The depth of the U.S. securities market helps ensure dollar hegemony
1. The Ukraine Crisis and Dollar Supremacy
Since the collapse of communism in the early 1990s and the subsequent rise of the world economy as a single market-based operational totality, its monetary counterpart has been a unipolar currency system centered on the US dollar as the premier vehicle currency in the private sector, as well as the premier reserve currency in the official sector. The hegemony of the dollar has survived several global economic shocks, including that of the financial crisis of 2007-9. Whether the system can survive the seismic shocks stemming from Russia’s invasion of Ukraine in February 2022 is now under active debate.
Many prominent commentators argue that it will not, noting the ongoing attempts by Russia and her trading allies to circumvent the US-led imposed financial sanctions. Barry Eichengreen, for instance, observed that because of the Russian and other central banks’ increased diversification of their reserve holdings away from the dollar “we are seeing movement towards a more multipolar international monetary system.” James Galbraith sees a dual currency system in the making, as Russia and her trading allies “carve out… a significant non-dollar, non-euro” rival financial system. In a wider context of innovations in technology and finance, the IMF also noted the possibility of a scenario where “the greenback could be felled not by the dollar’s main rivals but by a group of alternative currencies,” including crypto and digital currencies.
This is not the first time that a geopolitical crisis has prompted musings, at various levels of the academia and the commentariat, about the coming end of dollar hegemony. Invariably, they turned out to be wrong. Given the rather long history of failed forecasts, current predictions about the dollar’s future tend to be given with more caution and hedged with various caveats and qualifications. Indeed, to be fair to Barry Eichengreen, he is careful to emphasize that dollar dominance will not end soon, even while the Ukraine crisis may have accelerated the ‘stealth erosion’ of that dominance. A more general qualifying refrain is that a multipolar currency system, while not yet here, is nevertheless in the cards.
Is it, though? Can the ongoing attempts to establish a non-dollar alternative amount to a serious challenge to the hegemony of the dollar? The contrasting answers to this question reflect two alternative visions of capitalism. The declinist school of thought on the dollar supremacy stems, as Susan Strange noted some 30 years ago, from academic traditions that have historically overlooked the importance of the financial system in shaping the balance of power. It was a result of a methodological choice: at best, they have proxied it with currency regimes that serve international trade relations. As such, the declinist school of US power (and hence the dollar) originates in the productionist vision of capitalism, where trade reflects the structure of production, and where monetary regimes of individual states reflect the position of a country in international trade flows.
An alternative approach, known as the money view of capitalism, or capitalism of futurity, places the tradability of debt as the core institutional setting that defines political economy generally, and, more specifically, the force that anchors major decisions and developments in production, trade, and investment. From the latter perspective, we see no end to dollar supremacy, whether rapid or gradual. As Susan Strange wrote in her seminal critique of a realist school of international relations:
“the error of the declinist school of American scholars lies in assuming that if the US has lost power, some other state must have gained it… The facts suggest that this zero-sum idea is far too simple. The US government has lost power mainly to the market.”
Today, we can add, the financial market. Focusing on the trade flows and currency reserve tactics of the central banks, the declinist perspective on the global role of the dollar overlooks the central force that underpins not only the hegemony of the dollar but lies behind global financialized capitalism in general. That force is the gravitational pull of the dollar-denominated securities markets.
2. The Gravitational Pull of the Dollar
“As recent crises make clear, up to now the dollar-based order has been supported mainly by instability elsewhere and the lack of a credible alternative or compelling reason to create one, or where such reasons are felt, the ability to do so… The system has been held up, in short, by confidence in itself, and not, so far as one can see, by much of anything else.”
Galbraith is correct about the importance of the lack of alternatives to the dollar, yet the problem with his argument is his reading of the cause. He sees the confidence in the dollar as something highly fragile because it apparently lacks any material substance to back it. A lack that, presumably, comes down to the gap between the US share of world production on the one hand, and its share of world securities supplies, on the other.
Between 1986 and 2019, daily forex turnover had risen from about $0.4 trillion to $6.6 trillion. During this period, the dollar’s share of this turnover has averaged about 44%. In today’s terms, this percentage is roughly on a par with the US’s respective percentage contributions to the world’s equity stocks (40% of the $95 trillion outstanding in 2019) and to the world’s bond stocks (39% of the $106 trillion outstanding in 2019). However, it is also far above the US’s percentage share of nominal world output (23% of the 2019 world GDP figure of $88 trillion). These numbers, taken in combination with the trend increase in the US trade deficits, underpin the widely held view, shared by Galbraith, that there will soon come a time when foreign investors will lose confidence in the dollar and thus abandon it due to mounting concerns about the US ability to meet its financial obligations in the face of its deteriorating macroeconomic fundamentals.
This scenario is realistic only if one assumes that there has been no structural change in the relationship between the financial sector and the macroeconomy. Yet, citing Strange again, the addition of credit has altered the balance of power in the world economy. But not in the way that Galbraith and others envisage it.
The expansion of financial markets, the explosion of debt and asset values, are typically associated with the phenomenon of financialization. Over the past few decades, financialization has evolved at an accelerated pace; the financial sector now completely dominates the real productive economic sector on which it rests. In 1980 the combined nominal value of the world’s equity and bond stocks stood at about $11 trillion, a figure on a par with that of nominal world GDP in that year. By 2020 the combined value of those securities stocks had grown over twenty-fold to $234 trillion, while world GDP had only registered an eight-fold increase to $84 trillion in that same period. The growing scale disparity between the financial sector and the underlying real sector is what ultimately fuels narratives of an impending collapse, and the declinist school on the power of the dollar forms one of those narratives.
But financializaton is not a one-dimensional force. Its depth is just as important as an indicator of its historical significance, as is its speed of development because it reflects the structural role of finance in economic transformation. To be specific, the recent scale growth of the world’s equity and debt securities markets is an outcome of fundamental changes in both their supply and demand sides.
From a supply-side standpoint, this growth manifests the radical change in corporate and government dependence on financial security issuance. Previously that dependence may have been small, or, if large, always temporary (e.g., bond issuance to finance a large-scale project or to meet the costs of an emergency). Today, it has become both large and permanent, because of the new financial pressures on corporations and governments that are rising in tandem with the increasing size and complexity of modern economies. For increasing volumes of security issuance to be possible, there obviously must be investors with a correspondingly large enough demand capacity. Chief amongst those investors are the institutional asset managers, the pension and mutual funds, and insurance companies.
Once a small cottage industry catering to the wealthy, over the past four decades asset management has in many countries become a mass industry catering to the retirement and other welfare arrangements of large sections of the population. Along with this growth in asset management scale has come a corresponding growth in the need for investable assets - most notably, for equities and bonds. Although there are other types of assets that serve as stores of value for asset managers, the exigencies of their role as financial intermediaries mean that it is financial securities that necessarily comprise the majority proportion of their asset holdings. What sets these securities apart from other asset classes is their ability to combine a value storage capacity with a relatively high degree of liquidity. “In most countries, bonds and equities are the two main asset classes in which pension assets were invested at the end of 2018, accounting for more than half of all investments in 32 out of 36 OECD countries, and 39 out of 46 other reporting jurisdictions.”
The new structural presence of the asset management sector has important implications for the financial system as a whole. The large absorption capacities of asset managers represent ample opportunities for corporate and government borrowers in having these investors on the buy side of the securities markets. However, at the same time, the industry is operating under new tight constraints regarding the disbursements of cash. As securities have no intrinsic value, their ability to serve as investables with a determinate value storage capacity depends entirely on the degree to which their prices are held firm and thus made tangible, a condition which, in turn, depends on the rate and regularity with which cash is returned.
Here lies the crucial significance of the transformation of asset management from a subsector of finance serving individuals, into an industry of wealth management populated by large institutional players. When households were the representative type of investor in the securities markets, borrowers had far more room for maneuver over cash disbursements. This was partly because households, as small investors, were less able to constrain security issuing organizations, but also because they had less motivation to do so, given that they themselves were under no obligation to invest any part of their savings in financial securities.
By contrast, institutional asset managers are always obliged to keep a substantial proportion of the portfolios that are marketed to the public in the form of liquid securities. It is this obligation that explains why these investors have been instrumental in the establishment of a whole new type of transparency and governance infrastructure in the financial markets that can help guarantee the regularity with which borrowers return cash.
In the final analysis, all understanding of what sustains the dollar’s supremacy in the contemporary era comes down to an insight into the remarkable transformation that securities have undergone in line with the new governance rules and constraints that are now binding on security issuers. Without these constraints, promises of returning cash are always in danger of remaining fictitious: promises filled with empty air. With the new regulatory and governance constraints, securities have been transformed from mere promissory notes into genuinely solid stores of value; from being particles without matter, they become particles filled with matter. What this means is that when all the securities of a country’s organizations are aggregated together, this aggregation endows that country’s financial markets with mass and a corresponding power of attraction for asset managers and other institutional investors: the greater the mass, the greater the power of attraction.
No facet of this power is greater than that exerted by the US securities markets.
Foreign investors currently have trust in the US and in its legal and governance infrastructure of tradability debt, or futurity. Far from there not being “much of anything else” underpinning this trust, there is, on the contrary, much of everything underpinning it. What the US offers, and what no other region can do at present, is a huge and varied abundance of securities (not only equities but also bonds, including corporate, financial, Treasury, agency, and municipal bonds) in which foreign investors can store large amounts of funds and across which they can also move these large amounts relatively easily according to any change in circumstances.
Given the need for dollars as a means of accessing the US securities markets, it follows that just as it is the sheer depth and liquidity of these markets that attracts foreign institutional investors in droves, this attraction serves, in turn, to further amplify the depth and liquidity of the market for dollars itself. This development helps to explain why the dollar remains the most widely used currency in the execution of various cross-currency transactions. For example, the dollar is the funding currency of choice in foreign exchange swap transactions that currently account for nearly a half of the $6.6 trillion daily forex turnover and that are mostly used by banks to hedge exchange rate risks and meet short-term liquidity needs. Similarly, the sheer depth and liquidity of the dollar market means that even when those institutional investors holding globally diversified portfolios transfer funds from one set of non-dollar securities to another non-dollar set of securities, they usually do so indirectly, via the dollar, to contain the costs of these fund transfers.
How will the financial sanctions currently imposed on Russia impact this situation? The answer is, hardly at all. Of course, these measures will see an increase in the amount of pairwise emerging market economy (EME) currency transactions. Yet to put this increase into perspective, there needs to be an estimate of the percentage share of the $6.6 trillion daily forex turnover that these transactions had prior to the Ukraine crisis. Even a cursory look at the figures makes it clear that this share was negligible.
In the first place, EME cross-currency transactions relate primarily to trades in goods and services, and these trades, taken in conjunction with all other real-sector-related currency transactions, account for no more than 8% of total daily forex turnover. Once one strips out the real-sector-related transactions conducted between the advanced market economies (AMEs) themselves and those between the latter and the EMEs, it turns out that the remaining inter-EME currency transactions barely register as a meaningful percentage ratio.
The combined share of all EME currencies in daily forex turnover is just 13%. Even then, in most cases the counter currency was not another EME currency but an AME currency such as the euro, the yen, the Australian dollar but most notably the US dollar. China’s yuan, although the highest-ranked EME currency in 2019 at 8th place in daily forex transactions, accounted for just 2% of these transactions and no less than 45% of these in turn had the dollar as the counter currency.
In sum, the Ukraine crisis will certainly lead to an increase in “non-dollar, non-euro” currency transactions, just as James Galbraith has argued. But the pre-crisis volume of these transactions was so vanishingly small as to invalidate any suggestion that this increase portends a multipolar currency system in the making.
3. An emergent multi-polar reserve currency system?
The same conclusion holds regarding predictions about the dollar’s primacy as a reserve currency. When Barry Eichengreen recently argued that the Ukraine crisis will accelerate the movement towards a more multipolar international monetary system, his line of reasoning was as follows:
- the share of dollars in globally identified foreign exchange reserves has been trending down so that they now account for 59% of these reserves as opposed to the 70% figure of 20 years ago;
- the principal cause of this downward trend has been central banks’ diversification away from dollars towards the currencies of smaller economies such as Australia, Canada, Sweden, South Korea, and Singapore;
- this diversification into smaller currencies has been facilitated by the liquidity of these markets and hence the low costs of transacting in them, developments that have been made possible by the advent of electronic trading platforms and other financial innovations; and
- the principal motivation for this reserve diversification has been the central banks’ attraction to the higher yields that the smaller currencies offer in contrast to those offered by the large currencies.
There is nothing wrong with this explanation as to why central banks are diversifying their reserve portfolios to include more smaller currencies. Nor is there anything wrong with the IMF’s observation that these reserve portfolios may now include alternative currencies such as cryptocurrencies and digital currencies. What is wrong is that these narratives are presented in entirely self-enclosed terms rather than in the broader context of what any increased diversification signifies for the overall composition of central bank reserve portfolios.
As with all institutionally managed asset portfolios, foreign exchange reserve portfolios are organized according to a core-satellite structure, where the core segment in this case typically comprises US treasuries and the satellite segments comprise the higher-yielding securities of other governments.
A key question, therefore, is whether dollar reserves in central bank allocations will fall far enough below 59% to warrant the claim about an emergent multipolar reserve system? The answer to this question, in turn, boils down to the question of whether the dollar core segment in reserve portfolios will shrink to a size comparable with the non-dollar satellite segments. The expectations are that it will not.
Recall that the reason why institutional asset managers must hold a significant, if not majority, proportion of their portfolios in the form of financial securities, is that these best combine liquidity with a value storage capacity. Now, while the huge growth of the stock of securities in recent years has provided these institutional investors with abundant supplies of safe and portable value containers, the flip side of this growth in financial value storage capacity is that it has also provided hedge funds and other speculative vehicles with massive financial firepower when targeting national currencies that are perceived to be vulnerable. As was pointed out in a Group of Ten report back in 1993:
“the growth in the size, integration and agility of international financial markets has greatly increased the scale of pressure that can be exerted against an exchange rate when market sentiment shifts.”
The European currencies felt the scale of that pressure in the EMS crisis of the summer of 1992, while all the Asian currencies (bar the yen) felt the scale of that pressure in the summer of 1997. Indeed, it was largely because of the unnerving experiences of these crises that there was a subsequent sharp increase in central bank foreign exchange reserves. From barely $0.5 trillion in 1995, the total amount of allocated reserves held by central banks had risen to $5.4 trillion by 2010, an amount that was more than doubled again to $11.8 trillion by 2020.
In 2020, the dollar’s share of allocated reserves was indeed 59% as compared with its share of 70% in 2000. However, to say that there was a “trend decline” in the dollar’s share over this twenty-year period is misleading because it gives the impression of a continuous, year-on-year decline. Rather, while there was an initial downward adjustment of the dollar’s share to about 60% that occurred in the first few years following the introduction of the euro, from 2005 to 2020 that 60% share then remained stable, as did the euro’s share of 20%, and as did the remaining 20% collective share of several other smaller currencies. The fundamental reason why the dollar has continued to maintain this 60% share of foreign exchange reserves even as these continue to grow exponentially in absolute terms comes down to the large mass of US Treasuries.
In today’s era, when the world’s capital markets are deep and highly integrated and when cross-currency capital movements accordingly combine huge scale with high mobility, central banks that are concerned to minimize the impact of these movements on their domestic currencies need to have in reserve financial securities that: (i) have a large and safe value storage capacity, (ii) are available in abundance, and thus (iii) are highly liquid. No other financial securities, and no other financial instruments including crypto and digital currencies, can match US Treasuries as regards these criteria.
If any EME-based central banks needed any reminder of this crucial fact, the events of early March 2020, provided it. By that time, the covid-19 pandemic’s negative impact on the global economy became clear to the world’s institutional investors, and they quickly withdrew funds amounting to over $100 billion from the EMEs in the space of days. That withdrawal was catastrophic for many of these countries, but its impact would have been even more devastating had their central banks not quickly intervened in their domestic currency markets with huge sales of the US Treasuries kept in their reserves.
Central banks around the world may well add the higher-yielding securities of other smaller currencies to their reserve portfolios. But can we seriously believe that, at a time when the world’s financial markets continue to grow in scale and become ever more closely integrated, and the threats posed by sudden surges of cross-border portfolio investments grow accordingly, that these central banks will risk substantially shrinking their core holdings of US Treasuries in the search for higher returns? Of course not.
4. The Primacy of the Dollar as an International Currency
On April 1st, 2022, the Bank of International Settlements launched its 13th Triennial Central Bank Survey of Foreign Exchange Transactions and OTC Derivatives Markets, the full results of which are due to be published in November. In the two full years between the 2019 survey and the current one, the world economy suffered its biggest shock since the great depression of the 1930s with the outbreak of the covid pandemic. In 2020, nominal world GDP fell from its 2019 figure of $87.4 trillion to $84.9 trillion, while the world’s combined bond and equity stocks increased by more than 15% from $200.9 trillion in 2019 to $234.3 trillion, an increase principally driven by the steep increase in government bond issuance on the one hand, and the increase in security prices fueled by monetary policy easing, on the other.
The story in 2021 appeared somewhat better, as nominal world GDP rose above its pre-pandemic level to $94.9 trillion, but the world’s combined equity and bond stocks again rose substantially, to reach over $241 trillion. In both these Covid-impacted years, the US share of the world’s supplies of equities and bonds remained stable at around 40%. Thus, going by the observation that forex turnover volume is overwhelmingly driven by financial sector interests as distinct from those of the real sector, we can safely predict that the dollar’s share of the new 2022 figure for daily forex turnover will remain around 44%, while, at the other end of the spectrum, the combined percentage shares of all the EME currencies will stay around 13%, with China’s yuan share at 2%. In other words, our prediction is that the Ukraine crisis that broke out just after the commencement of the latest BIS triennial survey of forex turnover will have had no discernible impact on the currency breakdown of that turnover.
As to the longer term, we also predict that there will be no serious challenge to dollar supremacy in the foreseeable future because there will be no other regional or national currency that will have a sufficient backing mass of equity and debt securities to enable it to mount such a challenge over that time span. To support this prediction, we need only invoke the experience of the euro.
When this currency was launched in 1999, it was widely assumed that, as the currency of the world’s largest single market and trading bloc, it would soon overtake the dollar as the world’s premier international vehicle currency. Chinn and Frankel, for example, argued that the dollar would relinquish that position by 2015 not only because ‘the euro now exists as a more serious potential rival than the mark or yen were’ but also because ‘the United States by now has a 25-year history of chronic current account deficits and the dollar has a 35-year history of trend depreciation.’
This argument could not have been more wrong, because while the euro’s share of daily forex turnover hovered around an average of 19% between 2001 and 2010, it subsequently fell to an average of 16% between that year and 2019, the principal reason for this reverse movement being the eurozone’s failure to supply the world’s large institutional investors with sufficient amounts of euro-denominated securities in which to park their funds.
This insufficiency is even starker in the case of the world’s EMEs that today collectively account for about 20% of world equity stocks and about 15% of world bonds stocks. Many EMEs have too small a domestic real economic base to support securities markets of any appreciable size. Those EMEs that do have large production bases nevertheless continue to have relatively small financial markets principally, if not exclusively, because of continuing weaknesses in their domestic legal and governance infrastructures.
China’s situation illustrates the point. Although China’s equity and bond markets are by far the largest of any EME, these are still small by comparison with those of the US, largely because its governance standards are currently of uneven quality, high in some sub-categories (e.g. law and order, crime prevention) and low in others (e.g. protection of minority shareholders). As for the period ahead, China, which is still a middle-income developing country, will find it difficult to move all its legal and governance institutions rapidly in the required direction.
Nothing that has been said above should be taken to mean that we favor a dollar-centered international monetary system. Far from it, for we believe that there are many sound reasons, ranging from the political to the economic, why a multipolar system is desirable.
Desire, however, is not enough. Nor is it enough to hope that the foundations of dollar supremacy are so fragile that it is only a question of time and of another shock or two to the world political and economic order for those foundations to come tumbling down. On the contrary, those foundations are strong, which means that any attempts to elevate rival currencies to a position where they can challenge dollar supremacy must start by recognizing the reason why its foundations do remain strong. That reason comes down to the hard stuff of the financial securities markets, their constituent solid matter. The chief purpose of this short contribution has been to explain the nature of that matter.
Arslanalp, Serkan, Eichengreen, Barry and Simpson-Bell, Chima, 2022, “Dollar Dominance and the Rise of Nontraditional Reserve Currencies”, IMF Blog, 1 June 2022, https://blogs.imf.org/2022/06/01/dollar-dominance-and-the-rise-of-nontraditional-reserve-currencies/
BIS, 2019a, “12th Triennial Central Bank Survey of Foreign Exchange Transactions and OTC Derivatives Markets”, November.
BIS, 2019b, Quarterly Review, December.
Chinn, M. & Frankel, J. 2008, “Why the euro will rival the dollar”, International Finance, 11(1), 49–73.
Commons, John, 2017, Institutional Economics. Its Place in Political Economy, London, New York: Routledge.
Eichengreen, Barry, 2022, “Ukraine war accelerates the stealth erosion of dollar dominance”, Financial Times, 28 March 2022.
Galbraith, James, 2022, “A multipolar financial world is here”, INET, May 5th 2022; https://www.ineteconomics.org/perspectives/blog/the-dollar-system-in-a-multi-polar-world
Georgieva, Katarina, 2022, “The Future of Central Bank Money”, 2 February 2022, https://www.imf.org/en/News/Articles/2022/02/09/sp020922-the-future-of-money-gearing-up-for-central-bank-digital-currency
Group of Ten. (1993). International capital movements and foreign exchange markets: Report to the Ministers and Governors by the Group of Deputies. Basel, Switzerland: Bank for International Settlements.
IMF, 2017, Composition of Foreign Exchange Reserves, March.
IMF, 2021, Composition of Foreign Exchange Reserves, March.
Mehrling, Perry, 2010, The New Lombard Street, Princeton: Princeton University Press.
OECD, 2019, Pension Markets in Focus, p.29.
SIFMA, 2020, US Capital Markets Fact Book.
SIFMA, 2021, US Capital Markets Fact Book.
SIFMA, 2022, US Capital Markets Fact Book.
Strange, Susan, 1994, “Wake Up, Krasner! The World Has Changed”, Review of International Political Economy, 1:1.
UNCTAD, 2019, “Financing a Global Green New Deal”, Trade and Development Report.
UNCTAD, 2022, “Tapering in a Time of Conflict”, TDR Update, March. https://unctad.org/webflyer/ta…
 Eichengreen, Barry, 2022, “Ukraine war accelerates the stealth erosion of dollar dominance”, Financial Times, 28 March 2022.
 Galbraith, James, 2022, “A multipolar financial world is here”, INET, 5 May; https://www.ineteconomics.org/perspectives/blog/the-dollar-system-in-a-multi-polar-world
 Arslanalp, Serkan, Eichengreen, Barry and Simpson-Bell, Chima, 2022, “Dollar Dominance and the Rise of Nontraditional Reserve Currencies”, IMF Blog, 1 June 2022, https://blogs.imf.org/2022/06/01/dollar-dominance-and-the-rise-of-nontraditional-reserve-currencies/
 Mehrling, Perry, 2010, The New Lombard Street, Princeton: Princeton University Press.
 Commons, John, 2017, Institutional Economics. Its Place in Political Economy, London, New York: Routledge.
 Strange, Susan, 1994, “Wake Up, Krasner! The World Has Changed”, Review of International Political Economy, 1:1.
 Galbraith, James, 2022, “A multipolar financial world is here”, INET, May 5th 2022.
 BIS, 2019a, 12th Triennial Central Bank Survey of Foreign Exchange Transactions and OTC Derivatives Markets, November.
 BIS calculates currency percentage shares out of 200%, to allow for the double counting of each currency pair. For simplicity, in what follows we halved the shares to give figures out of 100%.
 SIFMA, 2020, US Capital Markets Fact Book.
 SIFMA, 2021, US Capital Markets Fact Book.
 OECD, 2019, Pension Markets in Focus, p.29.
 BIS, 2019b, Quarterly Review, December.
 Eichengreen, Barry, 2022, “Ukraine war accelerates the stealth erosion of dollar dominance,” Financial Times, 28 March 2022.
 Group of Ten, 1993, p.33.
 IMF, 2017, Composition of Foreign Exchange Reserves, March. IMF, 2021, Composition of Foreign Exchange Reserves, March.
 UNCTAD, 2019, “Financing a Global Green New Deal”, Trade and Development Report.
 SIFMA, 2022, US Capital Markets Fact Book.
 Chinn, M. & Frankel, J. 2008, “Why the euro will rival the dollar”, International Finance, 11(1), p.51.