With the dollar’s global reserve currency status eroding, could bitcoin pose a serious challenge?

For some bitcoin advocates, replacing the U.S. dollar as the global reserve currency is a lofty goal, if it can be achieved. But is it realistic?

With the dollar's global reserve currency status eroding, could bitcoin pose a serious challenge?

The U.S. dollar has been the global reserve currency since the end of World War II and the Bretton Woods Conference. Today, more than 59% of foreign bank reserves are denominated in U.S. dollars, according to the International Monetary Fund (IMF). (Note: The Bretton Woods Conference, a conference held during World War II, focused on world economic issues.)

However, the dollar’s status as a global reserve currency has recently faltered somewhat.

Last July, strategists at Goldman Sachs argued that the U.S. government’s COVID-19 response, which included a fiscal stimulus package and money printing, was triggering a “devaluation panic” that could cause the dollar to slip from its status as a global reserve currency.

With the U.S. dollar’s status as the global reserve currency potentially up for grabs for the first time in decades, bitcoin advocates have seized the opportunity to heavily promote bitcoin as a possible alternative currency.

Money Printing Leads to Devaluation
Back in December 2020, Morgan Stanley’s chief global strategist Ruchir Sharma published an op-ed in the Financial Times predicting the end of the U.S. dollar as a global reserve currency and its eventual replacement by bitcoin.

“Fearing that central banks, led by the Federal Reserve (FED), are devaluing the dollar, many have started buying bitcoin in large quantities since March.” Sharma wrote. His argument is that cautious savers are attracted to bitcoin because the supply of bitcoin is artificially limited, while the U.S. dollar and other fiat currencies have no supply constraints.

According to Erik Voorhees, CEO of digital asset trading platform ShapeShift, “Printing fiat currencies has led to devaluation. We have come to accept this, but historically, regimes that devalue local currencies tend to collapse them.”
One of the consequences of devaluation is inflation. George Selgin, director of the Center for Monetary and Financial Alternatives at the Cato Institute, a think tank, explains that an established international currency does lose ground to other currencies and may eventually lose its dominance. But, he adds, “that’s not something that’s going to happen easily; it has to become very volatile in value.”

The U.S. inflation rate last year was 1.25 percent. And according to calculations released last month by the Minneapolis Federal Reserve, there is a 33 percent chance that the U.S. inflation rate will reach more than 3 percent over the next five years. All of this gives Selgin reason to be concerned about the dollar’s long-term prospects, “but even so, it’s not certain that we’ll see double-digit growth in the medium to long term.”

He suggested that inflation in the U.S. is nowhere near Argentina’s 36% or Turkey’s 15%.

According to Selgin, “It’s when the level of inflation is high that people decide whether they should jump off the bandwagon and go into something else.”
He then adds that if the dollar collapses, the next currency people will gravitate toward won’t be bitcoin, but other fiat currencies. That’s because they are highly liquid, which is what matters most in global transactions.

However, Sharma’s argument for bitcoin as a reserve currency isn’t just based on the devaluation triggered by printing money. Cryptocurrencies also need to act as a useful medium of exchange.

He writes, “Smaller businesses are starting to use bitcoin in international trade, especially in countries where the U.S. dollar is hard to come by (such as Nigeria) or where the local currency is unstable (Argentina).”
But can Bitcoin pose a serious challenge to the use of the U.S. dollar as a global medium of exchange?

“The huge liquidity and network effects of the dollar are the biggest headwinds to bitcoin’s rise,” Voorhees said. At the same time, he notes, bitcoin’s market cap has risen from zero to trillions of dollars in the past 10 years. Over time, bitcoin is gaining a network effect of its own.

Bitcoin’s whopping $827 billion market cap seems shocking. After all, as of March 2021, the global circulation of the U.S. dollar is $2 trillion, slightly higher than the Euro, which is $1.43 trillion.

But these numbers don’t exactly provide a side-by-side comparison. The dollar and the euro are actively used in everyday transactions – unlike bitcoin, which may be employed in certain isolated situations. A report released by Deutsche Bank (Deutsche Bank) in March 2021 noted that the average daily volume of bitcoin transactions is about 500 million, equivalent to 0.02% of euro transactions and 0.009% of U.S. dollar transactions.

According to the report, “Bitcoin’s liquidity is closer to that of the Thai baht.”
And while the Thai baht is not a contender for global reserve currency status, it is also not a competitor to bitcoin. If “international trading” is a requirement for reserve currency status, then Bitcoin doesn’t stand much of a chance of winning, at least for the foreseeable future.

Institutional Holdings
The reserve currency status is not just down to its use as a medium of exchange, but can also be understood in terms of the assets held by global financial institutions.

Sharma mentioned that the U.S. dollar is “the anchor point for other countries to value their currencies,” which has been the case since the Bretton Woods era.
Voorhees said, “Anchor is an appropriate descriptor, but since it broke away from gold in 1971, the dollar has been purely legal tender.” Bitcoin, he argues, will likewise gain the status of a reserve asset because it is scarce, immutable and apolitical.

There is no doubt that for now, the U.S. dollar remains comfortably in that dominant position. In the last quarter of 2020, central banks of 149 countries held $7 trillion, or 59 percent of all allocated foreign exchange reserves, followed by the euro with a 21 percent share and the yuan with 2.25 percent.

“Central banks hold a wide range of assets. But that doesn’t mean a currency like the yuan can pose a threat to the dollar’s position simply because it’s part of a central bank’s portfolio.” Selgin said, “That’s true of gold, and it’s true of bitcoin.”
Erik Voorhees counters that central banks shouldn’t be the measuring stick. That’s because there are many other financial institutions. He adds, “Central banks may be the last institution to acquire bitcoin, and they will only do so when their dominance becomes apparent.”

Jeff Miron, a senior lecturer in economics at Harvard University, said nothing can tie up the value of bitcoin. “It’s worth whatever the market thinks it’s worth, unless Bitcoin somehow succeeds in becoming a dominant means of payment.”
But Bitcoin is unlikely to become a dominant means of payment, Miron explains, because the ubiquity of government in economic activity (not just taxing, but also spending) makes the official method of payment “the most natural default in most other transactions.”

“Governments want to control how payments are made in their economies, so they can make it difficult for any new methods to emerge through regulation.” Miron added. And governments have no incentive to allow non-national currencies (bitcoin) to replace their national currencies as legal tender.

In his first speech to the U.K. Parliament in 2010, Steve Baker, a Conservative MP from Wycombe, noted that “the Bank of England controls the price, quantity and quality of money.” He asked other MPs, “If money is a product of the state, we should ask ourselves: is this a good idea?”

Baker said, “In a hypothetical world, I would expect the market economy to choose commodity currencies as it has done in the past.” He firmly believes that the most likely future is a “technology-supported” currency, even if it’s not necessarily Bitcoin.
If it does happen ……

Selgin explained that the loss of the dollar’s reserve currency status could unilaterally reduce the welfare of Americans. “Look at our debt, we’d be in big trouble.”

But Bitcoin advocates argue that this is a short-term pain that will pay off in the long run.

As Voorhees puts it, “Unlike the dollar, bitcoin is neither a burden nor a privilege for a country.”

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/with-the-dollars-global-reserve-currency-status-eroding-could-bitcoin-pose-a-serious-challenge/
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