This month marks the 50th anniversary of the end the Bretton Woods system, when US President Richard Nixon suspended the US dollar’s convertibility into gold and allowed it to float. We are also approaching the 20th anniversary of the Taliban’s removal from power in Afghanistan at the hands of US-led coalition forces. Now that the Taliban has again prevailed, we should consider whether its victory over the world’s most powerful military and largest economy will have any implications for the dollar and its role in the world.
Looking back over the 50 years since Nixon closed the gold window (39 of which I spent being professionally engaged in financial markets), the biggest takeaway is that the floating-exchange-rate system, and the dollar’s dominant role in it, has turned out to be more robust than initially expected. Even knowing what we know now about the evolution of the world economy, most experts would have doubted that the system could survive for as long as it has.
Given this resilience, it is tempting to dismiss America’s failure in Afghanistan as inconsequential for the dollar. After all, the greenback weathered the fall of Saigon in 1975 and the debacle in Iraq following the US invasion in 2003. Why should this time be any different? Ultimately, the answer depends on one’s expectations about the evolution of the world economy and the behaviour of its principal financial players, namely China and the European Union.
To understand the dollar’s prospects, consider three key reasons why the current system has persisted. First, most countries did not choose to have their currencies float freely against the dollar. Even though more countries have floated their currencies in recent decades, others have maintained fixed exchange rates, devised their own regional exchange-rate relationships, or launched a common currency – as in the case of the euro.
Second, and on a related note, the few countries that had enough economic heft to influence the global monetary system – Japan, Germany (previously West Germany), and, more recently, China – made a conscious decision not to do so. True, the German Deutsche Mark played a regional role from 1973 until the establishment of the European Monetary Union in 1992 and the introduction of the euro in 1999. But beyond that, Germany consistently took steps to keep its currency from assuming a larger global role.
Moreover, German authorities have persistently opposed the idea of pan-European bonds (notwithstanding the EU’s decision last year to launch a Covid-19 recovery fund based on mutualised debt obligations). Without a common budget, the euro will always be held back from competing with the dollar or playing a much bigger role in the world financial system.
As for Japan, it never showed any interest in a global role for the yen, even in the 1980s and 1990s, when it was fashionable to believe that the Japanese economy would catch up to that of the United States.
Finally, despite its frequent objections to the current global monetary system, China has long been reluctant to expand the renminbi’s footprint in financial markets – both internally and internationally. Instead, China has indicated occasionally that it would prefer a global monetary order centered more around the special drawing rights (SDRs), the International Monetary Fund’s reserve asset, whose value is based on a basket of five currencies (the US dollar, the euro, the renminbi, the yen, and the British pound).
This idea has some appeal, especially in terms of global fairness. But it would be difficult to implement in practice. Not only would it depend on China allowing for more free use of the renminbi; an SDR-based monetary system also would have to be embraced by the US, which is probably a non-starter – at least for now.
That brings us to the third reason why the current system has lasted: the US wanted it to. As we saw during Donald Trump’s presidency, the US enjoys the benefits conferred by issuing the dominant global currency, not least its potential as a tool for pursuing diplomatic and security objectives. The Trump administration’s use of secondary sanctions against countries that did business with Iran was a perfect example of this. If current or future US leaders choose to use the dollar’s dominance in a similar fashion – perhaps against countries doing business with a hostile Afghanistan – that could have a significant bearing on the currency’s future.
While the world marks the 20th anniversary of the September 11, 2001, terrorist attacks in the US, the IMF will be working on its mandated five-year review of the composition and valuation of the SDR basket. To the extent that the exercise increases the share allocated to renminbi, that will be taken as a sign that the world’s currency system is slowly but ineluctably evolving.
Just as China’s growing share of the global economy implies the need for a fundamental rebalancing, the renminbi’s share of the SDR basket cannot continue to grow without that increase meaning something for the future of the world financial system.
Jim O’Neill, a former chairman of Goldman Sachs Asset Management and a former UK treasury minister, is a member of the Pan-European Commission on Health and Sustainable Development.
This article was published by Project Syndicate.