- Government stimulus measures in response to the COVID pandemic have led some to argue that the U.S. Dollar risks being displaced as the global reserve currency.
- Bitcoin advocates have argued that the cryptocurrency could take the dollar's place; but skeptics disagree.
Since the end of the Second World War and the Bretton Woods Conference, the U.S. dollar has been the global reserve currency; today, more than 59% of foreign bank reserves are denominated in U.S. dollars, according to the International Monetary Fund.
But the dollar's position as the global reserve currency has been looking somewhat shaky of late.
Last July, strategists from Goldman Sachs argued that the U.S. government's COVID-19 response, taking in fiscal stimulus packages and money printing, is triggering "debasement fears" that could see the dollar toppled from its position as the world's reserve currency. And China's yuan continues to nip at the dollar's heels as the country races ahead with an ambitious programme of digital currency innovations.
With the dollar's status as the global reserve currency potentially up for grabs for the first time in decades, advocates have seized on the opportunity to talk up the cryptocurrency as a possible alternative.
‘Money printer go brr’
Back in December 2020, Ruchir Sharma, chief global strategist at Morgan Stanley, penned a Financial Times op-ed predicting the end of the dollar’s status as the global reserve currency and its eventual replacement by Bitcoin.
"Fearful that central banks led by the US Federal Reserve are debasing the value of their currencies, many people have bought bitcoin in bulk since March," wrote Sharma. In Sharma's thesis, wary savers are drawn to Bitcoin because its supply is artificially capped, unlike the dollar and other fiat currencies, which have no supply limit.
"The printing of fiat currency is debasement; it is the theft of value from current holders," Erik Voorhees, CEO of digital asset trading platform ShapeShift, told Decrypt. "We have come to embrace this phenomenon," he said, "but historically, regimes that debase their currency tend to collapse their currency."
One consequence of debasement is inflation. "An established international currency can indeed lose ground to others and may eventually lose its dominant position," explained George Selgin, director of the Center for Monetary and Financial Alternatives at the think tank Cato Institute. But it’s not an easy thing to happen. "It has to become sufficiently unstable in value."
The US last year recorded an inflation rate of 1.25%. And according to a Minneapolis Federal Reserve calculation released last month, there’s a 33% chance that the U.S. inflation rate will jump above 3% over the next five years. This all gives Selgin some reason to be concerned in the longer run, "but even then it's not by any means certain that we are looking at double digits in the medium or long run." The U.S. inflation rate is nowhere near Argentina’s 36% or Turkey’s 15%.
"It takes a heck of a lot of inflation for people to decide it’s worth jumping off that bandwagon onto anything else," Selgin said.
If the dollar were to collapse, the next bandwagon people would jump to wouldn’t be Bitcoin, Selgin added, but other fiat currencies. That’s because they’re popular—liquid—and that’s what matters in global transacting. It’s the idea behind what economists call "network effects".
Sharma’s argument for Bitcoin as a reserve currency doesn’t rest solely on debasement from money-printing, however; the cryptocurrency would also need to function as a useful medium of exchange. "Smaller businesses are starting to use bitcoin in international trade, particularly in countries where dollars can be hard to come by (such as Nigeria) or the local currency is unstable (Argentina)," he wrote.
But can Bitcoin pose a serious challenge to the dollar’s use as a global medium of exchange?
"The dollar’s massive liquidity and network effects are the strongest headwind against Bitcoin’s ascent," Voorhees told Decrypt, while noting that Bitcoin has risen from nothing to a trillion-dollar market capitalization over the course of a decade. "Bitcoin’s earning its own network effect with time," he said.
Bitcoin’s $827 billion market capitalization seems staggering. After all, there are 2 trillion dollars in circulation, and just over 1.43 trillion euros as of March 2021.
But those numbers don’t exactly provide an apples-to-apples comparison. Dollars and euros are actively used in everyday transactions—unlike Bitcoin, even though it may be adopted in some isolated cases. A Deutsche Bank report released in March 2021 noted that Bitcoin transactions average about 0.5 billion per day, equivalent to 0.02% of transactions in the Euro and 0.009% of transactions in dollars.
"Bitcoin’s liquidity is much closer to the Thai baht", said the report. And the Thai baht—not even a remote contender for the status of global reserve—isn’t the sort of rival Bitcoin’s poised to take down. If "international transacting" is the necessary condition for the reserve-currency status, then the odds don’t stack in Bitcoin’s favor, at least in the foreseeable future.
The status of reserve currency doesn't just boil down to its use as a medium of exchange. It’s also understood in terms of assets held by global financial institutions.
Sharma mentions the dollar as an "anchor against which other nations value their currencies." That happened during the Bretton Woods era, Voorhees said. "Anchor [was] an apt descriptor," he said, but since it untethered from gold in 1971, "the dollar has been pure fiat."
"Bitcoin will similarly earn the position of reserve asset, because it is scarce, immutable, and apolitical," Voorhees added.
There’s no question that the dollar comfortably holds that dominant position today. In the last quarter of 2020, central banks in 149 countries held 7 trillion dollars, representing 59% of all allocated reserves, followed by the euro with a share of 21%, and the Chinese renminbi with a distant 2.25%.
But central banks hold a variety of assets. "That doesn’t mean currencies like the Chinese renminbi pose a threat to the dollar’s status simply because it’s part of the central bank portfolios," Selgin told Decrypt. That’s also true for gold and would also be true for Bitcoin, he said.
"Central banks will likely be the last to acquire Bitcoin and will do so only when its dominance has become obvious."
But central banks shouldn’t be the yardstick, according to Voorhees. There are many other financial institutions. "Central banks will likely be the last to acquire Bitcoin and will do so only when its dominance has become obvious."
Nothing ties down the value of Bitcoin, Jeff Miron, senior lecturer in economics at Harvard University, told Decrypt. "It is worth whatever the market thinks it is worth unless Bitcoin somehow manages to become a dominant means of payment."
But Bitcoin can’t become a dominant means of payment, Miron explained, because the pervasiveness of governments in economic activity—not just taxing but also spending—makes the official government means of payment "the most natural default for a large fraction of other transactions."
"Governments want control over the means of payments in their economies, and they can make it difficult for any new means to emerge by regulating that new approach out of existence," Miron told Decrypt.
And governments aren't incentivized to allow money that isn’t theirs—Bitcoin—to replace what is theirs—fiat. In his first address to the UK Parliament in 2010, Steve Baker, Conservative MP for Wycombe, noted that "The Bank of England controls the price, quantity, and quality of money." He asked fellow parliamentarians, "if money is a product of the state, we should ask ourselves: Is this a good idea?"
It’s not, Baker told Decrypt, but "in a hypothetical world, I would expect a market economy to choose commodity money in the future as it has in the past." He’s convinced that the most likely candidate in the future is one that’s "enabled by technology," if not necessarily Bitcoin.
And if it ever happened...
The dollar losing its reserve-currency status could single-handedly reduce the welfare of Americans, Selgin explained. "Looking at the debt we have, we'd be in big trouble."
But that’s just a short-term pain, Bitcoin defenders argue, and one that will pay off over the long run.
And unlike the American dollar, Voorhees pointed out, "Bitcoin is no nation’s burden, and no nation’s privilege."