US dollar cash might usually be considered a ‘safe’ (and so ‘store of value’) investment, but with low nominal interest rates post the Global Financial Crisis less the haircut arising from inflation, real returns per year averaged around 1% from 2010 to 2022. Only when the Federal Reserve was forced to raise rates aggressively in 2022 to counteract fast-rising domestic US inflation did these real returns edge up. But even now they are less than 2%.
As Charles Gave, chairman at Gavekal Research has noted, since 2014’s peak of $3.7-trillion, foreign exchange cash reserves deposited at the US Federal Reserve by foreign institutions have declined by $500-billion to $3.2-trillion. This is in very sharp contrast to the pre-2014 trend where this deposit total rose five times in 14 years.
Gave suggests either foreign multinationals have chosen to sell their US dollar earnings and not hold them offshore with the Fed, or some foreign central banks no longer think their assets are safe at the Fed (or both).
For many private sector investors, the epitome of a store of value is widely regarded to be the US 10-year Treasury bond, so much so that its yield stands at the crux of determining the cost of capital for much of the corporate world. This yield is sometimes called the “risk free rate”, even though given the UST10’s post-2020 dismal performance, it is patently not risk free.
US bonds losing ground
Dismal performance? How has this benchmark instrument done?
Even if the beholder lives firmly within Dollar World (where, by definition, that holder sees no currency effect and so faces “no” currency risk), US bonds have consistently lost ground since August 2020.
With an aggregate 17.2% decline, this has been the greatest drawdown in the US bond market for 48 years, worse than 1979/1980’s 12.9% decline. Stretching now to 52 months, it is also by far the longest: over three times the 14-month decline from July 1980 to October 1981. (The US 10-year Treasury had a yield of 0.69% at the end of August 2020; today it is 4.20% - the capital value of a bond moves inversely to its yield.)
By contrast, Chinese government bonds are up about 19% in US dollars since August 2020. The Chinese 10-year yield has fallen from 3.17% to 1.98%, a bond price gain that must be trimmed by a 7% fall in the renminbi versus the US dollar over the same period.
The additional advantage the CGB10 now possesses is that the interest paid on a Chinese government renminbi bond is less than half that of its US dollar equivalent. Currency risk noted, borrowing in Chinese renminbi is now far cheaper than borrowing in US dollars.
This massive Chinese bond outperformance of its American equivalent is rarely commented upon by the likes of Bloomberg and CNBC, fixated as they are with equity returns. Also barely mentioned has been the fact and remarkable feat that, last month, a BRICBond for $2-billion was issued by the BRICS Bank and with the same yield as US Treasuries; it was 20 times oversubscribed.
A foreign institution issuing US dollar bonds at the same price as the US government? Almost unprecedented!
And if the yield of a Government Bill is optically indicative of its strength – in reality, it is more complicated than that! The Chinese 10-year, now at 1.98%, has for four years been both “stronger” and less volatile (so less “risky”) than the US equivalent, now yielding 4.20%.
There are clearly more than hairline cracks in the longstanding claim the anchor investment instrument underlying the US dollar and so the global cost of capital, the US 10-Year Treasury Bond, is the world’s store of value ne plus ultra.
Diversification into other currencies
There are two other telltale signs, one visible and one in the making, that suggest all might not bode well for the future status of the US dollar as a store of value.
The visible evidence is the US dollar’s reputation as a reserve currency amongst official institutions – specifically central banks as suggested by Gave above – as reflected in the US dollar’s share of their foreign exchange reserves.
On an exchange rate and interest rate adjusted basis, this weight has fallen from 73% in 2002 to 56% in 2022. Diversification has taken place into what the IMF calls “non-traditional” currencies (Australian dollar, Canadian dollar, Chinese renminbi, South Korean won, Singaporean dollar, the Nordic currencies) as well as gold.
In gold’s case, since 2008’s Global Financial Crisis (which coincided with an aggregate bullion holding low point of 26,500 tonnes), non-US central banks have since added over 10,000 tonnes to their FX reserves. This increased allocation is worth $800-billion at today’s prices. Six of the top seven central bank buyers of gold since 2014 have been Asian: China, Russia, Turkey, India, Iraq and Singapore. The seventh, Poland, only joined this list after the Russian invasion of Ukraine.
The rise of digital currencies as legal tender
The telltale-sign-in-waiting is the promise implicit in the creation of digital currencies, notably Central Bank Digital Currencies (CBDCs). Here China’s offering is the world’s clear leader: the e-CNY is now legal tender, operational in 29 provinces, storable on mobile phone wallets, has been trialed for cross-border payments and in Changshu is used to make salary payments to government employees and state-owned enterprises.
As China does not allow trading in cryptocurrencies, as a CBDC, the e-CNY is a pioneering digital and official “stable coin” as its renminbi value is guaranteed 1:1 by the Bank of China. Thus, when viewed from the Global South, opting to hold e-CNY – especially when doing so arises from payment flowing from selling product into China – is considered a very viable option in the not-too-distant future.
Elsewhere, pilot schemes for CBDCs are in place in many of Australasia’s leading economies (South Korea, Japan, Thailand, Indonesia, Australia, India, Malaysia, Iran, Saudi Arabia, Kazakhstan, Turkey, the UAE) as well as the non-Asian BRICS members, Brazil and South Africa.
Crypto enthusiasts argue that the success of the likes of Bitcoin and Ethereum is also a sign that all is not well with the US dollar as a store of value and that investors are looking for “something better”, even “something safer”.
Exactly what impact digital currencies and instruments will have on the status of the US dollar as a store of value is difficult to gauge, but it is hard to see them being US dollar-supportive.
The modern-day epitome of a unit of account is arguably a share in an ETF of the US’s S&P 500 Index. And here there is no question about it: the unit of account for that index is denominated in US dollars with the result that the US dollar remains the modern world’s clear leader of the unit of account money function.
(An alternative modern-day benchmark of the unit of account is not equity but loan-based: the “risk-free rate” in the yield of the 10-year US Treasury, but, as noted above, post-Covid this benchmark has fared far worse than its equity – and even Chinese! – counterpart.)
All this noted, since Ben Bernanke’s “helicopter speech” in 2002, history’s most fabled unit of account – gold – has outperformed the S&P 500 Index … and with less volatility. Asia’s gold-buying central banks have been right to choose gold over the US dollar – even an investment in the S&P 500 Index – as a place to store their foreign exchange reserves.
The US dollar also still dominates the currency denomination of most international loans. But, as standards of deferred payment, the market for non-US dollar bonds is growing. Asian issuance is increasingly frequent: Samurai bonds (in Japanese yen), Dim sum bonds (Hong Kong-issued, but in Chinese renminbi), Arirang bonds (in Korean won), Baklava bonds (in Turkish lira) and the above-mentioned Panda bonds (China-issued, in Chinese renminbi).
The frequency of these non-dollar issues tends to be tied to the longer-term prospects of the issuing currency versus the US dollar. If, as has been the case recently, the US dollar is seen as having “strong” prospects versus that issuing currency, a multinational corporate earning US dollars from their exports may well seek an alternate currency denominated loan: paying back that loan in the future might require less of those dollars earned from exports and, in this regard, it is a cheaper option. (Samurai bonds have been more common in 2024 because of this logic.)
For now, these non-US dollar bond issues are more the exception than the rule: about 64% of world debt is dollar-denominated, up from 49% since 2010 … though this rise to 64% has been materially driven by debt issuance from the US Treasury to fund the US’s budget deficit. In 2010, US federal debt was $13.6-trillion versus $36.2-trillion today, a rise of $22.6-trillion in 14 years. As public debt worldwide rose about $50-trillion between 2010 and 2024, the US can be seen as accounting for nearly 50% of that increase. In 2024, US government debt is 35% of all government debt worldwide, a statistic which has likely contributed to the decision by both S&P and Fitch to strip the US of its AAA sovereign credit rating and downgrade it to AA+. Moody’s US credit rating is still AAA, but with a negative outlook.
Cutting out the ‘dollar leg’
All this noted, at least for now, the US dollar’s position as the dominant standard of deferred payment in global bond markets remains relatively secure, notwithstanding the fact that Chinese bonds have been a much better investment since mid-2020.
It is in the realm of the currency used to denominate the medium of exchange that the US dollar’s position has shown most slippage, a realisation and a sensitivity that likely prompted Donald Trump’s recent outburst against the BRICS grouping. Why? Because this bloc has exhibited the most willingness to use a currency other than the US dollar in the settlement of their bilateral trades.
The US dollar’s share in global trade invoices has registered a decline from near total dominance after World War 2, but this share has recently stabilised at around 50% of global trade settling via the SWIFT mechanism. (Yes, China uses SWIFT too, but is also fast growing its own alternative network, CIPS: in 2023, the number of transactions processed by CIPS rose over 50%.)
In the past few years, there has been growing evidence of countries outside the West cutting out the “dollar leg” from their trade finance procedures: India is now regularly buying oil from the UAE in dirhams while Brazil is exporting its resources to China in return for renminbi.
The Bank of China has carried out currency swaps with 35 countries totaling 3.2 trillion renminbi ($440-billion); this has provided the significant financial wherewithal required to facilitate non-dollar trade finance carried out between China and its trade partners.
Internal BRICS trade
While Donald Trump rails against the (remote) possibility of the BRICS creating their own currency to compete with “the mighty dollar”, the simple reality is that this nine-member grouping (with nine partners in the “waiting room” seeking full membership and a further eight that have applied for membership) is rather working on the mechanics of how to settle trade among each other using their own currencies and thus cutting out the US dollar. Preliminary evidence suggests that carrying out such direct trades has been surprisingly hassle-free as well as cheaper than invoicing via the US dollar.
The recent and growing weaponisation of the US currency by successive US administrations – both Democrat and Republican – appears to be adding to the impetus of finding ways round for Global South nations being obliged to use the US dollar in intermediating trade transactions. Dollar-trade finance forcibly requires using the clearing house mechanism in New York to settle transactions; this subjects bilateral trade between two non-US parties to US law and so oversight.
So, where does this leave the deeper status of the US dollar today, considering the varied roles it plays in the four functions of money? For those who live and breathe the world of capital, the status of the US dollar naturally appears über-secure. Suggesting otherwise usually provokes TINA-laced outbursts of disbelief!
That said, there are very visible fault lines in the pre-eminent status of the US dollar, notably as a store of value and a medium of exchange, and particularly in Asia.
The writing on the wall
For those of us who work within but travel beyond the largely Anglo-Saxon capital ecosystem into the parallel ecosystem of global trade, the writing on the wall is clear for all to see. My recent visit to Peru allowed me to conclude that China’s commercial influence there – indeed across much of Latin America – is fast displacing that of the United States. This buffers the insight that something is very visibly amiss in the status of the US dollar outside the West.
It will no doubt take time for this dollar decay to be realised and acknowledged by the West’s captains of capital. But were they to glimpse, as Belshazzar did at his feast, these MENE, MENE, TEKEL, UPHARSIN warnings scrawled upon the walls of many aspects global trade and finance, they might well be moved to ask – echoing Herbert Spencer not in his TINA quote but rather his “survival of the fittest” quote: “Just how fit is the US dollar in today’s fast changing world? Is it adapting to shifting trade regimes and, in particular, the return of the centre of economic gravity to Asia? If it is not adapting, for how long will the US dollar survive as the world’s paramount currency?”
The evolution of global currencies over the past 700 years is testament to the logic and rhythm of the survival of the fittest: those money regimes most adaptable to change. The world of both trade and investment has witnessed the rise and fall of the Venetian ducat, the Florentine florin, the Spanish real de a ocho, the Dutch guilder and the British pound. Will the fate of the US dollar be any different?
Given the rusting now evident on the US dollar’s armour plating, at what point might the penny – the US dollar’s penny! – start to drop? DM
This is Part 2 of a two-part series on the challenges to the US dollar’s dominance. Read Part 1 here.