HomeThe role of USD in times of crisis

The role of USD in times of crisis

26 May 2020 By Mircea Vasiu

One of the most exciting debates of the last several decades concerned the US Dollars’ role within the international financial system. It is still unclear if the role of being the world’s reserve currency is a privilege or a burden for an economy. However, everyone agrees that the USD is the pillar of the financial system as we know it today.

The World After the Gold Standard

In the late 60s, early 70s, the United States decided to drop the gold standard. Up to that point, the Bretton Woods agreement required that the Fed would issue USD’s only backed by a corresponding gold ratio held in its vaults.

Since those years, the Dollar’s role in the world increased significantly. Nowadays, almost 80% of all world’s trade is conducted in US dollars. Moreover, a higher percentage (84%) of all non-domestic debt globally is denominated in USD. A rough figure would be somewhere close to $100 trillion worldwide denominated USD debt.

If the percentages and numbers ahead are not convincing enough to understand the key role of the USD in the current financial system, think of the rest of the world (i.e., currencies, central banks), dealing with their own internal issues. The fight to offset systemic risks has its own particularities for each central bank and in each individual or bloc  economy.

When trading/investing, it is important to have a short, medium, and long-term perspective. Sometimes, the economic troubles in one part of the world (e.g., 2012 Eurozone sovereign debt crisis) favor dumping a currency for the USD. Some other times, the interest rate differential between free-floating currencies makes certain exchange rates more appealing than others.

However, from a macro-perspective, all financial markets’ participants should consider the mind-boggling high USD denominated debt circulating in the world. At some point, individuals, institutional investors, countries, and governments must service it.

In fact, each passing day, the USD denominated debt is serviced somewhere in the world. The high level of debt implies a continuous demand for the Dollar, dwarfing what the Fed printed so far and will print in the future.

The Fed’s balance sheet rose to around $7 trillion – but other central banks increased their balance sheet too. Offsetting the debt impairment is highly unlikely in the current financial system, regardless of the Fed’s decisions in normal economic times or during a crisis.