Special Ep. - Trump 2.0 and the future of dollar dominance

In this special edition of the Hinrich Foundation’s podcast on global trade, the Association of Foreign Press Correspondents-USA sits down with Stewart Paterson, Senior Research Fellow at the Hinrich Foundation, to examine whether the world is moving toward a more fragmented, multi-currency system as US inflation, alternative payment systems, and China’s renminbi ambitions test the dollar’s dominance. 

The US dollar has anchored global trade and finance for decades, giving the United States extraordinary leverage over payment infrastructure, sanctions enforcement, and global financial stability. But the foundations of dollar dominance are coming under pressure. Persistent inflation, America’s deteriorating net international investment position, and China’s growing role as the world’s dominant manufacturing power are weakening some of the economic conditions that have long supported the dollar’s centrality. 

But dollar dominance is no longer being tested by economics alone. The weaponization of dollar-based financial infrastructure has encouraged China and other economies to explore alternatives, while central bank digital currencies, instant payment networks, and platforms such as mBridge could make non-dollar settlement faster, cheaper, and more commercially viable. China’s renminbi remains constrained by capital controls and a fragile banking system, but its push to build alternative financial infrastructure points to the possibility of a more fragmented monetary order. 

Tune in to this podcast as Stewart Paterson, Senior Research Fellow at the Hinrich Foundation, joins the Association of Foreign Press Correspondents-USA to break down the economic, geopolitical, and technological pressures reshaping the dollar’s role in global trade and finance. The podcast follows up on Paterson’s recent paper for the Hinrich Foundation, “Trump 2.0 and dollar dominance: Make or break?”

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Transcript

Here is an excerpt from their conversation:

Roseanne Gerin: You write that hegemonic currencies succeed when they preserve purchasing power, maintain value relative to other currencies, and are backed by a dominant producer of goods the world wants. How well does the US still meet those criteria today?

Stewart Paterson: Interesting question. Clearly, if we come to being a dominant producer of goods and services that the world wants, there's a bit of a bifurcation here because the United States quite clearly is a technological leader, if not the technological leader. In a lot of advanced technology, the United States almost has a monopolistic position in the provision of those services and the goods around them. The US is blessed with an abundance of fossil fuels and food, which makes it a net exporter of those. It is a leader in weapons technology. And so, when you come to the reasons why other countries might hoard a currency, [or] might keep reserves in case of an emergency, the United States still stacks up quite well. However, what has become increasingly apparent is that China's dominance of manufacturing, particularly the headway it's made in advanced manufacturing, means that a lot of that United States output is dependent on Chinese input, be it parts or key components. And so, it is no longer really fair to say [it is] the dominant producer of goods and services that people want. And in fact, given the breadth of China's footprint in manufacturing, really, that mantle has passed to China.In terms of preserving its purchasing power, clearly, we're getting on for six years now since the Fed last hit its inflation target, and therefore, there is a good argument to be made that the Federal Reserve is eroding confidence in the US dollar through its failure to hit those inflation targets. Inflation has not been an issue in China and, therefore, just on that narrow measure, you'd have to say that the RMB [renminbi] is looking superior at the moment. But I think what's more worrying, in a way, is that there's a question mark over whether the Fed actually has the wherewithal and the mandate to actually hit its inflation targets now, given the potential impact that that would have on economic growth, which would be, obviously, very negative in the journey toward bringing inflation down, unless there are some extraneous factors that do some of the heavy lifting for them. And then, relative to other currencies, clearly, the dollar has been very strong in recent years. We are arguably near the end of a 12-year or so bull market in the US dollar. What matters, though, is the outlook going forward, and we'll come on to talk about some of the factors that are potentially calling out for a weaker dollar, which could also lead to a sort of very sharp adjustment down in the value [of the] dollar and, therefore, lead to a loss of confidence in it.

Roseanne Gerin: Your report breaks down the pressure on the dollar into three forces — economic, geopolitical, and technological. Let's take them one by one. You argue that the dollar’s economic foundations have eroded, citing persistent inflation, a deeply negative net international investment position, and America's shrinking share of global output. Which of these, in your view, poses the most immediate risk to the dollar's long-term credibility?

Stewart Paterson: Well, I think the three act in unison with each other, and so it'd be difficult to single one out, although if I had to, I think I would go for the net international investment position. Just to explain, clearly, Americans buy overseas assets, foreigners buy American assets, [and] the net international investment position is the difference between the two. America's perennial current account deficits need funding, and those are funded through foreign acquisitions of US assets. Foreigners now own about US$70 trillion worth of US assets, and that is US$28 trillion or so more than Americans own of foreign assets, which is the net international investment position. And that's about 90% of US GDP [gross domestic product], which is off the charts relative to anything we've seen in history. And what it means is that if there is a loss of confidence in the future returns, real returns measured in the foreigners’ currencies in those US dollar assets, then they will turn net sellers. And, obviously, if there's US$70 trillion worth of holdings, that's a lot of dollar selling that could take place. Bear in mind that the sort of current account positions — the various fundings of that — you're talking sub-a-trillion dollars or so of that on a yearly basis. So, these potential balance sheet adjustments dwarf the flows that are associated with the current account.

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