This August marks the 50th anniversary of the “weekend that changed the world”, when US President Richard Nixon suspended the convertibility of the dollar into gold at a fixed price and lowered the curtain on the international monetary system of Bretton Woods.
The next half century brought many surprises. From a monetary point of view, one of the most important was the continued dominance of the dollar as a vehicle for cross-border transactions.
Under Bretton Woods, the supremacy of the dollar was easily explained. America’s financial position out of World War II was unassailable. Changes in the price at which dollars could be exchanged for gold were unthinkable, first because of the aforementioned financial strength and then, as the country’s monetary position weakened, because of the possibility that one devaluation would create expectations of another.
Many thought that Nixon’s move would diminish the international role of the dollar. With the US currency fluctuating like any other, it would be too risky for banks, businesses and governments to put all their eggs in the dollar basket. Therefore, they would diversify by maintaining more reserves and conducting more transactions in other currencies.
The reason why this did not occur is now clear. The greenback had the advantage of its deep roots: the fact that your customers and suppliers also use dollars makes it very difficult for you to resort to other alternatives. Furthermore, the alternatives were – and still are – unattractive.
As for the euro, there is a shortage of government bonds denominated in euros with the maximum AAA rating that central banks can hold as reserves. For this reason, these authorities are reluctant to use the Community currency without limits as a reserve currency. China’s capital controls complicate the international use of the renminbi, while there are justified fears that Chinese President Xi Jinping may abruptly change access rules. And the currencies of the smallest economies lack the scale necessary to move a large volume of cross-border transactions.
Some say that the issuance of central bank digital currencies (CBDC) will transform the status quo. In this new digital world, any national currency will be as easy to use for cross-border payments as any other. This will not only erode the dominance of the dollar, the argument goes, but it will also greatly reduce transaction costs.
That conclusion is highly debatable. Let’s imagine that South Korea issues a “retail” CBDC that individuals can keep in their digital wallets and use in their transactions. A Colombian coffee exporter to South Korea can then receive payment in digital won, assuming, of course, that non-residents are allowed to download a digital wallet in Korean currencies.
But that Colombian exporter will continue to need someone to turn those won into something more tangible and useful. If that someone is a bank that acts as a counterpart with offices or accounts in New York, and if that something is the dollar, then we are right where we started.
Alternatively, the central banks of Colombia and South Korea could issue “wholesale” CBDCs. Both would transfer the digital currency to national commercial banks, which would deposit it in clients’ accounts. Now the Colombian exporter would end up with a loan from a South Korean bank instead of holding a portfolio of South Korean currencies – assuming this time that non-residents are allowed to have Korean bank accounts. But, again, the exporter would have to ask the South Korean bank to find a counterpart to convert that digital balance into dollars and then into pesos to have something of use.
Changing the situation would require that CBDCs be interoperable. The South Korean payer would then ask his bank for a deposit order denominated in won, and a corresponding amount of CBDC would be deducted from the payer’s account.
That deposit order would be transferred to a specific international “broker”, where it could be exchanged for another deposit order in pesos at the best exchange rate offered by the operators authorized to operate there. Finally, the account of the Colombian beneficiary would register the entry of the corresponding number of digital pesos, and the deposit order would no longer be valid. Voilà !: the transaction would be completed in real time at a lower cost than the current one, without involving the dollar or intermediary banks.
Unfortunately, the conditions for this to work are very demanding. The central banks involved would have to agree on a joint protocol and coordinate to control its operation. They would have to authorize and regulate operators who have currency inventories and deposit orders to ensure that the exchange rate provided for in the protocol does not deviate from that in force in the market. And they would have to agree on who would provide emergency liquidity, and under what guarantees, in the event of a serious imbalance between supply and demand.
In a world with 200 currencies in circulation, agreements of this type would require the signing of thousands of bilateral agreements, which is obviously not feasible. And protocols signed between many countries, while sometimes carried out, would require considerably more elaborate rules and governance arrangements than those of the World Trade Organization and the International Monetary Fund. This, clearly, is unfeasible.
CBDCs will certainly be used in the future. But the rules of the game for international payments will not change. And they won’t dethrone the dollar either.