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The Future of the Monetary System Leading perspectives to navigate the future
Table of contents
04 Editorial
05 Introduction
07
1. The checkered history of the
USD-centric monetary system
Since its formal anointment as the world’s lead
currency, dollar hegemony has frequently been in
question, especially when US monetary policy was
regarded as irresponsibly lax or too tight.
14
2. Macroeconomic imbalances
and geopolitical conflict
US macro imbalances could once again undermine
trust in the US dollar. Moreover, the Russia-Ukraine
war and ongoing US-China tensions may lead some
to question whether geopolitics might also weaken
US dollar dominance.
About the Credit Suisse Research Institute (CSRI)
The Credit Suisse Research Institute (CSRI) is Credit Suisse's in-house think tank. It was established in the aftermath of
the 2008 financial crisis with the objective of studying long-term economic developments, which have – or promise to have
– a global impact within and beyond the financial services industry. The Institute builds on unique proprietary data and
internal research expertise from across the bank and in collaboration with leading external specialists. Its flagship
publications, such as the Global Wealth Report, regularly attract more than 100,000 readers online, generating high press
coverage and over three million impressions on social media. Further information about the Credit Suisse Research Institute
can be found at www.credit-suisse.com/researchinstitute.
2
21
3. Rethinking foreign currency
reserves
One of the most direct measures of its dominance
remains the weight of the US dollar in global
foreign exchange reserves. Although it has indeed
diminished in trend, evidence of a major reallocation
to other currencies remains limited.
28
4. How the monetary system
could evolve
For the foreseeable future, there are no candidates
to replace the US dollar as lead currency, and the
creation of a global currency remains illusory. The
monetary system is, however, gradually becoming
more multipolar.
35
5. Conclusion: What (else)
will count
37 Panel of experts
Editorial deadline: 12 January 2023
Cover photo by Bill Oxford, Getty Images
39 General disclaimer / For more information, contact:
Nannette Hechler-Fayd’herbe
important information Chief Investment Officer for the EMEA region
and Global Head Economics & Research of
Credit Suisse
Authors: nannette.hechler-fayd’herbe@credit-suisse.com
Zoltan Pozsar
Oliver Adler Richard Kersley
Maxime Botteron Executive Director of EMEA Securities Research
Nannette Hechler-Fayd’herbe and Head of Global Product Management,
Credit Suisse
Editor: richard.kersley@credit-suisse.com
Oliver Adler
The Future of the Monetary System 3
Editorial As our in-house think tank, the Credit Suisse Research Institute (CSRI) studies long-term economic and financial developments with a global impact. In this report, we pull together facts and thoughts by our leading internal experts as well as external thought leaders about key developments in the international monetary system. This analysis draws on our CSRI Fall Conference 2022 on the same topic. It discusses how macroeconomic imbalances and geopolitics can catalyze change in the current largely USD-based monetary system, how central bank reserves have evolved so far and may be re-assessed going forward, and sketches out a vision for a gradually more multi-polar monetary system. While declaring the demise of US dollar We hope this report and the insights shared by hegemony and dominance is premature, its fate our authors and guest speakers at the CSRI Fall as a backbone of the international monetary Conference 2022 make a valuable contribution system depends on a number of factors, with the to current macroeconomic thinking. degree to which US policy makers would be able to maintain macroeconomic stability and trust relative to other countries of supreme importance. Axel P. Lehmann Understanding monetary developments and Chairman of the Board of Directors functioning is key to a global bank like Credit Credit Suisse Group AG Suisse and to the broader financial sector, which plays a role in monetary transmission. 4
Introduction
The past three years have seen abrupt potentially increase the risk of a rupture and
changes in the global economy, economic policy potential realignment of the monetary system.
responses and the realm of geopolitics – the Meanwhile, doubts as to whether US monetary
latter, in fact, date further back. Not surprisingly, and fiscal stability will be restored, together with
these changes have triggered hefty reactions in significant imbalances in global capital flows,
financial markets, including money, bond and increase the potential for stresses in the US
foreign exchange markets. As in past periods of dollar-centric monetary system. Conversely,
economic and geopolitical turbulence, they have improved macro management in key emerging
also raised the question as to whether the markets has arguably helped limit such stresses.
international monetary system may be subject
to more long-term and fundamental changes. Chapter 3 analyzes to what extent changes in
To discuss this question, the Credit Suisse the composition of foreign reserves at the major
Research Institute held a conference in central banks might be pointing to a longer-term
November 2022, at which a number of diminution in the role of the US dollar.
academic experts and practitioners presented
their perspectives on broader political and Chapter 4 describes the concrete efforts that
economic matters as well as more technical have been underway, especially since the
issues related to the evolution of the monetary financial crisis of 2008, to increase the
system. This report presents some of the main robustness of the monetary system and, in
areas of debate as well as insights from the particular, to better protect emerging markets
conference. from the stresses that emanate from the US
dollar-centric system. It also points to the role
Chapter 1 of the report provides a historical that central bank digital currencies could play in
perspective on the evolution of the current, such an enhanced insurance setup.
primarily dollar-based monetary system, drawing
attention to the series of crises it has endured. Chapter 5 provides a checklist with which to
Of particular relevance for our discussion are assess potential changes in the monetary system
periods in which major shifts in US monetary and concludes with a key message: when
policy generated stresses outside the United assessing the likely evolution of the monetary
States and which, in turn, led to calls for reforms system and the role the US dollar (or for that
of the system or even its replacement. matter any other currency) will play in it, the
focus should not only be on central banks. At
Chapter 2 lays out the current geopolitical and least as important is whether the dynamism of
economic context in greater detail. The the US economy will suffice to continue to attract
geopolitical tensions between China and the large pools of private and institutional investment
West, which have been building over the past capital from around the world.
several years, and the Russia-Ukraine war
The Future of the Monetary System 5
6 Photo by Tanarch, Getty Images
1. The checkered history
of the USD-centric
monetary system
Since its launch at Bretton Woods in 1944, the USD-centric monetary
system has undergone profound change, typically in response to
“systemic” crises. High US inflation in the 1970s undermined trust in the
US dollar, but the Federal Reserve under Chairman Volcker re-established
credibility. However, shifts in US monetary policy continue to amplify
business cycles or even trigger crises in other countries. While the Fed
and other central banks have developed tools to limit the fallout, calls for
systemic change persist.
The goal of the Credit Suisse Research Institute The Bretton Woods system as devised in 1944
Fall Conference held in November 2022, and was regarded as a response and solution to the
which this publication draws on, was to discuss chaotic monetary relations that reigned in the
the future of the global monetary system. The inter-war years. Many countries, notably Britain,
term “system” might suggest that we are had gone off the gold standard at the start of
referring to a well-defined and, in some sense, World War I in order to gain leeway for the
rather mechanical set of economic relationships. monetary financing of war expenditures.
Nothing could be further from reality. While the Subsequently, high inflation in the post-World
USD-centric system launched at the United War I period, most dramatically in Germany, led
Nations Monetary and Financial Conference at countries to temporarily return to the gold
Bretton Woods in July 1944 (hence “the Bretton standard in the mid-1920s, only to once again
Woods system”) was indeed conceived as a strict abandon that system in the early 1930s in order
set of rules under which countries’ exchange to escape its deflationary impact. This period of
rate policies would operate, the system has severe monetary system instability stands in
undergone frequent and often profound change, marked contrast to the pre-World War I century
typically in response to “systemic” crises. In the of “Pax Britannica,” in which the British pound
process, it has become more flexible, which has was effectively the dominant global reserve and
allowed the system to survive, but is no longer anchor currency (see Figure 1), with others,
rule-driven. Moreover, many argue that the such as the French franc, German Reichsmark
system remains crisis-prone, which has and US dollar playing far lesser roles.
frequently produced calls for reform. Whether a
truly new system might emerge, or whether the Crises and evolution of the
current system will continue to adapt and, if so, USD-centric system
in which directions, are the key questions this
report addresses. Reviewing the checkered As noted, the monetary history that formed the
history of the USD-centric system provides some mental background for the participants at the
insights into the weaknesses of the current 1944 Bretton Woods conference was the severe
system, especially its asymmetric impacts on monetary instability of the inter-war period. On
third countries. the “real” side of the economy, the key concern
was to prevent renewed setbacks to world trade
The Future of the Monetary System 7
Figure 1: From Pax Britannica to Pax Americana
GBP/USD exchange rate; a decline implies a weakening of GBP vs. USD
14
US Civil War
12
10
8
Interwar
turbulence Bretton Woods
6 Conference
4
2
0
1800 1811 1823 1835 1846 1858 1870 1881 1893 1905 1916 1928 1940 1951 1963 1975 1986 1998 2010 2021
Source: Craighead (2010), Federal Reserve Board and ONS, Refinitiv Datastream
such as those of the inter-war period in which their currencies came under undue pressure,
the imposition of tariffs had exacerbated the while the International Bank for Reconstruction
Great Depression (in that period, the imposition and Development (today’s World Bank) was
of tariffs was also a response to competitive established to provide long-term capital for
devaluations of currencies by trading partners). countries in need of aid.
In addition, the destruction caused by World War II
called for a system that would not only ease trade, The first major shock to the system:
but also provide international capital to support Breaking the gold peg
reconstruction. Given the rise of the United States The first major shock to BWI was the
and the US dollar as the dominant economic and abandonment of US dollar gold convertibility by
geopolitical power as well as currency, the Bretton US President Richard Nixon in 1971. As Perry
Woods conference settled on the US dollar gold Mehrling, Professor of International Political
exchange standard (Bretton Woods I, or BWI). Economy at Boston University, pointed out at the
CSRI Fall Conference, Nixon’s decision was
In the eyes of John Maynard Keynes, who was effectively an effort to end US responsibility for
a central figure at Bretton Woods and the global monetary affairs and to provide the US
preeminent economist of the time, this was a Federal Reserve (Fed) with the freedom to fully
suboptimal solution. He recognized early on that focus on the domestic economy. Under BWI, the
monetary hegemony by a single country could United States had emerged as an international
lead to severe imbalances and stresses. His idea financial intermediary, borrowing short term and
was to establish a globally accepted monetary lending long term like a bank. Convertibility of
instrument (“Bancor”) and an International those short-term liabilities into gold, however,
Clearing Union (ICU) that would manage the meant that the “bank” was vulnerable to a run in
system and ensure that international trade would case of loss of confidence. Nixon’s decision in
proceed smoothly; capital mobility between 1971 to close the gold window led to a period of
countries was not foreseen at the time as the international instability, in which exchange rates
norm. Keynes’s idea was, however, swept aside between the US dollar and other major currencies
at the conference, and the US dollar became the floated, with some countries limiting fluctuations
world’s reserve currency. The value of the US more than others; some countries maintained a
dollar was pegged to gold at USD 35 per ounce fixed exchange rate to the US dollar or even
and the exchange rate of other currencies was instituted currency boards (e.g. Hong Kong in
pegged to the US dollar. The International 1983). In retrospect, this period of instability can
Monetary Fund (IMF) was established to address be understood as the birthing pains of a new
shorter-term liquidity problems of countries if Eurodollar system, in which international financial
8
Figure 2: USD setbacks limited after mid-1980s
USD exchange rates versus other major currencies; index (Jan. 1970 = 100)
120 USD depegged Plaza Accord
from gold
Paul Volcker
IT bubble
100 appointed
bursts/
Fed Chairman
9/11
80 Asian crisis Global
Financial Pandemic
Crisis Euro crisis
60
40
20
0
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
EUR (DEM) JPY CHF
Source: Haver Analytics, Credit Suisse
intermediation in dollars took place much more “Volcker: The Triumph of Persistence,” the
offshore, supported by central bank cooperation legendary Fed Chairman attended a lunch
rather than the Fed acting on its own. meeting in October 1979 with German
Chancellor Helmut Schmidt in Hamburg en route
Nixon’s decision to abandon the peg to gold to the fall meetings of the IMF in Belgrade,
had been preceded by years of increasingly Yugoslavia; with the dollar trading at 1.75
expansionary US fiscal policy under Presidents deutschmarks, the German Chancellor said “the
Kennedy and Johnson to finance the Vietnam world needs stability much more than anything
War and Johnson’s “War on Poverty.” The Fed else […]” a message Volcker had already heard
had largely accommodated that policy by keeping from him six years earlier in 1973, when the
interest rates below what was needed to avoid dollar was still worth three marks. Now Schmidt
economic overheating and rising inflation. expressed a more modest objective, one that
Indeed, the ending of the peg to gold was one reflected the dollar’s weakened status: “I would
of triggers for an inflationary dynamic in the like to get back to a world in which the dollar
United States, while the OPEC price shock that would be two marks and stable.” A joint press
followed shortly after fully unleashed inflation in release after the meeting noted that “…
the United States and the rest of the world, and exchange rate stability and a strong dollar are in
ushered in a period of general “economic the interest of both countries.” Perceptions of
malaise.” The OPEC (Organization of Petroleum the rest of the world may well have influenced
Exporting Countries) price shock also led to a Volcker’s decision to dramatically tighten
large accumulation of petrodollars and the monetary policy. Indeed, strengthening the dollar
recycling of those petrodollars into US against the mark and other currencies required
Treasuries, which made OPEC the first set of some radical monetary actions. While formally
captive buyers for Treasuries (see Chapter 3). switching to a monetary growth target, the Fed
raised its lending rate sharply, with the Fed funds
Volcker’s re-establishment of dollar rate reaching an unprecedented 20% in 1980.
dominance… The actions worked: inflation peaked in the early
Not surprisingly, the abandonment of the dollar’s 1980s and the dollar rallied.
gold peg and the period of high US inflation
during the 1970 also triggered a marked …hurts many emerging markets
weakening of the US dollar (see Figure 2), The combination of still-tight Fed policy with
which naturally raised doubts about the President Ronald Reagan’s tax cuts (i.e. fiscal
sustainability of the dollar as the world’s reserve easing) kept real interest rates high into the
currency. As William L. Silber recounts in mid-1980s. Now, the world’s problem was no
The Future of the Monetary System 9
longer lax US monetary policy and a weak dollar, abandon the currency peg (Thailand’s and South
but rather an excessively strong US dollar. This Korea’s choice). With currencies sharply lower,
caused unease in advanced countries and led to but debt denominated in a strong US dollar,
the Plaza Accord of September 1984, in which these countries came close to defaulting. In
the United States, France, (West) Germany, the contrast to the Latin American experience,
United Kingdom and Japan agreed to jointly defaults were nevertheless avoided. Instead, the
weaken the US dollar. Although concrete actions IMF provided substantial financing, albeit under
were limited, the declaration achieved its goals strict conditionality, to Asian countries. While the
and the US dollar began to retrench. Meanwhile, adjustments were painful for these countries, the
the strong US dollar and high real interest rates turnaround nevertheless occurred much faster
in the early 1980s triggered outright crises in than in Latin America.
Latin American emerging markets (Mexico, Brazil
and Chile). In the period of low real interest rates
and a weak dollar of the 1970s, Latin American
governments and banks had borrowed heavily in
US dollars, in part from cash-rich oil exporters.
With oil prices dropping after 1979 and the US
economy going into recession in 1981/82, Latin
American exports collapsed and foreign exchange
reserves came under pressure as capital fled the The “lost decade” of
countries. With real interest rates stubbornly high,
debt could no longer be serviced. It took many
Latin America attests
years of negotiation and piecemeal interventions to the fact that it is not
by the IMF until debt was finally rescheduled in
the late 1980s and early 1990s under the just periods of US
so-called Brady and later Baker plans (named
after the two US Treasury Secretaries). The “lost
dollar weakness (and
decade” of Latin America attests to the fact lax US monetary
that it is not just periods of US dollar weakness
(and lax US monetary policy) that can cause policy) that can cause
problems in the rest of the world, but that
periods of tight Fed policy and a strong dollar
problems in the rest of
can be even more disruptive. the world, but that
Fairly smooth sailing during the 1990s periods of tight Fed
and early 2000s
In fact, the experience of Latin America was
policy and a strong
largely repeated in Asia in the mid-1990s. With dollar can be even
the purge of inflation by the Volcker Fed, interest
rates declined in the second half of the 1980s more disruptive
and early 1990s, while US and global economic
growth began to pick up. In the United States, the
Savings & Loan crisis (also a partial result of high
interest rates in the early 1980s) had gradually
been resolved. Meanwhile, the fall of the Berlin
Wall in 1989 and, above all, the entry of China This was also due to the fact that, in contrast to
into the world’s trading system ushered in an era the 1970s, the period of US monetary tightening
of rapid growth in global trade, with many other in the 1990s was mild and short-lived. China’s
Asian countries (the Asian “Tigers”) benefiting rise as the “factory of the world,” a widespread
strongly. The combination of strong global growth trend to liberalize markets for goods, services
and low US interest rates induced countries such and labor as well as well-anchored inflation
as South Korea and Thailand to borrow heavily expectations prevented inflation from rising
while adhering to a fixed exchange rate with the anywhere near as much as in the 1970s. As a
US dollar, with the intention to stabilize their result, interest rates remained subdued. The
exports. As the Fed under Chairman Greenspan extensive accumulation of US Treasuries by
began to raise interest rates in 1994, and with China in an effort to prevent yuan appreciation,
the US dollar once again appreciating, Asian combined with a significant improvement in the
currencies came under pressure and foreign US fiscal position under President Bill Clinton
exchange reserves dwindled rapidly. contributed to the persistence of low interest
rates. Alan Greenspan referred to this as a
The choice was to either impose capital controls “conundrum,” while his successor Ben
(a choice made by, for example, Malaysia in the Bernanke ascribed this phenomenon to a
face of heavy criticism from the IMF) or to “global savings glut.”
10Indeed, when the US Fed once again began to targeting inflation at around 2% was easily
tighten policy in mid-2004 in order to slow the achieved. For more than a decade, the main
US housing boom, it turned out that the policy concern was deflation (always feared,
preceding prolonged period of low long-term though never realized), which central banks in
interest rates had led to a huge build-up of risk the West fought with low policy rates and QE.
in US and European banks. While the leverage Financial market volatility was repressed during
had supposedly been offloaded onto the “shadow this period and asset prices experienced a
banking” system, these exposures were revealed spectacular rise. Financial market professionals
as effectively still being on the banks’ balance dealt mostly with technical shocks. The source
sheets (see Pozsar, 2010).1 What was initially of these shocks was the roll-out of Basel III,
regarded as a limited problem of subprime which imposed balance sheet constraints on
mortgages thus evolved into a full-blown global global banks and dealers, other pieces of reform
financial crisis (GFC). Meanwhile, emerging like money market fund reform, a shortage of
markets, which had “learned their lesson” in the collateral in Europe and Japan due to QE, and a
1980s and 1990s, largely avoided being caught shortage of reserves in the United States due to
in the crisis. quantitative tightening (QT) during 2018–19.
Rather than major crises, the main market
Significant expansion of Fed toolkit events from 2015 onward were spread
after the GFC dislocations in US dollar funding markets
The Latin American and Asian debt crises did not involving Libor, cross-currency bases and repo
lead to significant adjustments in the toolkit of the rates, which the Fed managed to address by
Fed, the “manager” of the USD-centric monetary deploying new lending tools.
system. Instead, reforms were implemented in the
emerging markets themselves: macro management
improved, with central banks moving to inflation
targeting, similar to the policy approach in advanced
economies, and exchange rate flexibility was
increased to soften the impact of external shocks,
while currency reserve policies were reviewed (see
The current
Chapter 3.) In contrast, the GFC called for reforms
in the advanced economies and it did engender
monetary system
changes in the Fed’s policy toolkit. The first lesson
from the crisis, enshrined in Basel III, was that the
has repeatedly
banking system needed higher capital and liquidity
reserves. These had clearly not been sufficient to
been criticized by
maintain stability in the system, requiring the Fed to
act as a lender of last resort to other central banks
senior policy
in order for them to be able to provide dollar liquidity
to their commercial banks. The system of Fed
makers, both in
swap lines was thus the key innovation in the
USD-centric monetary system post-GFC (also see
advanced
Chapter 4).
economies as well
But an even more important legacy of the global
financial crisis was the “birth” of quantitative
as emerging
easing (QE) as a standard and everyday policy
tool. It was applied because the Fed, in contrast
markets
to the European Central Bank and other central
banks in Europe, was not prepared to move
interest rates into negative territory. It meant that
the Fed’s balance sheet expanded massively,
with the central bank advancing to a major holder
of US Treasuries (see Figure 5 in Chapter 3).
During the waves of money printing and zero
interest rate policies that followed the GFC and The key questions going forward are whether
the Eurozone debt crisis, the USD-centric recent geopolitical and economic dislocations are
monetary system had a relatively stable run. likely to usher in renewed major disruptions in
There were no meaningful financial crises and, the monetary system and whether the USD-
until late in 2021, the key policy objective of centric system will be preserved via a continued
adaptation of policy tools as has been the case
1. Pozsar et al. “Federal Reserve Bank of New York Staff so far, or whether a more fundamental shift to a
Reports;” https://www.newyorkfed.org/medialibrary/media/ new system is on the horizon. On the one hand,
research/staff_reports/sr458_July_2010_version.pdf. this will depend on the geopolitical and economic
The Future of the Monetary System 11fundamentals prevailing in the years to come, Figure 3: Key events during period of USD-centric
which we will discuss in the following chapter. It monetary system
will also depend on whether true alternatives are
already available or likely to emerge, a question 1944: US dollar formally anointed global
we will address in Chapter 4. What is clear is reserve currency, replacing the British pound;
US dollar pegged to gold, other currencies to
that the current monetary system has repeatedly US dollar.
been criticized by senior policy makers, both in
advanced economies as well as emerging 1971: US dollar peg to gold abandoned;
markets, for the stresses it tends to generate flexible exchange rates.
and which we have described above. Not
surprisingly, these criticisms have been especially 1979: Re-establishment of Fed credibility
through massive policy tightening.
fierce both in periods of excessive ease of US
monetary policy (e.g. during the early and 1984: Plaza Accord, a joint effort of major
mid-1970s or immediately following the GFC) economies to limit US dollar strength.
and in periods of strong policy tightening (e.g.
the late 1970s and early 1980s, as well as in the 1997: Most Asian “tigers” abandon US dollar
mid-1990s) because the disruptions to other peg, others accumulate Treasuries.
countries were then greatest.
2008: Fed provides massive US dollar
liquidity to other central banks and foreign
Prominent criticisms of USD-centric banks via swap lines.
monetary system
2008: Birth of Quantitative Easing (QE) as
For example, during the onset of QE in 2009, primary policy tool of Fed and others.
Zhou Xiaochuan, then Governor of the People’s
Bank of China (PBoC), delivered a speech 2015: Fed deploys new lending tools to
address spread dislocations in US dollar
entitled “Reform the International Monetary funding markets involving Libor, cross-
System,”2 in which he argued that fundamental currency bases and repo rates.
reforms in the international monetary system
2015–17: Cautious Fed rate hikes and start
were necessary because “…the frequency and of Fed Quantitative Tightening (QT).
increasing intensity of financial crises following
the collapse of the Bretton Woods system 2022: Sharp Fed rate hikes to fight
suggests the costs of such a system to the world post-pandemic inflation surge.
may have exceeded its benefits.” He called for
“…creative reform of the existing international Source: Credit Suisse
monetary system towards a…super-sovereign…
international reserve currency with a stable value,
rule-based issuance and manageable supply…
that is disconnected from individual nations and
can remain stable in the long run, thus removing
the inherent deficiencies caused by using
credit-based national currencies.”
A decade later, former Bank of Canada and
Bank of England governor Mark Carney also
lamented “the deep flaws in the international
monetary and financial system (“IMFS”)” and,
in particular, that “growing dominant currency
pricing (DCP) [i.e. in US dollars] was reducing
the shock absorbing properties of flexible
exchange rates and altering the inflation-output
volatility trade-off facing monetary policy
makers,” and he suggested that a “new Synthetic
Hegemonic Currency (SHC)…possibly provided
by the public sector, perhaps through a network
of central bank digital currencies” might lead to
better outcomes.3
2. Zhou Xiaochuan, Governor of the People’s Bank of China,
Reform the international monetary system (essay published in
BIS Review 41/2009, March 2009).
3. Mark Carney, The Growing Challenges for Monetary
Policy in the current International Monetary and Financial
System (Speech given at the Jackson Hole Symposium, 23
August 2019).
12Photo by pookpiik, Getty Images The Future of the Monetary System 13
2. Macroeconomic
imbalances and
geopolitical conflict
Like other countries, the United States is battling a burst of inflation,
while the economy slows. Meanwhile, fiscal and external imbalances
have worsened substantially. This situation is somewhat reminiscent
of the 1970s, when trust in the US dollar was significantly undermined.
In addition, geopolitical tensions have escalated substantially in recent
years. This combination raises the specter of a potential major pivot
away from the US dollar. On balance, we believe this remains a fairly
unlikely case for now and that a gradual evolution to a more multi-polar
monetary system is more likely.
As our first chapter showed, the dollar-centric
monetary system has suffered considerable Figure 1: US dollar dominance well beyond the USA’s
volatility over its almost 70 years of existence, economic size (in %)
but has adapted and so far survived. In fact,
despite the significant liberalization, expansion 0 20 40 60 80 100
and deepening of non-US financial markets, the
US dollar has largely maintained its prominence World trade
over the past several decades. Relative to the Global GDP
size of the US economy and its role in global
Cross-border loans
trade, the US dollar certainly plays a very
outsized role (see Figure 1). That said, the International debt securities
share of US dollars in central bank reserves
FX transaction volume
has declined over the past decades (Figure 2),
a topic we will return to in the following chapter. Official FX reserves
Trade invoicing
What stands out in the chart and is particularly
relevant to the discussion in this chapter is that SWIFT payments
the US dollar’s position as a global reserve
currency weakened sharply, albeit only US share US dollar share of the global markets Of which: Offshore
temporarily, in the period following the
abandonment of the dollar’s gold peg and the Source: BIS Quarterly Review, December 2022
phase of US monetary instability that followed.
Today, the US dollar represents slightly less
than 60% of global FX reserves at central banks,
compared to more than 80% in the 1970s.
14Figure 2: Foreign currency reserves Focus on potential macro instabilities
Share of various currencies in % of global foreign currency reserves in the United States
When trying to assess the US dollar’s future
100%
role in the global monetary system, close
90% attention should be paid to potential
80% macroeconomic instabilities in the United
70% States. The picture in this regard is not
60% particularly comforting. Inflation has increased
50% markedly over the past 18 months, while
40% economic growth has begun to slow. The US
30% economy is thus suffering from stagflation,
20% albeit so far clearly in a much milder form than
10% during the 1970s. A “redeeming” fact is that
0% inflation in other industrial countries, not least
Germany, is currently just as high, in contrast
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
to the 1970s, when the United States was the
USD GBP EUR* RMB Other currencies negative outlier (Figure 3). Conversely, a
number of emerging markets, including China
*EUR: Includes DEM, FRF, NLG between Q1 1970 and Q4 1998, and ECU between Q1 1979
and Q4 1998. Source: Haver, IMF, Credit Suisse and other countries in non-Japan Asia and the
Gulf region, are faring significantly better in
terms of price stability. How US (and global)
inflation evolves over the medium- to longer-
Figure 3: Inflation spike after many years of calm term will depend on the actions of central
Headline inflation rate (YoY %) banks. So far, it appears to us that the Fed,
at least, is intent on bringing inflation under
30
control. Hikes in the federal funds rate have
25 been sharper than ever before, albeit from an
20
extremely low level, and market expectations for
inflation have receded considerably from their
15 peak in March 2022 (Figure 4).
10
5
0
-5
1956
1961
1966
1971
1976
1981
1986
1991
1996
2001
2006
2011
2016
2021
Inflation has
increased markedly
Germany USA China
over the past 18
Source: Haver, IMF, Credit Suisse
months, while
economic growth
Figure 4: US inflation expectations have remained anchored
Breakeven inflation, derived from TIPS (% YoY)
4 has begun to slow
3
2
1
0 That said, there may be structural factors that
make it hard to vanquish inflation. These include
-1 structural shortages in labor due to
-2 demographic change and possibly shortages of
certain commodities even if some of these
-3 shortages, such as disruptions in the supply of
1998 2001 2004 2007 2010 2013 2016 2019 2022 oil and gas, are due to the war in Ukraine and
5-year breakeven inflation 10-year breakeven inflation
should eventually abate. Similarly, shortages of
computer chips have resulted from the US-
Source: Refinitiv Datastream, Credit Suisse China trade war and pandemic-related
The Future of the Monetary System 15disruptions. All these factors have led to Figure 5: Trade has recovered from the pandemic setback…
extreme volatility and an unusually high level of Volume index for world exports, Dec 2019 = 100
uncertainty regarding the price level, which has
120
translated into high volatility for interest rates
and currencies. The latest indications are that
volatility is declining, but it is probably 100
premature to sound the all-clear as ongoing
uncertainty over the evolution of price levels in 80
major economies could harm the standing of
the US dollar and other major currencies as 60
stores of value (see Mehrling, 2019).1
40
Stagflationary forces could persist
In particular, if conflicts over trade were to further 20
escalate (see below) and, combined with supply
chain disruptions, were to impair global trade, 0
the stagflationary environment might persist. So 2000 2005 2010 2015 2020
far, however, and contrary to perceptions, we
observe that global trade has largely returned to Source: DataStream, CPB Netherlands Bureau for Economic Policy Analysis, Credit Suisse
its pre-pandemic trajectory (Figure 5), even if
the share of trade in global gross domestic
product (GDP) has declined from its peak in Figure 6: …but the share of trade in global GDP
2010 (Figure 6). The latter is most likely the (a measure of globalization) has peaked
result of slower growth in the world’s largest Sum of exports and imports of goods and services, in % of GDP
trading nation, China, as well as its turn toward
domestic demand as a growth driver, and less 65%
because of international trade conflicts. 60%
Nevertheless, the data suggest that this
measure of globalization has peaked. 55%
50%
Fed tightening regardless of high
45%
government debt?
Possibly of greatest concern is that central banks 40%
might be unable or unwilling to raise interest 35%
rates sufficiently due to the heavy burden of
government debt. Indeed, while the interest 30%
burden has so far been moderate in most 25%
advanced countries as governments were able to
20%
refinance and raise new debt at very low rates in 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
the post-GFC period (the US Treasury’s interest
expenses are currently running at around 3% of Source: Haver Analytics, Credit Suisse
GDP versus 4.6% at the peak in 1991), deficits
and debt are on an “uncomfortable” path
(Figures 7 and 8). Figure 7: Budget deficits have risen sharply in
advanced economies...
In the United States, the outsized fiscal Fiscal deficits in % of GDP, selected countries
expansions during the pandemic have caused
massive deficits, although they have stabilized 4%
considerably in the meantime. In fact, the US 2%
deficit ratio is currently similar to Germany’s and 0%
better than that of other advanced economies. -2%
Meanwhile, the fiscal position of China (which is -4%
difficult to measure due to the unclear delineation -6%
of government entities) has deteriorated sharply -8%
and is worse than that of the United States. The -10%
picture of government debt is similar: the debt -12%
ratio has been on a rising trend in the United -14%
States since the global financial crisis (GFC) -16%
and has surged as a result of the deficits in
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
1. Routledge, 2019. “The Vision of Hyman P. Minsky.” Germany Japan USA China
Journal of Economic Behavior and Organization 39 No. 2
(June 1999): 129–158. Source: Haver, IMF, Credit Suisse
16Figure 8: ...further boosting government debt the past two years, even though the latest
Gross government debt, in % of GDP data indicate some stabilization. The US debt
position is clearly worse than Germany’s. It is
300% now of similar size to a number of other
European countries such as the United
250%
Kingdom and France, but still significantly
200% better than in Japan or Italy. Meanwhile, while
China’s public debt has been worsening faster
150% than in the United States, even excluding the
debt of the many semi-governmental entities,
100%
the situation is significantly better in many
50% other emerging markets. Many Asian as well
as some Latin American governments have
0% continued to run a disciplined fiscal policy,
while oil exporters in the Gulf as well as Russia
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
have very low public debt (see Figure 9).
USA Germany Japan China However, as Zoltan Poszar, Global Head of
Money Market Analysis at Credit Suisse noted
Source: Haver, IMF, Credit Suisse during the CSRI Fall Conference, in a world
that is re-arming, the risk is that debts will rise
in many countries just as a potential trend
Figure 9: Fiscal discipline better in many emerging markets toward re-shoring as well as efforts to
Gross government debt in 2021, in % of GDP decarbonize might be adding to inflation
pressures.
Russian Federation
Saudi Arabia
United Arab Emirates The ultimate test: Willingness to
Indonesia
Turkey finance the current account deficit
Switzerland
Korea
Mexico A further indication of US domestic economic
Qatar
Thailand imbalances (i.e. of excessive spending) is the
Colombia country’s rising current account deficit (Figure 10).
South Africa
Malaysia The deficit ratio is now close to the peak of
Germany
China pre-GFC imbalances. While reserve currency
India countries “need to” run structural current account
Brazil
United Kingdom deficits in order to satisfy the global demand for
France
Spain investable assets, excessively large deficits risk
United States
Italy undermining the trust needed to preserve the status
Singapore of reserve currency (this paradox was first noted by
Greece
Japan the US-Belgian economist Robert Triffin in the late
0 100 200 300 1950s, hence the “Triffin dilemma”). With surpluses
declining sharply in Japan and the Eurozone, the US
Refinitiv Datastream, IMF, Credit Suisse (and UK) current account deficits are now largely
being financed by the surpluses in China and other
Asian emerging markets as well as the Gulf States
Figure 10: US current account deficit close to pre-GFC peak and Switzerland. Whether or not these countries
Current account balances in % of GDP will “willingly” finance the US deficit remains to be
seen. Part of the answer will be provided by
12.0 non-US central banks and their decisions about
10.0 foreign exchange reserve holdings, which we
8.0 discuss in the next chapter, but also by other
6.0 international investors.
4.0
2.0 So far, there are few signs in financial markets, at
0.0 least, that trust in the US dollar has been seriously
-2.0 undermined – since the onset of the COVID
-4.0 pandemic the US dollar has appreciated markedly
-6.0 against most major currencies (Figure 11),
-8.0 including the Chinese renminbi (RMB) (Figure 12),
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
suggesting that its historical position as a safe-
haven currency remains intact. Similarly, real yields
China Eurozone USA Japan on US Treasury bonds, another indicator of trust in
USD-denominated assets, remain moderate
Source: Haver, Credit Suisse despite the recent rise.
The Future of the Monetary System 17In sum, while macroeconomic imbalances in joined the World Trade Organization (WTO) in
the United States – the anchor currency of the 2001 has given way to intense and sometimes
dollar-centric system – are indeed considerable, aggressive rivalry between the two major powers.
it remains to be seen to what extent this will Since the Trump administration introduced tariffs
seriously undermine trust in the reserve currency. on a broad range of Chinese products in 2016,
Investors will need to monitor whether US policy US-China relations have entered a period of
makers (both the Fed and the Congress) act to tension. In the economic field, the relationship
correct these imbalances, while analysts will has also soured over issues such as the
want to monitor markets for signals that trust in protection of intellectual property and US efforts
the US dollar is being lost. One somewhat to limit Chinese access to advanced IT
“redeeming” (albeit not particularly comforting) capabilities as well as its investment in Western
factor is that many other advanced economies companies. In the sphere of geopolitics, tensions
are facing similar structural issues, suggesting over Taiwan (Chinese Taipei), the South China
that the relative position of the US dollar in an Sea and other areas have at times flared up.
international “beauty contest” of currencies is
less negative than its absolute position.
Figure 11: The USD has remained a safe-haven currency…
DXY currency index
So far, there are
130
120
few signs in 110
financial markets, 100
at least, that trust 90
in the US dollar 80
has been seriously 70
undermined 60
1990 1995 2000 2005 2010 2015 2020
Source: Bloomberg, Credit Suisse
Geopolitical conflict as a potential Figure 12: …while the RMB has lost some of its luster
pivot point? USD/RMB exchange rate
Geopolitics has played a pivotal role for monetary 8.5
systems in the past. World War II led to the
emergence of the USD-based system. The 8
creation of the euro, the most recent monetary
experiment of scale, was also strongly influenced
7.5
by geopolitical change, with the fall of the Iron
Curtain and the reunification of Germany playing
a major role. The CSRI Fall Conference 2022 7
thus debated whether the current geopolitical
context might also be a catalyst for changes in 6.5
the monetary system.
6
The end of cooperative multilateralism
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
The geopolitical environment has indeed
changed substantially since 2016. The era of
cooperative multilateralism and globalization that Source: Bloomberg, Credit Suisse
was initiated by the fall of the Berlin Wall and
intensified significantly with China’s reforms
under Deng Xiaoping and China’s ascent as the
“factory of the world” to culminate when China
18More recently, the Russia-Ukraine war has set Will mutual interest in maintaining
Russia and the West on a conflictual path. At the US-China trade prevail?
CSRI Fall Conference, former US Presidential That said, the interest of both sides in the
Advisor and independent economist, Dr. Pippa conflict to maintain trade seems very high.
Malmgren, went further to suggest that we have In the West, reliance on Chinese consumer and
already entered a “hot war in cold places” (the investment goods is still significant, while China’s
Arctic, space and on the high seas) and “cold growth continues to require Western technology
war in hot places” (Africa, South Pacific Island and still relies heavily on exports – with the
chains, etc.) and suggests that “…the trend of Chinese economy under pressure due to
multiple countries towards re-arming, re-shoring, problems in the real estate sector and, more
re-stocking and re-wiring (all comms and power short-term, due to the fallout from severe
grids) are all symptoms of reduced mutual COVID restrictions and their sudden partial
geopolitical and economic trust.” Meanwhile, relaxation, this dependency has even increased
other large emerging market countries such as in recent quarters. Moreover, there are
India, Indonesia and a number of Middle Eastern indications that negotiations to resolve disputes
and Latin American countries are maintaining over technology trade may be advancing. In sum,
distance from these dominant geopolitical the base case is that a breakdown of relations
conflicts and trying to pursue their national between the two sides is unlikely, even if an
interests in a non-aligned manner. intense geopolitical rivalry is most likely to
remain in place for a long time.
Russia-Ukraine war: Unprecedented conflict
and unprecedented monetary sanctions
With the freezing of Russia’s foreign exchange
reserves by the G7 countries, the scale of the
conflict in Ukraine has also triggered
unprecedented Western sanctions against
A trend toward a
Russia; i.e. the conflict and its potential
consequences for monetary affairs set it apart
more multipolar
from any previous post-World War II geopolitical
conflict. The question arises whether the reserve
monetary system
freeze could induce other central banks to
attempt to diversify out of the US dollar due to
is indeed visible
the potential threat of sanctions, more than they
would do otherwise. If so, such actions would,
at the margin, help undermine the dominant role
of the US dollar. Conference participants
generally agreed that the answer to the question
would depend significantly on the outcome of the
conflict and on the evolution of geopolitical This rivalry is also likely to affect the monetary
alliances in the conflict, both of which appear system to some extent. As we show in Chapter
very difficult to predict. 4, China has been at the forefront of efforts to
develop an alternative international payments
Somewhat greater clarity may exist in the other system as well as schemes to enhance mutual
more long-lasting geopolitical conflict, i.e. support by central banks in emerging markets.
between the United States and China. This Moreover, the potential for military escalation
conflict has been building over a number of cannot be ruled out. This already seems to have
years, with the imposition of significant tariffs by had a certain impact on how China manages its
the United States on China in 2016 as a first, currency reserves (see next chapter). However,
very visible step. Since then, the conflict has this in itself is not likely to lead to a major shift
shifted to the area of technology, with the out of the US dollar as the major reserve
United States as well as other Western currency. What is clear at this point is that China
countries trying to limit China’s access to the is not capable or willing to establish its own
means for producing high-tech goods, in currency, the renminbi, as a serious rival for the
particular advanced computer chips. As Dale US dollar; nor are there any other candidates for
Copeland, Professor of International Relations that role so far. That does not mean, however,
at the University of Virginia, pointed out during that the position of the US dollar will remain
the Fall Conference, this conflict is highly unchanged and unchallenged: as we discuss in
sensitive because a severe cut-off of China Chapter 4, a trend toward a more multipolar
from advanced technology would likely be seen monetary system is indeed visible. Moreover,
by China as the crossing of a “red line” which at some point in the more distant future, the
might, in turn, increase the likelihood of China ascendance of a new anchor currency similar to
taking military action against Taiwan. the US dollar can obviously not be ruled out.
The Future of the Monetary System 1920
Photo by andreygonchar, Getty Images3. Rethinking foreign
currency reserves
The weight of the US dollar in foreign exchange reserves remains an
indicator of USD “hegemony.” That said, floating exchange rates, better
macro policies and the availability of central bank swap lines reduce the
need for such reserves. Conversely, high reserves have often resulted
from central banks’ efforts to fight their currencies’ appreciation against
the US dollar. In the meantime, however, there is some evidence that
major central banks are diversifying away from the US dollar, possibly to
limit sanction risks.
In Chapter 2, we noted that foreign currency has gradually been moving toward a more
reserves denominated in US dollars and held multipolar currency system. The question is
by non-US central banks are clearly outsized whether this process will continue in a fairly
relative to the size of the US economy and its smooth manner, or whether we might see abrupt
role in international trade. That is, of course, moves in one or the other direction, indicating
typical for a global reserve currency. Figure 2 in that a structural break or pivot is underway.
Chapter 2 also shows, however, that the share
of the US dollar in global currency reserves has As we noted in Chapter 2, one of the factors
declined over the past two decades, effectively that could lead to a further sharp move out of
extending the trend that had set in during the the US dollar would be a serious weakening of
late 1970s after the de-pegging of the US US economic stability relative to other major
dollar from gold and the period of high macro economies, implying a loss of trust in the US
instability in the United States. The figure also dollar, similar to the 1970s. A second reason for
reveals three other trends. some central banks to try to rapidly shed US
dollars from their portfolios might be the threat
First, the share of euros jumps in 1999, although of further reserve freezes in the context of a
it does not increase noticeably thereafter. significant deterioration in relations between the
Second, the share of other (non-euro) currencies United States (or the West in general) and other
increases gradually, in particular after 2008 (the countries. For the moment, this appears
global financial crisis). The third and final trend is somewhat unlikely, in our view. We noted, in
the gradual increase in the share of Chinese fact, that efforts seem to be underway to
renminbi since around 2015, although its share somewhat calm the major geopolitical conflict,
remains very low; in the context of its capital i.e. between the United States and China.
controls, the People’s Bank of China (PBoC)
limits the amount that foreign central banks can Even in the absence of geopolitical and
invest in Chinese bonds. economic calamities, a further diminution of the
role of the US dollar in global foreign exchange
That said, the decline in the US dollar’s share has reserves is possible, and in fact seems rather
proceeded in a rather steady manner throughout likely, in our view, for three reasons: first,
the past two decades. In other words, the world because the need for foreign exchange reserves
The Future of the Monetary System 21diminishes in a world of floating exchange rates has evolved such that many countries, instead
as well as improving macro management; of “pre-funding” with US dollars to deal with
second, due to active diversification policies of crises, can just access US dollars “on tap”
central banks; and, third, because the increased when needed. For countries where imports are
use of swap lines between central banks sourced to a large extent from areas with
diminishes the quantity of reserves required. currencies other than the US dollar, central
banks may want to hold fewer US dollars and
instead acquire currencies of their main trading
partners. They will especially want to do so if
those currencies are structurally strong and
thus particularly expensive in periods of stress.
Conversely, if the goods traded (especially
commodities) are denominated in US dollars,
A further the reserve currency of choice will remain the
US dollar (see below).
diminution of the Second, and more fundamentally, in a world of
role of the US dollar (purely) floating exchange rates, the need for
foreign exchange reserves to “defend” the
in global foreign home currency against depreciation pressures in
principle no longer applies; countries can simply
exchange reserves let their currencies depreciate until the market
finds an equilibrium. The more credible economic
is possible, and in policy making is, the more confident policy
makers can be that extreme depreciation
fact seems rather pressures can be avoided. The recent experience
in many leading emerging economies, both in
likely, in our view Latin America and Asia, has been just that –
despite rapid policy tightening by the Fed, most
emerging market currencies have remained far
steadier than in past episodes of Fed tightening.
Nevertheless, many countries may not want to
rely fully on the rationality of foreign exchange
markets, and their central banks will thus want
Traditional reasons for holding to hold meaningful amounts of foreign exchange
reserves have diminished in a world reserves in order to smooth currency fluctuations
of floating exchange rates by means of foreign exchange market
intervention.
The traditional role of foreign exchange reserves,
namely to provide a buffer to finance a country’s Fighting appreciation pressure is a
imports, has become far less important over the key reason for reserve accumulation
past decades. Trade finance is now generally
extended by global private sector banks in both Of course, if central banks deem it necessary
importing and exporting countries, which can to intervene in foreign exchange markets to
refinance themselves in global money markets. prevent their currency from appreciating against
This implies that central bank buffers are needed the US dollar or another reserve currency, they
to a lesser extent, except in poorer developing will automatically accumulate foreign exchange
countries. Therefore, traditional “rules” by which reserves. In fact, the most important reason that
central banks were encouraged to hold a certain foreign exchange reserves have increased in
percentage of annual imports as foreign many countries, notably in China in the period of
exchange reserves are far less relevant today. rapid growth up to about 2010 or in Switzerland
That said, because some commercial and central during the euro crisis, has been their central
banks risk being cut off from the global (USD) banks’ efforts to prevent the Chinese renminbi
money market in times of crisis, a considerable (RMB) and Swiss franc (CHF) from appreciating
incentive remains to hold US dollar reserves, not against the US dollar and, in Switzerland’s case,
least because the Fed’s swap lines are not the euro.
available to all central banks.
Conversely, when appreciation pressures
For central banks that are confident they will be diminish or even reverse, these central banks
able to activate and draw on the swap lines in may want to, or have to, actively sell some of
adequate amounts during times of crisis, the their foreign exchange reserves. We would
hoarding of foreign exchange reserves is less venture to say that the decline in US dollar
imperative; indeed, the global financial system reserves at the People’s Bank of China since
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