Doing without the dollar

 The staggering sum of US$18 trillion – nearly equal to a year’s gross domestic product (GDP) – is the amount that the United States has taken in from foreigners since the Great Financial Crisis of 2008.

The notion that the dollar’s dominance in world finance might come to an end was a fringe view only five years ago when America’s net foreign investment position was a mere negative $8 trillion. Now one reads forecasts of the end of the dollar era in research reports by Goldman Sachs and Credit Suisse.

Washington’s seizure of Russian foreign exchange reserves seems like a self-defeating measure given America’s enormous and accelerating dependence on foreign borrowing. Paradoxically, America’s strength lies in its weakness: A sudden end to the dollar’s leading role in world finance would have devastating consequences for the US economy, as well as the economies of its trading partners.

In addition to the $18 trillion of net foreign investment in the US, foreigners keep about US $16 trillion in overseas bank deposits to finance international transactions. That’s $34 trillion of foreign financing against a US GDP of not quite $23 trillion. Foreigners also have enormous exposure to the US stock and real estate markets.

No one – least of all China with its $3 trillion in reserves– wants a run against the dollar and dollar assets. But the world’s central banks are reducing dollar exposure, cautiously but steadily.

The trickle of diversification out of dollars could turn into a flood. What the International Monetary Fund on March 22 called “the stealth erosion of dollar dominance” prefigures a not-so-stealthy exit from the dollar. Unlike Nebuchadnezzars’ handwriting on the wall, the king’s soothsayers can read the message as plain as day.

Notably, Russia’s central bank cut the share of the US dollar in its reserves from 21% a year ago to just 11% in January, while increasing the share of RMB to 17% from 13% a year ago. Russia’s central bank has also bought more gold than any other institution in recent years.

With just 8% of world export volume versus China’s 15%, the reserve role of the US dollar no longer reflects American economic strength. It derives, perversely, from the rest of the world’s desire to save.