There have been growing claims in recent years that the US dollar could lose its status as the reserve currency – not least from China, where head of the country’s central bank, Pan Gongsheng, said recently that he anticipates a new “multipolar” system of competing sovereign currencies.
In Europe, European Central Bank (ECB) president Christine Lagarde wrote in the FT that “the dominant role of the US dollar is no longer certain”, and that there could soon be a “global Euro moment”.
But is this political noise, or is there a real risk of ‘dedollarisation’ in a world of tariffs and geopolitical instability? To answer that question, we spoke to associate at Oxford University’s China Centre and former UBS chief economist George Magnus.
‘Euro moment’?
“That’s a bit of European wishful thinking,” Magnus suggests, regarding Lagarde’s remarks.
“It’s not totally irrational for her to say that, because, just as a lot of people are reevaluating what they think the US is all about under Trump, there’s a recognition that the Europeans believe in a rules-based system, and seem to be more committed to the operations of the World Trade Organization.
“Okay, they may not be the biggest tech region on earth but it’s a big trading area and it’s very well-off.”
The core reason that the euro “can’t really rival the dollar” is persistent anxiety that “the whole is not bigger than the sum of the parts”, Magnus argues.
“There’s no common debt issuance, there’s not enough capital markets integration; too many barriers outside of merchandise goods. So it could be a ‘euro moment’, but the European Commission need to really get behind the Draghi plan.”
That plan, a set of recommendations set out by former head of the ECB Mario Draghi, focuses on reorientating the European economy towards competitiveness. “If there was a movement towards realising a number of those initiatives, I think [Lagarde] has got a point,” Magnus says, “but we’ll see.”
‘Financial plumbing’
Regarding Gongsheng’s claims of a “multipolar” global currency order, Magnus says China has “got a lot of form” with such statements.
“It’s quite normal for them to warn of the perils of a dollar-based system, and how we need to move to a multi-currency reserve system using local currencies more in trade.
“This is par for the course for them – it’s part of the rhetoric and narrative that they spin both domestically and in the context of BRICS.”
“It’s a narrative that a lot of people use and cite,” Magnus says, but it fails to reckon with the reality of “financial plumbing” in the global trading system.
Changing towards such a multipolar currency order would require creating a financial environment in which it can “plant roots” through directed government policy – something that has yet to happen. The speed with which China’s commercial relationship with Russia has changed since the latter began its war in Ukraine has given the rhetoric around dedollarisation a “turbocharge” – but it remains rhetoric.
“The attempts by many countries to develop alternative trade and invoicing systems to the US dollar will persist,” Magnus expects, “but I don’t think the dollar’s overall role in global finance is going to erode unless the Americans themselves do it.”
The debt risks
There are two scenarios in which the status of the dollar really could be threatened, however.
One is a domestic debt crisis in the US – a possibility on which American minds are likely to be focused after president Donald Trump’s “big, beautiful” tax and spending bill made it through the US senate earlier this week.
If the debt-to-GDP ratio in the US continues to rise – as it is predicted to – and hits a figure in the region of 150%, as deficits keep coming in at 7–8% of GDP, then the market for US bonds could have a “meltdown”. The US government may then be forced to introduce “draconian measures to curb public expenditure” to hold back the crisis, and this could devalue the dollar as confidence in the US collapses.
“Under those circumstances, I could see desertion by private and official investors out of the dollar and into a variety of substitutes – it would be untimely but probably quite positive for European currencies, and maybe the [Japanese] yen, Swiss francs, sterling, gold and precious metals. It would be where people felt like they had relative safety.”
The US can run deficits – in both government spending and trade – that other countries can’t because of the dollar’s position, but there are limits to this, Magnus suggests.
China conflict
The other scenario that could precipitate a real move away from the dollar would be a military humiliation in a confrontation with China over Taiwan.
If the US “lost or got a bloody nose”, or failed to end a blockade of Taiwan, it would be “an albatross over the US body politic” that could make the dollar “persona non grata”.
Even in this scenario, there could still be a flight into the dollar, with people regarding it as a safe haven currency. It underscores why some, including within the US administration, believe the US’ so-called “exorbitant privilege” as the proprietor of the reserve currency is in fact an “exorbitant burden”. They argue that the unwarranted strength of the dollar has a number of second-order effects that include making US exports more expensive.
The bottom line
Even in these scenarios, Magnus says, the situations themselves, rather than their impact on the dollar, are likely to have a greater effect on trade.
In a military conflict between the US and China – rather than a trade war – the consequences for shipping, including the difficulty of getting insurance and the physical impossibility of moving goods through blockades, would have “really, really negative consequences on trade anyway”. Chinese ports could be blockaded, as could some of the other global trade ‘chokepoints’.
The volume of trade during a military conflict would suffer more than in a US debt crisis scenario. However, a debt crisis would hurt other countries’ exports to the US more, particularly in the case of a US recession – and “there is no substitute market for consumer goods imports” that could take its place.
For now, however, the dollar is likely to remain on top for a while: its “networking effects” easing global trade, and its prominence in insurance and foreign exchange, ensure it. While it would be “churlish to deny” the overtures being made towards dedollariation, Magnus says, the change remains a way off, at the very least.
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