Stephen Sacca, SF ’90
Director, MIT Sloan Fellows Program
The globally diverse and sometimes emotional response to the U.S. dollar—love, hate, begrudging respect—can make it difficult to know where the currency really stands. The MIT Sloan Fellows Program has among its alumni and faculty some of the great finance minds in the international marketplace, including Jose Maria Fernandez, SF ’10, who was just named Director General of the Spanish Treasury. We decided to reach out to a number of these global leaders to find out what they really think about the dollar and its future as a dominant currency. A few of MIT Sloan’s top finance faculty also weighed in. The discussion covers a breadth of geographic and industry viewpoints—some of them competing, but all of them enlightening.
Simon Johnson, Ronald A. Kurtz (1954) Professor of Entrepreneurship and Professor of Global Economics and Management at MIT Sloan, observes that each new international economic or political upheaval generates a fresh round of discussion and analysis about the role of the dollar. "The position of the dollar is something every business leader should be paying attention to. If the potential exists for a change in the dollar's position as the world's dominant currency, you can gain a huge advantage if you understand when that shift will come and what factors will drive it."
In White House Burning, Johnson and coauthor James Kwak trace the dollar’s current position back to the 1944 United Nations Monetary and Financial Conference at Bretton Woods, where the international monetary system was rebuilt around the dollar. The decision proved widely beneficial. For the next three decades, fixing exchange rates in terms of dollars discouraged trade wars based on currency devaluation, promoted global economic stability, and facilitated rapid expansion in global trade.
Despite some bumps in the road—the 1971 closing of the gold window by U.S. President Nixon and the 2008 financial crisis among the most notable—the enormous international appetite for U.S. dollars and dollar-denominated assets remains. “As long as people around the world think that the U.S. economy will continue to grow and that government policy will remain generally responsible,” Johnson and Kwak note, “they are willing to buy and hold dollar assets.”
Jiang Wang, Mizuho Financial Group Professor at MIT Sloan, sees both demand and supply generating the dollar’s unique position. “On the demand side,” says Wang, “the dollar is even more important for financial services than as the common currency for international trade. The U.S. market is not only the world’s largest but also by far the world’s most open and integrated, which supports more opportunities and delivers a higher level of service than any other market. By contrast, the Japanese yen is far less competitive. It’s one of the world’s largest markets, but it’s difficult to enjoy the same level of service because the system isn’t as open and accessible.”
Jim Walker, SF ’06, COO and Head of Business Development at Private Bank-Americas, Credit Suisse, sees no immediate threat to the hegemonic status of the dollar. “Enduring factors drive the demand for dollars globally,” he says. “As our clients build substantial wealth in their countries of origin, they want a significant portion of that wealth to reside in the U.S.—and you have to own U.S. dollars to buy U.S. assets. Even our Chinese and Brazilian clients want their children’s assets to be U.S.-based.” Walker notes that many are willing to accept a negative yield just to park some of their wealth in the relative security of the U.S. dollar. Among central banks, only the U.S. Federal Reserve has consistently demonstrated a capacity for timely and decisive action in times of turbulence.
Walker points to the International Bank of Settlements as another illustration of the preference for dollars in commerce. Nearly 90% of its transactions are in U.S. currency. Sales of energy, gold, and assets are conducted primarily in dollars. And among bond managers in emerging economies, the non-dollar market accounts for a very small percentage of total holdings.
Hadiza Ambursa, SF ’09, General Manager and Group Head of Private Banking for Nigeria’s Access Bank Plc., says the dollar is an invaluable tool in the day-to-day financial realities of doing business in Nigeria. Ambursa doesn’t see change on the immediate horizon. Nigeria, the largest country in Africa, imported only 14% of its commodities from the U.S. in 2013, yet 80% of business in Nigeria was transacted in dollars that year. “Many goods are transacted in U.S. dollars, irrespective of the origin,” Ambursa says. “And many importers deal in dollars because it’s easier to compare the value of the import if you’re dealing in just one currency—rather than getting one invoice in Euros, another in Swiss francs, and another in British pounds. If all invoices are in dollars, it’s a lot easier to compare the cost of goods.”
“In Nigeria,” she adds, “dealing primarily in dollars reduces negative exchange rate exposure. Having to change Nigerian nairas to Euros to U.S. dollars makes the importer vulnerable to multiple exchange rates. Dealing only in dollars limits the volatility of transactions.” She also notes that many companies have global buying offices—importing from one location for offices all over the world from exporters all over the world. It would be chaotic, she says, for them to deal in the indigenous currency of each individual vendor.
Ambursa adds that there is a compelling macroeconomic reason for the dollar’s dominance in Nigeria. “The U.S. is the world’s largest economy, and many countries have their reserves in dollars, irrespective of the credit situation. The U.S. is considered a safe haven compared with other currencies around the world. The enormity of change necessary to shift the economic balance would be too great for us to see any other currency dominate in the near future.”
Nick Harwood, SF ’12, Managing Director and Head of Equity for Sberbank CIB in Moscow, has observed similar patterns in Russia. For international investors, settlement in the Russian equities market has been in dollars by default because of the bureaucratic nature of the local settlement and banking system. “In countries like Russia, Australia, and Canada,” he says, “the prices of commodities are dollar-denominated. It’s a key driver in the bottom line for revenues and income statements. Whether there’s a stronger or weaker dollar when converted into the native currency can be a big deal, especially for low-margin commodities like aluminum—in that market, 5% can mean the difference between profit and loss.”
Harwood points out that the dollar is not dominant everywhere. “The dollar holds less sway in non-commodity-centric economies like France, for example, which doesn’t buy a lot of oil because it relies heavily on nuclear power.”
The introduction of Euroclear into Russia in late 2014 or early 2015 will also have an impact on the landscape, according to Harwood. “We expect settlements in the Russian equities market to move toward rubles. That should make the dollar a little less dominant here. This also has been our experience in new Euroclear markets like South Africa and Turkey.”
Andrew Lo, Charles E. and Susan T. Harris Professor of Finance, sees a mixed bag in the future of the dollar as the world’s reserve currency. “Certainly, the dollar enjoys special status at present,” he says. “That status grows out of the economic and political strength of the U.S. But other currencies are emerging as strong enough and credible enough to be in a global basket—the euro, Japanese yen, renminbi, Australian dollar, Swiss franc, and the British pound should all factor into the mix.”
Wang believes that one risk factor for the dollar is laziness. “As the central bank for the world’s strongest financial system, it’s possible to imagine the Federal Reserve taking the dollar’s position a bit for granted. Domestic priorities could outweigh global implications to such an extent that international demand for the dollar slackens, which could boost supplies of alternative currencies.”
Yaya Moussa, SF ’10, founder and CEO of Kontinent, which assists African countries in extractive contract negotiation and management, believes that the strength of the dollar is tied to its reputation as low-risk. “The dollar is the leading currency for reasons of safety, not for return. The remuneration rate is very low. But in the international oil business, for example, business is transacted in dollars because of that safety factor—that’s the standard, and it’s not going to change in the next decade.”
George Karam, SF ’14, founder of Karpos Investimentos, a boutique investment firm with offices in Sao Paulo and Boston, attributes the endurance of the dollar to a lack of alternatives. “While the dollar is not stellar, there are few good options. In the U.S., the fundamentals (i.e. fiscal and monetary policies) are not attractive—the country holds an increasingly staggering debt and, at the same time, is increasing the money supply. And when interest rates rise, the fundamentals will get worse.”
But Karam notes why many economists are not so worried about the deficit. “Total government revenue from taxes accounts for a mere 28% of the U.S. GDP. Regardless of the electorate’s complaints, that is very low in comparison to other nations—and it could be increased if necessary. In Brazil, the world’s seventh-largest economy, taxes are 36% of the GDP, so there’s no room for the country to raise taxes.” The EU, Karam notes, is in a similar position—taxes are already too high. “The psychology of the market and the perceived strength of a currency is a huge factor in influencing which currency dominates the world marketplace, independent of the current government policies.”
Walker of Credit Suisse notes that with respect to foreign exchange markets, investors are willing to accept a negative yield in return for the relative security of the U.S. dollar. “That could change, however, if the rate cycle in emerging markets shifts. In that scenario, other safe havens like the Japanese yen and the Swiss franc could experience more activity. But the U.S. central bank would have to suffer a significant loss of credibility before the dollar would begin to lose its edge,” says Walker.
Lo observes that different currencies play different roles depending on the economic context and the psychology of the global marketplace. “In relatively tranquil times, diversification makes sense from an investment perspective. If war breaks out, however, or there’s another major terrorist attack, the dollar will continue to play a dominant role as a safe haven.”
Johnson makes clear that the dollar’s mystique is not invulnerable. “Beliefs can change, or other currencies can become more attractive, or countries like China might decide they don’t need quite so many reserves as they have now,” he and Kwak note in White House Burning. “And then the central bankers and sovereign wealth fund managers of the world might decide they don’t need as many dollars, making it harder for the U.S. government to finance its budget deficits.”
Moussa envisions a related scenario. “The dollar’s supremacy will mechanically decrease with the rising economic position of countries like China. The euro’s role as a reserve currency might also grow. Currency swaps among leading emerging economies like China, Russia, Brazil, and India may also affect dollar dominance.”
Walker is less confident about the ascendance of viable alternatives to the dollar. “When Russia emerged as a strong presence on the global energy scene, some predicted that the ruble would increase in significance, which did not turn out to be the case. Similarly, the deal between China and Brazil to swap energy in Brazilian currency did not produce the impact many predicted. And, of course, the recent EU crisis popped the bubble of expectation that the euro would soon be a major force.”
Wang is impressed by the sheer size of the pan-European market but says it has quite a few hurdles to clear before it can be considered a robust system. “Despite attempts to resolve the current crisis, European markets are still segmented. Each member country has its own legal and regulatory perspectives, and I don’t see a willingness to give those up in the near future.”
Roberto Rigobon, the Society of Sloan Fellows Professor of Applied Economics, does not believe the renminbi will overtake the dollar (nor the euro or the yen) in the foreseeable future. “I’ll give you three reasons,” he says. “First, the financial depth of the banking sector in China versus the U.S., Europe, and Japan. Second, the unwillingness to experience a massive appreciation of the renminbi if it becomes a currency of reserve. Finally, the fact that China lost the chance to break the network externality of the dollar after the 2008 crises—arguably its best opportunity to do so.”
Walker and his team at Credit Suisse believe the key hurdle that currencies like the renminbi face is the credibility gap between their central banks and the U.S. Federal Reserve. “Some will argue that Bank of China could be a contender, but it still has a way to go before it can gain the level of credibility that the Fed has enjoyed for five decades. This objective doesn’t seem to be a high priority for the Chinese at the moment.”
Xavier Ruiz Sena, SF ’10, Head of Finance for Santander Bank N.A., doesn’t consider the renminbi a challenge to the dollar in the foreseeable future. “I don’t see the renminbi as a true contender unless China lets the currency float freely in the market and carries out massive structural reforms in its financial system. That said, I don’t think the country is likely to liberalize its currency in the short term.” He is quick to point out, however, that the strength of a given currency is difficult to forecast more than five years out.
Wang believes that what holds back Chinese currency is the lack of openness in its financial system. “The level of efficiency, the development of products and services—it just can’t compare to the U.S. China’s dramatic derivatives splash in 2010 attracted a lot of attention, but it’s still just a drop in the $65 trillion ocean of the worldwide market. Despite the fact that China has made great leaps in many areas, developing a strong global financial system isn’t like building factories or electronics. So much depends on human capital, and the context—culture, legal system, boundaries between politics and economics—is vastly different. It’s difficult to see how they could just replicate or adapt what exists in the U.S.”
Lo believes that when it comes to BRICS, much depends on political factors. “The stability and credibility of BRICS governments is vital. These are incredibly resilient economies. If they can manage the volatility, including the threat of hyperinflation, and implement more disciplined monetary policies, it could be just a matter of time before they play a more important role.”
Moussa also thinks BRICS has potential as the economies of its member countries evolve. “Emerging nations see the World Bank as an instrument of Western dominance. The Bank’s inability to reflect today’s world balance of economic power among countries is self-defeating. The BRICS Bank might eventually be a solid alternative for developing countries striving to avoid World Bank and International Monetary Fund requirements.”
Moussa is quick to point out that for all the dollar’s potential vulnerabilities, he sees it maintaining its strong position for the foreseeable future. “The dollar will continue to dominate as a transaction currency—especially in finance, commodities, and natural resources—and as a reserve currency. But its relative role will certainly diminish.”
Johnson agrees with most of the experts interviewed that yes, it’s a fad—but maybe not a passing fad. “Crypto currencies like Bitcoin are a fascinating development, if not immediate contenders in the marketplace. Recent instances of fraud and theft reinforce the fact that Bitcoin is not ready for prime time. If someone steals your Bitcoins,” he points out, “you can’t get them back.”
Rigobon agrees. “Crypto currencies have a major flaw in their design. They are a confusing means of payment and require completely new and different institutions. In the end, the Bitcoin fiasco is a reflection of assuming properties to those financial assets that are not consistent with good currency.”
Lo sees digital token-based currencies as a curiosity, but one that bears watching. “I don’t think they have a major role to play at the moment. I can, however, envision crypto currencies making a bigger impact if they can be managed in a more robust and sustainable way.”
In addition to the MIT Sloan Fellows alumni and faculty we interviewed, we would like to thank Dapo Olagunju, Group Treasurer of Access Bank Plc. in Nigeria, and Barbara Reinhard, Danny Myer, and Park Stroughbridge of Credit Suisse in New York for their help in developing this story.
We’re already at work on the next MIT Sloan Fellows Program Newsletter. Please drop us a line at firstname.lastname@example.org if you have ideas about themes and news items for future issues.
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