Early last week, UBS hosted its 13th annual Reserve Management Seminar in Thun, Switzerland. In attendance were the people whose job it is to figure out what to do with the foreign currency reserves held by their country’s central banks. They came from 78 nations, representing institutions with reserves totaling $4.8 trillion.
In other words, these are the people who will determine whether the dollar will maintain its status as the world’s reserve currency. So the UBS folks asked them if they thought it would, 25 years down the road:
There are different ways to look at this. One is that a majority of those in the know don’t think the dollar will still be dominant in 2032. UBS hasn’t done such audience polling at previous reserve seminars, so there’s no way to tell if this attitude is new. But it is definitely worth paying attention to. Losing its status as the country whose currency everybody wants to own would certainly be painful for the U.S.–having the dollar as the world’s reserve currency allows us to get away with economic behavior that other countries can’t, plus the Treasury profits from printing money that gets stuffed in mattresses the world over. It wouldn’t be the end of the world, though. The British pound lost its reserve status to the dollar after World War II (actually, it started losing it during World War I, and the second World War merely completed the process), yet London is now back in the saddle as arguably the world’s most important financial center.
The question of what would replace the dollar, though, is clearly one that still flummoxes central bankers the world over. The only available candidate right now is the euro. The European common currency has been gaining ground on the dollar for five years now, which speaks in its favor, but that rise strikes me as more cyclical than secular. Economists argue a lot about what causes a currency to rise or fall against other currencies, but the two main long-run factors seem to be economic growth and price stability. I find it very hard to believe that the Eurozone economy will, over time, grow faster than the U.S. economy. Slower European population growth alone will make that almost impossible. As for price stability, one can argue that the European Central Bank is constitutionally more hawkish about inflation than the Fed (the Fed is legally obliged to balance unemployment and inflation, while the ECB is required only to consider the latter). But the practical differences in monetary policy since the ECB was founded nine years ago haven’t been all that great. In short, it would take some seriously bad policy decisions on the part of the U.S. (worse than anything we’ve seen so far) for the well-established dollar to lose out to the upstart euro.
The unnamed Asian currency favored by the reserve managers in their poll is another matter. China will, according to that famous Goldman Sachs BRICs report, overtake the U.S. economically (that is, it will have a bigger GDP than the U.S.) in 2041. If that happens, and if China continues to mature financially and politically (a big if, I might add), it only makes sense that the yuan (or remninbi, if you prefer) would displace the dollar as currency No. 1. That’s a long way in the future, though. Which is why, even though they’re obviously not universally thrilled about it, the world’s central bankers keep holding on to their dollars.