopolitical» divide seems to ever mention the fact that Hong Kong continues to bob along untroubled, a bit long in the tooth maybe, all the while happily settling dollars to maintain its local currency peg.

Maybe it is because it allows the two sides to play the game either way - although we are probably never going to get to the bottom of that.