The record fine imposed on France’s largest bank over transactions in U.S. dollars revived European complaints about the greenback’s pre-eminence in global finance. History shows calls to supplant the currency will be futile.
The dollar hasn’t budged from its top spot for the past three decades, withstanding repeated efforts to unseat it. Almost 90 percent of the $5.3 trillion a day in foreign-exchange transactions last year involved the dollar, the same share as in 1989, data from the Bank for International Settlements show. More than 80 percent of trade finance was done in dollars in 2013, according to Swift, a global financial-messaging network.
Companies, consumers and central banks around the world prefer the dollar to other currencies, including the euro and yen, because they trust the Federal Reserve and the U.S. government to back it, according to Marc Chandler, the chief currency strategist at Brown Brothers Harriman & Co.
“There are always people who say the dollar is going to be replaced, but it hasn’t happened,” said Chandler, who’s based in New York. “The biggest threat to the dollar’s dominance is the U.S. deciding to abdicate one day, not others complaining about it for this reason or that.”
As long as the dollar maintains its central role, banks around the world will have to bow to U.S. rules and oversight. BNP Paribas SA (BNP), the French firm hit with a $9 billion fine last month, also agreed to suspend clearing dollar transactions related to oil and gas trading when it pleaded guilty to violating U.S. sanctions against transferring cash for Iranian and Sudanese entities. New rules introduced this year tightened the regulation of foreign lenders’ U.S. units.
A week after the BNP Paribas plea, French Finance Minister Michel Sapin urged European governments to promote the euro more in international transactions. While he said he wasn’t fighting “dollar imperialism,” his comments echoed those of predecessor Valery Giscard D’Estaing, who coined the term “exorbitant privilege” in 1965, referring to the benefits the U.S. received for the dollar’s status.
When the euro was introduced in 1999, some predicted it would one day topple the dollar. Since then, the euro has only taken over the share of the European currencies it replaced in global central-bank reserves. In foreign-exchange transactions, it accounts for even less.
When the U.S. warned against doing business with Iran and North Korea in 2006, many -- including a former U.S. banking regulator -- predicted a shift by Iran and other oil-exporting countries away from the dollar. That didn’t happen.
After the 2008 financial crisis, when the Fed expanded its balance sheet by trillions of dollars and the government’s budget deficit swelled, some economists said that would devalue the dollar, making it unattractive. That didn’t happen either.
Currencies that have been candidates for ending the dollar’s supremacy have drawbacks of their own. The euro was on the verge of a breakup as recently as a year ago. The Chinese yuan isn’t freely exchangeable. Bitcoin plummeted after about $500 million-worth of the virtual currency went missing.
Having the global currency of choice has bestowed some benefits on the U.S., including cheaper funding of debt. It also has brought risks and responsibilities. Those became evident during the crisis, when emergency loans by the Fed to the U.S. units of European banks peaked at about $538 billion, almost as much as U.S. firms borrowed.
“The Fed is the central bank of the world,” said Joseph Quinlan, chief market strategist at Bank of America Corp.’s U.S. Trust, which oversees about $380 billion. “The rest of the world benefits from the dollar standard as well.”
The world needs a central currency to make trading and finance flow smoothly because it reduces transaction costs, Quinlan said. The global monetary system relied on gold until World War II. The dollar replaced the precious metal under the Bretton Woods regime after the war. It was fully convertible to gold until the U.S. broke the pact in 1971 so it could devalue its currency. Now the values of most major currencies are set by market forces, even as the dollar remains the anchor.
Economist Fred Bergsten, who has called for a multicurrency monetary system, acknowledges that the dollar won’t lose its dominance even as others gain significance.
“The dollar’s role will decline gradually and modestly over time, but it will still remain as the dominant currency,” said Bergsten, founder of the Peterson Institute for International Economics in Washington and a former Treasury Department official. “The euro has already claimed a central role, and the yuan keeps getting more important. Neither will likely replace the dollar, though.”
Last year, about 60 percent of foreign-currency reserves of the world’s central banks were in dollars, little changed from 1995, according to the International Monetary Fund. That’s because U.S. government bonds are seen as the safest investment. Euros make up about 25 percent.
More than 60 percent of banks’ cross-border liabilities are in dollars, as they were 25 years ago, compared with about 20 percent in euros, BIS data show.
Governments and corporations issue most of their foreign-currency debt in dollars. In 2012, 52 percent of such borrowing was denominated in dollars, up from 43 percent in 1999, according to the most recent data available from the European Central Bank. While the euro’s share has remained stable at about 25 percent, the yen now accounts for 5 percent of international debt, down from 17 percent almost two decades ago.
In trade finance, the yuan quadrupled its share from a year ago to claim the No. 2 spot, Swift data show. At 9 percent, it pales in comparison with the 80 percent in dollars.
“The U.S. dollar remains dominant in traditional trade finance, and we don’t see a replacement any time soon,” said Astrid Thorsen, the head of business-intelligence solutions at Swift in Brussels. “The yuan is gaining traction, and it has dethroned the euro from second place. But the competition has been between currencies other than the dollar.”
The dollar is also dominant in commodities markets. Of 1,785 active commodities-futures contracts, 1,133 are denominated in dollars, according to data compiled by Bloomberg.
U.S. regulators can go after foreign banks doing dollar transactions anywhere in the world because almost all are routed through two clearing networks in the U.S. Clearing of dollar transactions in Hong Kong and Singapore, though available for almost two decades, hasn’t taken off. Those two cities account for less than 1 percent of the global total, BIS data show.
“The Fed provides dollar liquidity, so dollar clearing will happen here,” said Karen Shaw Petrou, managing partner at Federal Financial Analytics Inc. in Washington, which consults for some of the world’s largest banks on financial regulation. “That’s why the Fed and other U.S. regulators worry about what foreign banks do. At the end, the U.S. is on the hook.”
The Fed’s new rules for foreign banks require their U.S. units to have higher capital and liquidity. While banks might not like tighter rules or stiffer fines from U.S. regulators, they have no way out because global trade and finance will continue to require dollars, Petrou said.
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