Bitcoin is unlikely to replace the greenback as a global reserve currency any time soon, according to one of the most highly regarded analysts in foreign exchange.
"Backing the dollar is the world's biggest, deepest and the most transparent government bond market," Marc Chandler, chief market strategist at Bannockburn Global Forex and author of the book "Making Sense of the Dollar," told CoinDesk in a recent video chat. "I just don't know how bitcoin can replace the greenback from that viewpoint."
A global reserve currency is the one that facilitates cross-border trade, including investments and international debt obligations. Global central banks hold reserve currencies to help protect against major swings in foreign-exchange rates, as well as in the conduct of monetary policy.
The U.S. dollar has been the primary reserve currency since 1944, and investors tend to park funds in dollar-denominated assets or hold dollars during times of stress in the global economy. For instance, the U.S. Dollar Index, which tracks the greenback's value against a basket of other major fiat currencies, rose from 94.65 to 103.00 in mid-March as global equity markets tanked on coronavirus-induced recession fears.
Some analysts, however, foresee markets losing confidence in the dollar over the next few years. That’s because the Federal Reserve has pumped trillions of dollars of liquidity into the financial system over the past decade and is likely to continue printing money at an elevated pace for some time.
The central bank's balance sheet has expanded from $905 million to over $7 trillion in the past nine years, according to the St. Louis Fed. It has grown by more than $4 trillion in the past five months, as the Fed rolled out emergency liquidity programs to counter the economic toll of the coronavirus, while ramping up monthly asset purchases in a process known as quantitative easing.
"The U.S. dollar is on the brink of losing its position of world's global reserve as inflation concerns in the U.S. grows," Goldman Sachs said in July. While the investment bank speculates that gold could replace the dollar, the crypto community contends that bitcoin, with its deflationary monetary policy, is the best alternative to the dollar.
Bitcoin's pace of supply expansion is reduced by 50% every four years via a process called mining reward halving. At inception, each bitcoin block reward was worth 50 BTC. As of now, per block reward is 6.25 BTC – down from 12.5 BTC prior to May 12. Bitcoin’s tapering supply growth while the Fed has increased dollars is a large reason why many in the crypto markets have long been predicting the dollar's collapse and bitcoin's rise as a global reserve.
However, such predictions often neglect that countries do not just accumulate dollars but also buy U.S. government bonds. "Central banks don't just hold dollars; they hold U.S. Treasuries. That's what corporations and large institutions do," Chandler said.
Why countries buy U.S. Treasury Bonds
As of June 2020, Japan held U.S. Treasury securities worth $1.26 trillion, and China held $1.07 trillion, according to data provider Statista. According to the Federal Reserve and U.S. Department of the Treasury, foreign countries held $7.04 trillion worth of U.S. Treasury securities as of June 2020.
The Chinese and Japanese purchases of Treasury bonds isn't a case of these nations' generosity, as is popularly perceived, but economic math. These nations run substantial current account surpluses (and capital account deficits) and invest their surplus forex reserves in the U.S. government bonds, given it is the deepest in the world. Also, investing in the U.S. Treasury helps Japan and China keep their currencies from appreciating and preserves current account surpluses.
As of Aug. 20, the size of the global sovereigns, supranational and agencies bond market was $87.5 trillion, of which the U.S. accounted for $22.4 trillion and China $19.8 trillion. While China is a close second, its currency, the yuan, has yet to achieve full capital account convertibility and there are transparency concerns regarding Chinese markets.
Put simply, no other bond market has the depth and transparency to absorb billions of dollars of demand other than the U.S. bond market. “No bond market can come close to Treasurys," Chandler said.
Meanwhile, no central bank has purchased bitcoin to date. While the institutional participation has increased this year, the cryptocurrency continues to behave like an investment asset rather than a safe haven or a future global reserve. Bitcoin fell during the March crash and has risen strongly over the past six months alongside the U.S dollar's sell-off.
Besides, price volatility is an issue. Bitcoin has moved at an average pace of 16% per month this year, substantially higher than a non-major currency like the Mexican peso, as noted by Chandler.
As such, the idea of bitcoin supplanting the U.S. dollar as the global reserve in the near term looks far-fetched.
Dollar has withered a bigger sell-off in the past
The U.S. Dollar Index (DXY) fell by 10% to a 16-month low of 101.75 in the mid-March to mid-August period. The slide, coupled with the Federal Reserve’s recent decision to adopt a more flexible approach to controlling inflation, has bolstered fears of the dollar’s collapse as a reserved currency.
However, the dollar has suffered bigger sell-offs in the past and still maintained its reserve status. For instance, the index, which rose sharply from 77 to 89 in the seven months following the collapse of Lehman Brothers in August 2008, reversed gains and fell back to 72.70 by May 2011. That’s a nearly 20% decline in 12 months or so.
More important, when the DXY made a low near 72.70 in May 2011, EUR/USD was trading near $1.45, up 23% from the current rate of $1.1750. Meanwhile, GBP/USD was trading above $1.65 – 28% more than the current exchange rate of $1.29. The Japanese yen, Australian dollar, Canadian dollar and other major currencies were also trading at significantly higher levels than seen today, as noted by Chandler.
Essentially, the U.S. dollar was aggressively sold on the Federal Reserve’s quantitative easing programs. Even so, it remained the dominant global reserve currency.
The dollar accounted for more than 60% of the global forex reserves in crisis and recovery years of 2009, 2010 and 2011, according to data source statista.com. The situation hasn’t changed much this year despite the coronavirus crisis. The greenback accounted for 61% of the global currency reserves in the second quarter, as per the International Monetary Fund.
Thus replacing the dollar is easier said than done. Bitcoin has to cover plenty of distance before it can threaten the dollar’s hegemony. For that to happen, the crypto community’s focus needs to shift from playing for price rallies to building infrastructure that would accelerate adoption at the institutional level.
Major central banks like the Fed and the People’s Bank of China are working on digital currencies. Chandler postulates that central bank digital currencies would pave the way for an alternative payment system.
Dollar sell-off likely to continue
The dollar bounced in September, ending a six-month losing trend even though the Fed adopted a more flexible approach to controlling inflation at the end of August.
According to Chandler, the dollar’s bounce has got more to do with technical factors. The currency looked oversold against majors and bullish positioning in EUR/USD had reached extremes in August. As a result, a minor bounce was overdue and was amplified by expectations for more monetary easing by the European Central Bank.
The Fed has created more room for itself to keep interest rates low for a longer period of time by signaling a willingness to tolerate above-target (2%) inflation for some time. As such, the path of least resistance for the dollar is to the downside, unless other central banks follow the Fed’s path.
With the dollar looking weaker, recent uptrends in bitcoin, gold and assets denominated in the greenback could soon resume. However, if Chandler is correct, the dollar is likely to prevail as the global reserve.
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