Do you think we should get rid of the currency?
World economyDollar, euro, renminbi and the future of the reserve currency
In July 1944, delegates from 44 countries met in Bretton Woods, New Hampshire, at the invitation of American President Theodore Roosevelt to open the United Nations Monetary and Financial Conference.
Why the dollar became the global reserve currency after 1945
It was the first major meeting since the 1933 London World Financial Conference, and it was to mark the rise of the US dollar as the world's leading currency. A historic decision that is essentially still valid today. Adalbert Winkler, economist at the Frankfurt School of Finance and Management, explains why the dollar became so important back then:
(imago stock & people) UN Financial Conference 1944 - The legacy of Bretton Woods
The Bretton Woods Agreement was the basis of functioning trade after World War II - until the 1970s. But the meeting shapes the global economy to this day.
"On the one hand, there were political reasons that the USA turned out to be the dominant Western power after the Second World War and that was of course then supported by a corresponding economic supremacy of the United States. That means the USA has a large, rich, efficient economy, and accordingly the demand for debt instruments issued by this economy, including in the form of money, was very high. "
Viewed from an economic and historical perspective, the dominance of the dollar is still young - but the question of whether the European common currency, the euro or the Chinese renminbi, could become key currencies also arises for completely different reasons. Economic and political factors are closely linked. It is possible that the era of the one currency that is the world's leading currency is coming to an end anyway.
John Maynard Keynes and Harry Dexter, the founders of the World Bank and IMF, at the Bretton Woods conference - where smoking was allowed (far left) (imago / United Archives WHA)
Before the dollar, until 1944, the pound sterling was the most important international currency. But the Second World War had hit Great Britain, but also the other European countries badly, they were financially strong. Back then, some governments tied their currencies to the dollar backed by gold reserves. It stayed that way for about 30 years. In the 1970s, then President Richard Nixon broke the link between the dollar and gold. The reason: He needed a lot of money for the Vietnam War:
"There was simply so much money printed and necessary that one was no longer able to maintain this gold cover. It was then canceled."
Says Martin Lück, Head of Capital Market Strategy for Germany, Switzerland, Austria and Eastern Europe at Blackrock, the world's largest asset manager. And yet the dollar has since managed to at least retain its unofficial status as the reserve currency, mainly because the US economy is so strong.
Functions and advantages of a key currency
But what actually constitutes a key currency? It is a means of payment for private transactions on an international level as well as for central bank interventions. It is the anchor currency for fixed exchange rates, and private investors invest in the reserve currency so that their assets are protected. And an investment in dollar securities is safe, explains economist Winkler:
"A reserve currency is held by non-residents. And that's obviously the case when they think that debt - and a currency is a debt issued by a state - if that debt is good. And the United States has - Since their founding, they have practically never been in default as a state, as a United States. And that gives you an uncanny reputation advantage over all other competitors. "
(Imago / Westend61) The predominance of the US dollar
The USA rose to become the leading world power in the 20th century. The US economist Michael Hudson describes in his book "Financial Imperialism" how important the monetary system was, with the dollar as the reserve currency.
Because that is exactly what the American Federal Reserve stands for. The central banks around the world are also aware of this, which is why they also rely primarily on the dollar when holding reserves. That is another criterion for the status of a reserve currency, says Gertrud Traud, chief economist at Helaba, the Landesbank Hessen-Thüringen.
"Here we see that the US dollar dominates with a share of a good 60 percent. The euro has 20 percent, but it is only 20 percent. There is a huge gap in between, and I don't see it in the foreseeable future either is closed. "
World currency dollar also demands responsibility from the US
Martin Lück explains that the dollar as the key currency brings clear advantages to the USA:
"That of course gives the American authorities a certain amount of freedom in designing them. In other words, you can basically say that we have the key currency available here, that we produce ourselves, there are no restrictions. And that's why it is different from such Countries in which this is not the case, which for example have a large part of their foreign debt in other currencies that they cannot produce themselves, that one has significantly greater freedom here, for example with regard to debt. "
The fact that international investors help finance this debt is a major privilege of the country that issues the reserve currency as long as inflation does not get out of hand. This also goes hand in hand with great political power, explains Michael Heise. He was Allianz's chief economist for a long time and now works for the HQ Trust asset management company:
"In addition, of course, the interest rate level in the United States of America is of global importance. And in this respect, the policy of the American central bank is decisive for the development in many other countries can hardly withdraw if they do not have to accept significant devaluations of their currencies. In this respect, one should not underestimate that. A key currency function is also an instrument of political power. "
Where the rise of the dollar as a world currency began: the luxurious historic hotel in Bretton Woods, the venue for the 1944 financial conference (imago / Michel Hersen)
However, a reserve currency also has disadvantages for citizens. When banks and companies, including private investors from all over the world, invest in dollar investments, this strengthens the importance of the currency, in this case the greenback. The high demand also makes investments in the USA, such as real estate, more expensive. On the other hand, this also has an important advantage, says Tobias Heidland, who heads the Research Center "International Development" at the Kiel Institute for the World Economy:
"As a result, we have a currency here and on land in which, due to the great demand for loans and investment opportunities, a large current account deficit can be financed at the same time; Capital that foreign companies take and flow back into the US market, for example company shares, real estate and so on are bought there and the currency is not destabilized as a result, although US citizens live above their means. "
But it was precisely this current account deficit that the former President of the USA, Donald Trump, had repeatedly called "unfair". He referred to another aspect: Because the USA has such a disadvantage, its goods and services are too expensive internationally. On other occasions, however, Trump said he was ultimately interested in a strong dollar.
This erratic back-and-forth has also repeatedly troubled the currency markets over the past four years. Many players in the financial markets watched Trump's Twitter interventions with a frown, as it is an unwritten law in the USA that the government does not abuse its own currency. This is also forbidden by the rules of the International Monetary Fund, because it wants to avoid deliberately weakening a currency in order to gain advantages in trade. In the financial markets, however, especially last summer, people kept asking themselves whether the age of the dollar as the leading currency was drawing to a close. Because having the privilege also means taking responsibility - especially in times of crisis such as the current corona pandemic. But the USA no longer seemed ready for this under the Trump administration, believes Adalbert Winkler of the Frankfurt School:
"In the crisis situation already mentioned, a government and a central bank that produces an anchor currency, an international currency, must not only look at its own plate, but also think outside the box. And that is sometimes relatively difficult politically. Because precisely In a crisis, many people think that we have to think about ourselves first and not about the others. "
What disadvantages a strong dollar means for the euro zone
In the years under Trump, the United States missed this responsibility, which they had still fulfilled during the financial crisis, but his government was also happy to use the geopolitical power associated with the greenback. In this way, the USA can better enforce sanctions through this special role of its currency, says Tobias Heidland, which happened against Russia, but also against Iran:
"There the EU also lacked the leverage to look for its own, perhaps more constructive, solution with Iran, because European companies that were still willing to trade with Iran, for example, were threatened with gaining access to it Dollar, would be cut off from the US financial system if they were to break these sanctions imposed by the US. And that is a very important geopolitical component of this question of the reserve currency or various strong currencies and one of the central goals of the EU, the euro zone in particular, why the Euro should be strengthened in the next few years. "
(picture alliance / Karl-Josef Hildenbrand) Reform of the Eurozone - Many conflicts
There are a few ideas for the necessary reform of the euro zone - from French President Emmanuel Macron, for example, or from German Chancellor Angela Merkel. And with it a corresponding number of conflicts.
Because that is the aim of the EU Commission. The strong dollar makes the euro and the economy in the euro area more susceptible to shocks or even company takeovers because the values of companies - converted into dollars - fall. Another reason concerns trade, believes economist Michael Heise:
"It is in the interests of a country that as much of the trade as possible is invoiced in its own currency. Then the risks for companies in this currency area are lower. I think that is a strong motivation."
Because the fluctuations in exchange rates have a direct impact on companies' balance sheets. So the economy would be more stable.
When the euro was founded more than twenty years ago, it was welcomed with great enthusiasm on the financial markets, recalls Tobias Heidland from the IfW:
"If you look at how large, for example, the share of the euro in financial transactions was, then it was well on its way to the great financial crisis at the end of the 2000s and then the subsequent euro crisis."
The financial market has no confidence in the long-term stability of the euro
At first, the euro quickly established itself as an international currency, albeit with a regional limit, says Adalbert Winkler of the Frankfurt School. For example, in countries that for historical reasons have close ties to euro countries, such as North African countries. Because of the geographical proximity to the euro zone, households, companies and even governments in the Balkans often used the new currency instead of the D-Mark:
"For example, the DM was always used as a parallel currency in the former Yugoslavia. We can see today that the euro also plays a major role in the present-day states of the former Yugoslavia."
(picture alliance / dpa / Bernd Wüstneck) "The D-Mark was a currency that was respected worldwide"
From its introduction over 70 years ago to its abolition, the D-Mark gained in value as a currency and was popular around the world, says Johannes Beermann, member of the board of the Deutsche Bundesbank.
Beyond that, however, the euro has not yet succeeded in diminishing the importance of the dollar. And there is one main reason for this: the market players have lost confidence in the long-term stability of the euro, and the financial market in the euro area is too fragmented, says Tobias Heidland from the IfW:
"The important argument here is that there are actually relatively few really safe forms of investment such as government bonds within the EU, i.e. German, Dutch and so on. Government bonds cannot completely satisfy the demand for safe euro investments."
Eurozone: one currency, but no common financial policy
This is another reason why the discussion about the issue of Eurobonds, i.e. common bonds for the euro area, was so important. They could make the euro more attractive for international investors and central banks, says economist Heise. Last year the EU decided to finance two-thirds of its "Next Generation EU" reconstruction fund through joint debts. However, the states are not jointly and mutually liable for them.
(imago / Westend61) EU financial policy - "Money doesn't grow on the tree"
The federal government is still against common European government bonds, the so-called Eurobonds - says Michael Fuchs (CDU). Every country must remain responsible for its debts.
In addition to the Eurobonds, there are still the respective country bonds. Martin Lück from asset manager Blackrock believes that the governments could not decide to issue a joint bond for which they are jointly liable, shows the deficit of the euro area:
"It is too obvious that Europe does not speak with one voice. You can see that in very, very many points. Whether these are the autocracies in Eastern Europe, whether these are questions about financing, whether it is the question of how far they should go we are entering into a transfer union, the questions now, for example, different answers to the COVID crisis: these are quite striking points where it becomes very obvious that Europe does not speak with one voice. We have one currency, but we have long since not a policy, we don't have a fiscal policy either. And that makes the whole story inconsistent. "
And that then also scares off potential new investors.
In order for the euro to gain in importance in international trade and as a reserve currency, the financial market in Europe must be expanded. Even if the British were not a member of the euro area, London was and still is the most important financial market in Europe. The completion of the banking union in the euro area and the capital markets union would be all the more important after Brexit. This could also be used to strengthen the euro as a trading currency. In the energy sector, for example, the dollar is predominant, and oil is invoiced in dollars around the world. However, the Commission would like to promote the development of euro derivatives on energy and raw materials. Tobias Heidland from the IfW:
"In such sectors the EU is actually trying to strengthen the role of the euro. And here I could imagine that something will change, perhaps only slowly, because the EU plays an important role as a consumer. In addition, for example, the euro as I don't really see the possibility of establishing a popular trading currency between non-European countries in the coming years. The dollar is established there, and the various countries know what they have in it. "
The euro cannot dethrone "King Dollar" for the time being. Rather, the dollar is strengthening again because the new President Joe Biden's trillion-dollar economic stimulus package is fueling hopes on the markets for a significant economic upturn.
The role of China: why the renminbi does not play a major role in the financial market
Economically, however, China has also been the USA's major competitor for years. The Middle Kingdom is already exporting more, and while China is steadily expanding its world market share, the USA is falling behind.
(dpa / picture-alliance / Xie Zhengyi) Yuan in the IMF currency basket - rise to global currency?
The yuan, also known as the renminbi, has been in the IMF's currency basket since 2016 - alongside the dollar, euro, yen and pound. China had been working towards this moment for years. Above all, it has symbolic value.
In the financial market, however, the Chinese currency only plays a negligible role. The central banks only hold around two percent of their reserves in the renminbi. On the one hand, China is interested in gaining more power in the global economy, believes Gertrud Traud, Helaba's chief economist. The Silk Road project already shows that.But in order to become the reserve currency, the government in Beijing would have to be ready to internationalize the renminbi:
"China is still hesitating. Complete convertibility is missing, so the currency is not completely free and can be exchanged indefinitely. And that is of course a real drawback. Two factors meet in China that hinder each other, control on the one hand and then the great importance of a reserve currency, where you have to give up control in part. I think China wants that, but the whole consequence of what that means, they are not yet ready to live, and that is why China is not yet facing the door to replace the US dollar. "
That is why China is not yet a threat to the dollar. For the time being, the country is going a different way, suspects Martin Lück from Blackrock. China relies on a second economic cycle within the Chinese economy:
"In other words, a circulation of money and goods, which is practically produced in China, for Chinese customers. This strategic orientation of the Communist Party clearly shows that China is not necessarily relying on the additional acceleration of globalization, including one Liberalization of the financial system, and that would be exactly this currency component, but that in China, even if in a completely different way than America, one relies on a kind of isolation, on a division of the world, so to speak, in a Chinese or Chinese-centric circle and probably in a circle that focuses somewhere around America and the EU. "
And something speaks against the rapid rise of the renminbi as an international currency: The Chinese central bank is one of the largest creditors in the United States because it holds high dollar reserves, says Adalbert Winkler:
"The strength of the Chinese currency depends on the strength of the US dollar. The Chinese are now faced with a financial policy problem similar to that which Germany faced in the sixties and early seventies, namely to break away from the dollar first of all, before you can even think of wanting to play an independent international role as a currency. "
Asian, European, American area: a multi-currency world in the future?
The dominance of the dollar is not guaranteed despite the weaknesses of the competition. Something has started to move on the sluggish currency market. That is why IfW economist Heidland expects the world to be divided into several large currency regions. The dollar would remain number one in this. But he thinks that ...
"... the Chinese currency will be clearly in second place in, let's say, 20 years, and the Southeast Asian countries in particular, maybe even Australia, are important trading partners for the Chinese, countries that are very dependent on exports to China will then be very much oriented towards the Chinese currency; the European neighborhood, for example in the Balkans, perhaps even in North Africa, will be strongly oriented towards the EU or the euro zone, the two Americas will be oriented towards the USA, so that we may will come to a multi-currency world. "
The currency market is therefore still firmly cemented for the time being. But the first breaks can be seen.
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