The benefits America enjoys from being the world's reserve currency, which include the ability to borrow seemingly endless amounts of money, has been a recurring topic on YDHTY as of late. It allows us to fund popular government programs, hold the world's largest military, and keep taxes and interests rates low so Americans have more money to go out and buy things we don't need.
All of this comes with an enormous amount of red ink, which seems to consume a generation's worth of prosperity with every passing year. The level has reached such a point that the practical question isn't how to preserve the dollar's status in the world, but what to do when it's lost?
In the early 1600s, the Netherlands enjoyed a similar experience, with the Dutch Guilder becoming the world's first reserve currency managed by a central bank. By the end of the 1700s, that bank had dissolved, and the guilder had lost its position to the British Pound.
To help explain the rise and fall of the guilder and what parallels we might draw to the dollar, I asked Stephen Quinn, Professor of Economics at Texas Christian University, to discuss. Quinn has done work for the Federal Reserve, as well as being an expert in the financial development of Early Modern Europe.
Like the dollar, the guilder was widely used as a method of payment in international trade - often being exchanged by parties in countries outside the Dutch Empire. Unlike prior currencies, which held their value in physical assets - like gold or silver - the guilder was a receipt issued by the Bank of Amsterdam for a given amount of silver. This offering a better store of value than metal coins, which could be debased with less valuable metals.
After a series of financial mishaps, the guilder lost value as depositors began to withdraw their silver, leading to the bank's dissolution in the late 1700s.
While the roles of the Bank of Amsterdam and the Federal Reserve differ, there are some trend lines that tell us about the rise and fall of reserve currencies and what might eventually take the dollar's place.
Reserve currencies are born out of crisis - The guilder’s rise followed a crisis of confidence in the value of gold and silver coins across Europe, which countries across Europe had debased to raise funds during the Thirty Years War. While gold and silver could be mixed with less precious metals to reduce their real value, the Bank of Amsterdam's role was to guarantee the value of the guilder, making it a more attractive option.
Reserve currencies require a pre-existing network - In the case of the guilder, the Dutch had an enormous commercial empire that already used its currency. This made it easier for other international traders to plug into the network and benefit from the guilder’s stability and global recognition.
Debt and lack of confidence are killers - Just as reserve currencies are born out of crisis, they die out of crisis, too. In the case of the guilder, the Bank of Amsterdam relied heavily on loans to the Dutch East India Company to finance its operations
After failing to adapt to a series of changes in global trade and the Fourth Anglo-Dutch War, the Dutch East India company dissolved, leaving the Bank of Amsterdam with a series of bad loans and depositors rushing to withdraw their coins.
Keeping the above in mind, to find the heir apparent to the dollar, we should be asking two questions:
- What other large, pre-existing financial networks exist that other nations could plug into?
- Of those networks, which one offers the greatest stability?
While bitcoin has been promoted as an option, it offers neither of the above. It's accepted by fewer merchants today than it was 5 eyars ago, and is volatile enough where payment could lose 10% of its value in the minutes it takes to transfer funds.
A more likely replacement would be a digital version of China's currency, the renminbi. China already leads the pack in terms of government issued cryptocurrency and has expanded its economic empire via a series of loans.
China also seems to see this, too. It currently holds 65% of the world's mining capacity for Bitcoin and has recently issued a series of regulations designed to stamp out the practice.
This points to the potential benefit of a stable, globally decentralized cryptocurrency as a replacement for a nationally issued one. It would provide the benefits of a globally accepted store of value without the power distortions created when one government holds power over it.
This being said, the appeal of crypto right now - and the adoption of it - seems tied to its potential to skyrocket in value. Until this happens, the central banks will hold all the cards.