The dollar’s closest competitor is the euro, which meets many of the conditions for use as a global reserve currency. The eurozone has open and liquid capital markets, and the euro is the world’s second most widely traded currency and the second most commonly held reserve currency. Yet the eurozone does not include a fiscal union, and the bloc’s largest country, Germany, was, until earlier this year, reluctant to issue significant quantities of government debt. The lack of a unified eurozone fiscal policy led to the 2010–12 European debt crisis, which in turn caused a sharp drop in euro trading volumes on foreign exchange markets, euro-denominated SWIFT transactions, and the euro’s share in central bank reserves. The eurozone’s design flaws have been compounded by the fact that U.S. equities have returned nearly five times as much as their European peers over the past 15 years, leading asset allocators to concentrate investments in the United States. To make matters worse for the euro, the geopolitical threat to Europe posed by Russian imperialism has given central bankers yet another reason to steer clear of the currency.
THIS TIME IS DIFFERENT
Perhaps the biggest danger to the dollar’s dominance comes from Trump’s threats to the rule of law, which will shake the foundation on which the dollar’s standing rests. The risk is not only that the administration may precipitate a constitutional crisis by defying the courts but also that a more corrupt and personalist form of government may become entrenched under a president inclined to cut deals with his friends and punish his enemies. A serious impediment to adoption of the Chinese renminbi is the rule of law, or rather the lack of it: companies would rather end up in an American courtroom than a Chinese one any day of the week. Should this U.S. advantage erode, the results could be catastrophic.
U.S. government debt, which the Congressional Budget Office has projected will rise from 100 percent of GDP to almost 150 percent by 2050, provides an additional risk. If Congress cuts taxes further without curbing spending (regardless of the budgetary tricks used in the process), the resulting debt will mean that a greater share of government revenue will go to interest payments rather than other spending priorities, hurting long-term economic growth and the appeal of U.S. assets.
...
The dollar has not always been the world’s reserve currency or the currency of choice for international trade. In the nineteenth century, it was the pound sterling that enjoyed that status, and British financiers would have felt secure in its reign. The United Kingdom had deep, liquid capital markets, and the British Empire was the world’s largest economy and the central player in global trade. Yet after two world wars and decades of political and economic decline, London watched as sterling’s global status ebbed away. There was nothing inevitable about the pound’s slide or the dollar’s emergence, just as there is nothing inevitable about the dollar’s potential demise today. Choices, not destiny, determine reserve currencies; if the dollar is finally dethroned, it will be a disaster of the Trump administration’s own making.
...