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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is an FT contributing editor and writes the Chartbook newsletter
What is the dollar system based on and how will it evolve? As we mark the 250th anniversary of the United States, our ability to realistically address those questions is clouded by all manner of myths. It is commonplace, for instance, to observe that since the second world war, the dollar has replaced the pound as the reserve currency of the world. But if that is true, it is because the dollar system has been repeatedly reinvented. Today, it is once again in a new and volatile configuration, quite different from that of 15 years ago let alone the 1940s.
To speak of a reserve currency itself risks anachronism. Holding large reserves of currency was not the norm prior to 1945. The gold standard was the gold standard. From the 1920s, both pounds and dollars were held in central bank vaults but only as a second-best.
Gold was king. Under the Bretton Woods system after the second world war, dollars were held as reserves, alongside the IMF’s special drawing rights. But those dollars were backed by gold.
The world only embarked on the experiment of fiat currencies when US President Richard Nixon took the dollar off gold in 1971. Though petrodollars accumulated to the benefit of some Opec members, the holding of dollar reserves remained small even into the early 1990s.
The norm of holding large quantities of fiat dollars in official reserves only emerged as recently as the new millennium. The so-called Bretton Woods 2.0 system was not planned in Washington. It was adopted in the late 1990s as a form of self-insurance by emerging markets seeking protection against the risks of financial crisis. Above all it was China that pegged its exchange rate and began large-scale official reserve accumulation in the 2000s. This conferred on the US the exorbitant privilege of stable, official funding of twin deficits — on current account and in government budgets.
Fifteen years later, in the mid-2020s, it is still this configuration that serves as the benchmark for most discussions of the “future of the dollar” and yet it was by no means the historic norm. And by the mid-2010s, in its original form, Bretton Woods 2.0 was already over. Around 2015, new reserve accumulation driven by China tapered off. The balance of different currencies within the pile of reserves has since shifted slowly against the dollar. But the more significant fact is that the accumulation of new reserves has plateaued.
And yet America’s twin deficits continue. But how are they funded, if not through official reserve accumulation? In part through off-the-books holding of reserves on the balance sheets of China’s state banks and, above all, through private foreign investors acquiring US assets.
Since the mid-2010s, it is US financial markets that have provided the draw. America’s unequal, K-shaped economy is the honeypot of global capitalism. Unlike in the classic phase of Bretton Woods 2.0, it is not China leading the way. Since 2015 Beijing has imposed tight capital controls that trap $50-60tn in Chinese bank accounts behind a financial firewall. Official reserve accumulation is one thing. A private capital exodus from Xi Jinping’s China would be quite another. America’s deficits are financed by inflows from Europe, South Korea, Taiwan and Japan.
What then, should we call this latest phase of the dollar system? Bastard Bretton Woods? The hedge fund dollar? Given the latter’s outsized role in Treasury markets, it is tempting. But relative value trades are too technical to really capture the flavour of this era.
Discussing the question in Beijing with a Chinese colleague who specialises in Marxist political economy, he remarked that the quality of a currency system is ultimately defined by the class relations that underpin it.
In that spirit, perhaps the best label for the current era would be the “billionaire dollar” in honour of President Donald Trump and his shameless self-enrichment. Or perhaps that should be the “trillionaire dollar” after Elon Musk and the SpaceX IPO, which has redefined the parameters of wealth.
Certainly, in the current iteration of the dollar system, anyone worrying too much about America’s chronic fiscal incontinence can easily seem out of touch. We aren’t in the 1990s any more. But if that is so, perhaps it is also time to stop speaking of the dollar as a reserve currency, with all its time-honoured connotations of bank vaults, probity and solidity.
America’s currency today is, above all, a promise of liquidity and a vehicle for outsized and unfettered capital accumulation: the profit dollar.
