The Future of the U.S. Dollar

Panelists discuss the post-COVID-19 role of the U.S. dollar, options for alternative currencies, and the impact of U.S. economic and foreign policy on both.

TYSON: Welcome, everyone, to today’s Council on Foreign Relations meeting on “The Future of the U.S. Dollar.” We have a very distinguished panel, and we have a very limited amount of time. I’m Laura Tyson—I’m a professor at the Haas School of Business at the University of California, Berkeley. We have more than five hundred members who are online for this exciting and important conversation. So without further ado, I want to make sure that everyone knows the panelists and then to open a question to all of them. So we have with us Eswar Prasad, he’s professor at Cornell University and a senior fellow at the Brookings Institution. We have Carmen Reinhart, who is the vice president and chief economist of the World Bank. And we have Benn Steil, who’s a senior fellow and director of international economics at the Council on Foreign Relations. So great panel, and I want to start the conversation with a general question to all, that is, is the dollar’s status as the dominant global currency now under threat? If so, why does it matter? If so, what are the causes? If so, what are the remedies? All of our panel members have thought about this very serious set of questions. And I’m going to go in alphabetical order to begin the conversation, so I’m going to turn it over to Eswar Prasad. Eswar?

PRASAD: Thank you, Laura. As with most important questions in economics, the answer to your question is “it depends.” It depends to a significant extent on what exactly one views as the important roles of the dollar in international financial markets. Now as a unit of account and as a medium of exchange, that is, as a currency that is used to denominate trade or financial transactions, or for payments and settlements purposes, one can very well see the dollar’s role possibly giving way to other currencies. There was a period about three or four years ago when, in fact, the euro had become the dominant payment currency in the world, although that’s again reversed and the dollar is once again the dominant payment currency.

But there are reasons why one might expect other currencies—the Chinese renminbi—perhaps even other emerging market currencies to start playing a bigger role in terms of international trade transactions. However, when we think about the dollar’s preeminence as the reserve currency, that is its role as a store of value, we enter very different territory. The dollar has, despite the fact that the global financial crisis began in the U.S., despite the fact that the U.S. has been taking a pretty big hit during the pandemic-induced recession. It doesn’t seem like there is much of an alternative to the U.S. dollar. At times of turmoil in global financial markets, investors want safety. And it turns out there is really only one currency that affords the kind of safety that international investors seem to want, and that is the U.S. dollar.

Now, this does not necessarily mean that the U.S. is going to be as dominant in terms of the global economy, as it has been in the past, China is fast catching up. But in terms of the depth and breadth of its financial markets, that is the amount of foreign assets that investors have access to and the amount of trading that goes on in those markets, and the institutional framework that supports the currency, it is hard to envision a rival to the dollar. Now there has been some notion that there are other currencies such as the renminbi nipping on the dollar’s heels. What we’ve seen in the last few years is actually something interesting that there has been a rejiggering of the relative importance of the second-tier currencies in which I would include the euro. So the dollar’s position remains as dominant as ever as a reserve currency. I don’t see that changing in the foreseeable future.

TYSON: Okay, thank you. So Dr. Reinhart, do you agree, have different insights you want to bring to this? Are you surprised by the fact that in fact, as Eswar said, events seem to have stabilized it somewhat? So Dr. Reinhart?

REINHART: So, it’s actually hard to disagree with what, you know, 99.9 percent of what Eswar has just outlined. Let me start out by putting a little backdrop in terms of the historical role of the dollar. And its, you know, its dominance. I’m not a giving history lesson, but very quickly, its prominence was established and anchored in Bretton Woods. And after the breakdown in Bretton Woods for a variety of reasons, it lost ground and it lost ground through the ’80s. You know, apart from the prominence of the Deutsche mark during that time, there was also the ruble block. This is relevant for today’s discussion, because what could one say about a parallel renminbi block? So, it’s had in its post-war trajectory, it’s had, you know, troughs and peaks. And right now, as Eswar highlighted, you know, defying expectations in some dimensions given that, you know, the surge in the share of global GDP that China has, the dollar is close to or at its peak as a global reserve currency, and that is not just as a reserve currency of what central banks hold, it’s what currency the developing world denominates its debt in. It’s also what role it plays in exchange rate policies, who, you know, what currency do emerging markets anchor their currency to and by all those metrics, the dollar really is going strong. I am skeptical of the belief that a replacement for the dollar is around the corner. For starters, financial institutions and investors don’t hold dollars, they hold greenbacks, they hold debt, and the liquidity, the depth, of the U.S. Treasury market at the moment is unparalleled.

And one of the reasons, there are others, but one of the reasons why the dollar surge vis-a-vis, say the euro in the post-2008 crisis landscape was that pre-crisis, pre-2008 global financial crisis, the perception for better or worse, was that there was a euro and there was a euro market sovereign debt. After the crisis, it became clear that there wasn’t a euro-fixed income market in anything resembling homogeneity, that Greek debt was a very different animal from German debt and German debt was very different from Irish debt and so on and so forth. So, in terms of the mechanics of the global financial architecture, the euro is fragmented in a way that stands in contrast to the very unparallel Treasury market.

Now, the renminbi is an interesting one because up until about 2015, the view was that the renminbi was going to gain ground and the perception that China’s rise in the real side of the economy would be matched by a rise in the financial dominance as well. Interesting, you know, I have done quite a bit of research on China’s overseas lending, primarily to developing countries and mostly low-income countries. Now, the overwhelming majority of that lending is denominated in dollars also. So unlike the, I alluded to the ruble block, historically, in which the internal transactions of Eastern Europe and the ruble block were indeed rubles. You know, China, just to put it in perspective, is the largest official creditor is bigger than all the Paris Club creditors combined. And those debts, those transactions are mostly dollar denominated, so we can debate the medium-term outlook, and what are some of the warning signs that one may look to, to see that, you know, receding in prominence, but over the near-term, this is as to the, you know, the issues that Eswar has already alluded to, it’s hard to see a competitor. Let me stop there.

TYSON: Great, thanks. So Benn, I know that we’ve talked about the RMB as a challenger, and so we’re hearing here that maybe a few years ago it looked like the RMB might be but clearly has not developed so far, what do you think about the future, the medium-term—I would also link that to COVID, does COVID in any way change your view of the medium-term of the outlook?

STEIL: Let’s start with COVID. COVID, I think has been largely a non-event in terms of the international position of the dollar, and that’s because the Fed handled the surge in international demand for dollars very well. Now, you remember there was this mad scramble period back in mid-March, where everyone was desperately scrambling for dollars and it took the Fed quite a while to get its bearings. The Fed bought up a record $450 billion of Treasuries from investors at the time, but I think they handled the surge in international demand actually much better than they handled the initial surge and domestic demand. By the end of March, the Fed had extended currency swap arrangements to fifteen central banks overseas. Five had permanent swap access, they added nine on an emergency basis, and in the first few weeks of April, they extended nearly half a trillion dollars of loans to foreign central banks through currency swaps. Furthermore, although this hasn’t gotten much attention, about 170 more central banks around the world have access to Fed lending facilities using U.S. Treasuries as collateral. So I think the Fed did an extremely competent job on the international front using 2007 as a template. In 2007, I think that, you know, the Fed was largely improvising, but they had that playbook, they dusted it off, and they handled it well.

Now, looking out to the future focusing on the RMB, I remember vividly this front-page article in the Economist back in 2014, saying that the internationalization of the RMB was “remorseless and unstoppable.” It was almost impeccable timing because less than a year after the article came out, the internationalization of the RMB went into sharp reverse. In 2015, the RMB hit its peak, in terms of its percentage of global payments, it had reached 2.8 percent. Within three years, that was back down to about 1.6 percent. Right now, it’s about 1.8 percent. It’s been pretty stable as a percentage of total central bank foreign exchange reserves at about 2 percent. So what happened? My reading is that the idea of internationalization was never really clear, it wasn’t that people were scrambling for RMB because they wanted to use it for international payments. From 2005 to 2013, the RMB was steadily and consistently appreciating, almost month by month. And as we know, the People’s Bank of China was slowing down that appreciation. But buying RMB during that period was seen as a one-way bet. So there were massive speculative flows going into the RMB. After 2014, that stopped. And as you know, since then, the PBOC has at times had to intervene to keep the RMB up. Once those speculative inflows stopped, the internationalization of the RMB went into shock reverse, and there are actually no signs that we’re seeing the RMB emerge as any sort of competitor to the U.S. dollar.

TYSON: So, Carmen mentioned the idea of a block. So one possibility is the RMB becomes increasingly important in a trading bloc that China dominates. I wanted to get your sense of that. And also, I know that Eswar talked about the rise of the digital currency, the central bank digital currency in China, and could that change things? So Carmen, why is it the case that one could not have—I don’t know why is China lending in dollars and why would it not develop over time an RMB-focused block around its own trade and financial transaction? And I’ll now go to Eswar to just sort of think about digital currency here.

REINHART: So this really goes to the heart of the point that Benn was making, you know, you had a period in which China was growing at double digits, its currency was really a one-way bet, it was steadily appreciating and during that capital inflow—big capital inflow phase—the idea of financial liberalization also took more root, you know, concerns about capital flight were not anywhere in the cart until 2015. And, you know, August 2015, you had a small by almost any metric depreciation, you know, of the RMB that was taken as a signal of a turning point. The outcome of that was a tightening of capital controls, specifically controls on outflows. You know, for a global reserve currency, capital controls, you know, as Rudy Dornbusch used to say, you went to a party because you knew you could leave at any time you wanted, if not, you wouldn’t go. And that was a big turning point. Now, this is entirely speculative. We could be at a conjuncture, they have once again moved to liberalize some inflows into there, in effect there have been, you know, big bond flows very recently as a result of liberalization that, you know, there is some, you know, some comeback in that dimension. But, you know, for global financial transactions, a convertibility is still, you know, and capital controls are still major hurdles.

Now, what about the central bank digital currency? Well, it faces some of the very same issues. Right? Now, it is true that, you know, China’s bilateral lending to low-income countries, which you know, soared especially during a period of rapid growth where they needed a lot of commodities—they were big buyers of commodities. And also, without derailing the conversation, but you know, the recipient countries, the low-income commodity exporters had relatively clean balance sheets at the time because of the HIPC [Heavily Indebted Poor Countries] Initiative. They’re debt write-offs, and so they look like an attractive, you know, venue for lending.

Post-COVID, it will be questionable or highly suspect whether those countries remain an important destination for Chinese outward flows. And having said that, you know, this connects to your question about central bank digital currency—could China in these bilateral agreements denominate some of its debt in RMB or in the newer central bank digital currency, yes, but why would it do that? It’s really not at all clear. I’d like to conclude though on, you know, the point that we may be seeing if the divergence, say, between China’s growth and U.S. growth goes in the direction that we’ve been seeing recently given that China got its pandemic house in order sooner than the rest of the world, we may be seeing a period of renewed inflows. But that’s a different cyclical, if you will, or you know, rather than some of the structural issues we’ve been discussing here.

TYSON: Right. So Eswar, you’ve written about the rise of the digital central bank currency in China. So I’d like your views on whether that strengthens the outlook of the RMB. And then also, maybe we can make this the transition in your comments to well why should we care? What are we doing in the United States that could weaken the U.S. currency? And as we do that, what are the dangers to the U.S.? So let me turn to Eswar.

PRASAD: Before I answer your set of questions, Laura, I should say that a lot of what I know in international finance, I’ve learned from talking to Carmen and from her writings, so I’m really eager to hear what 0.1 percent of my initial remarks she does not agree with because I’m sure we’d learn a lot from that.

On the China issue, I think it’s worth keeping in mind that as both Benn and Carmen have pointed out, the initial promise of the currency does not seem to have been borne out. And I think it really comes down to credibility, the Chinese government has committed to keeping the capital account open, that is to allowing free flows of capital both into and out of the Chinese economy, and to moving towards a market-determined exchange rate where the People’s Bank of China, the central bank, does not intervene extensively to control the exchange rate’s value. Neither of these commitments seems to be completely ironclad. As Carmen pointed out, when pressures on the capital account started building up with a lot of capital outflows in 2015 and 2016, China did return to the old playbook of using capital controls. So at the moment, we do have a fair bit of capital flowing into China, because China does provide a lot of opportunities to investors for better yield, better diversification. But I think a lot of money that is going in is really passive money because China is becoming included in stock and bond fund indexes around the world. But the sort of flows one might expect, given that China has now thrown open its doors, especially its corporate and government bond markets to foreign investors and largely its stock markets as well, we don’t see that many inflows and I think this credibility is an issue.

That comes to the broader point that connects what is keeping down the Chinese renminbi and what is keeping up the U.S. dollar, which I really think comes down to the institutional framework, and that has some critical elements. So if you think about not just a reserve currency, but a safe-haven currency, one that investors around the world turn to at troubled times, you need certain institutional elements such as an independent central bank, you need the rule of law, such that even the government has to play by the rules that have been set, you may or may not like the rules, but even the government is bound by them, and you need an institutionalized checks and balances system. China doesn’t quite have this institutional framework. Now one can certainly make the argument that in the last four years, in particular, every element of the institutional framework that I mentioned, has been undercut in the U.S. The rule of law isn’t quite what it was, the independence of the Fed, again, has been challenged, and the checks and balances don’t seem to be working terribly well. But in international finance, ultimately, it’s all relative.

So if you put together this combination of institutional framework, and one hopes that the checks and balances will work in the U.S., if you put together and, what Carmen referred to, the enormous depth of U.S. fixed-income markets especially the Treasury securities market and the liquidity in those markets, there really is no alternative. So does this matter for the U.S.? Does it matter for the world? In the lead up to the global financial crisis the concern was that this dominance of the dollar was letting the U.S. basically get away with running very large current account deficits, borrowing from the rest of the world very cheaply, and that this was creating imbalances in the global capital flows. Those imbalances did peter away a little bit after the global financial crisis, but they have come back up and certainly the level of debt to the U.S. is accumulating to the rest of the world even though that may be somewhat overstated in official measures, but it’s still a large amount. That is a potential problem. But the question again becomes if there is no alternative, if one cannot think about a better system, maybe having a unipolar world is not the best of all possible worlds, but among the available worlds, it may not be such a bad one.

TYSON: So Benn, you’ve written about the role of the frequent use of U.S. financial economic sanctions as something that leads to questions around the world of reliance on the dollar since basically the U.S. seems willing then to intervene in financial markets and pose economic sanctions in a way which other countries may not want to do. Do you think that looking forward—that’s related I think to Eswar’s point that the institutional framework has been weakened somewhat in the U.S.—what do you think are the main things that the U.S. can do to shore up its role as the global currency provider?

STEIL: Let me just briefly address the China question and then I’ll move into the U.S. question. First in terms of the Chinese government’s efforts to internationalize the RMB, there’s a long-term perspective and there’s a short-term perspective and they clash. Long term there’s no doubt that the Chinese government likes the idea of RMB internationalization and is taking steps to push it forward. But in the short term, there are many things pushing against that. First of all, international transactions outside of China, still overwhelmingly denominated in dollars, so a lot of Belt and Road financing from China is not only in dollars when it’s in RMB, it often gets swapped into dollars. So there’s, you know, there’s little that China can do in the short run. Secondly, China itself is conflicted, because in a crisis like we’re going through right now, capital flows are volatile, China often wants to encourage dollar inflows because it needs dollars. So in the short term we can expect China periodically to take actions that are going to push against the internationalization of the RMB.

With regard to the digital currency, I see that as having overwhelmingly domestic political and economic significance, not international significance. It will reinforce the power of the CCP over domestic financial transactions and weaken the power of private and state-owned financial institutions in the country, and it will push to reinforce CCP control over social interactions. For example, the social credit system, to the extent that the government is controlling, in essence, all financial transactions, it can use access to that system as a very powerful tool to compel people to behave in one way and not another. So I see that significance being overwhelmingly domestic.

With regard to the U.S., you and I have discussed this before, I think the biggest threat to the continued dominance of the U.S. dollar internationally is the behavior of the United States. Over the past decade, in particular, we’ve used financial markets and sanctions increasingly aggressively for understandable reasons. They’re a very powerful tool to compel nations to behave in certain ways and not others because nations need access to U.S. dollars in order to conduct any sort of international financial transactions. The problem is that the more you use this aggressive tool, the more we can expect the rest of the world to adapt to it, to find alternative mechanisms. It’s just like the overuse of antibiotics for treating specific types of bacterial infection. Antibiotics can be very powerful, but if they’re overused, you expect the bacteria to mutate and to become resistant to the antibiotic, and then you have to develop new antibiotics. And indeed, we are seeing the world beginning to develop new antibiotics against U.S. financial sanctions. In particular, Iran, as you know, has given the European Union enormous impetus to begin developing an alternative international payments system that will not involve any role for the U.S. dollar-based payments system. It’s still embryonic, but again the more we continue to use this tool in ways that the rest of the world finds offensive, the more we can expect the world to invest in alternatives that could ultimately over time begin whittling down the influence of the U.S. dollar internationally.

TYSON: It’s time to turn to the audience, but I want to take a moment to ask Carmen a question because it’s something that hasn’t come up here. So Carmen, you have written extensively on how countries can become over indebted, the debt-to-GDP ratio, the fact that a country can lose fiscal space by losing confidence. So the U.S. fiscal outlook has seriously deteriorated over the next decade clearly, and yet, we continue to see purchases of U.S. assets, federal government assets, and we continue to see very low borrowing rates. Are you concerned about the deficit outlooks for the United States and the implications for the dollar? And then I’ll turn it over to the members at that point.

REINHART: So, first of all, I want to clarify—Eswar I didn’t say 100 percent because it doesn’t look good. You know, it doesn’t look good in these things. It’s—

TYSON: (Laughs.)

REINHART: —So, the answer is yes, I am concerned and it is unclear over what horizon that plays out, okay. Before I launch into that, let me add one more thought on why the issue of what currency is dominant is important. Historically geopolitically, the correlation between dominant powers and dominant currencies is compelling. I mean, you know, during the colonial, you know, Spanish period it was Spanish silver that you would find in Asia and everywhere else. You know, we had the UK in its heyday, you know, the Dutch somewhere in between a little bit. And so those correlates are indicative of a much broader range of geopolitical issues, as well as economic ones. Now, what is the concern? I think the concern is, and this has been flagged in some recent academic papers by Helene Rey, by Maury Obstfel, sort of what is a modern-day Triffin dilemma look like.

Let me translate that into the English language for a moment, you know, you recall that, you know, at the tail end of Bretton Woods, you know, we were still linked to gold, you know, so there was a gold content to the dollar and the U.S. was financing the Vietnam War, and there was great demand for dollar debt. And the U.S. because of its own involvement in Vietnam and other issues supplied that debt. However, the backing by gold shrank relative to the amount of debt outstanding, the amount of debt outstanding was meeting the global demand, and the outcome was, you know, the breakdown of Bretton Woods, a big depreciation against the dollar, big depreciation against the dollar, versus the Deutsche mark and a period in which the dollar did not lose dominance, but it went through a very wobbly phase.

So given that we’re not connected to gold, why bring up the modern version of the Triffin dilemma, is the rest of the world wants less debt, wants to hold dollar-denominated debt. But in so supplying the external demand for debt, it begins to hit up against its own domestic objective of debt sustainability, and the backing here is not gold, it is goods and services, it is the size of the U.S. economy in the global context. If you look at the last 50–60 years, especially in the last twenty, the U.S. share of global GDP has been on a downtrend. So the combination of debt as a rising share of global GDP to meet the demand from abroad and a shrinking share of global GDP, not as rapidly shrinking as Europe’s, but nonetheless shrinking, can give rise to the Triffin dilemma which, you know, could undermine at some point. And that’s the million-dollar question, which I won’t tackle with a ten-foot pole, what that moment, that turning point, when that might be because I would recall that the U.S. hasn’t been alone in accumulating a lot of debt during, you know, the recent past.

TYSON: Okay, so I’ve already taken time from the members and I apologize for that. I want to point out that in the last remark, one of the things we could talk about and maybe members might be interested in, when we’re talking about the global status of the dollar, it’s not inconsistent with, as you pointed out, a significant depreciation of the dollar at a certain point. I mean the dollar could remain the global currency, but its value might actually at a certain point undergo some significant adjustment. Let me turn to the members. And a reminder that this is all on the record. And the way this will be handled is there’s someone at the Council who will recognize a question and direct it either to a particular panelist or to the panel overall. So let me turn it over and see if there are questions from the members.

STAFF: (Gives queuing instructions.) We will take the first question from Fred Hochberg.

Q: Thank you, this is great. I get a mixed message here. To what extent is the sanctions we’ve done with Iran and others sort of a theoretical threat or real threat to the dollar? It’s not clear from—maybe there may be three different opinions—and if it is a real threat, how do we explain that to American voters that this is important and therefore impacts them directly? Because I think it feels like too much of a theoretical or elite argument and not something that everyday voters and everyday even businesspeople have an understanding of.

TYSON: So Benn, you’ve actually written about the importance of these sanctions. Maybe what you might want to talk about is have they had an effect so far, or will they undermine going forward, because you’ve mentioned that the rest of the world is looking for alternatives? We’ve encouraged them to look for alternatives.

STEIL: Well, if the EU succeeded in building a credible infrastructure for international payments, that quarantines the U.S. financial system. That would most likely encourage more international transactions to be done in Europe. So that’s one possibility, but I should also emphasize to make it more practical, which is what Fred’s asked for, to give you an example of ways in which we have over the past two decades, in fact, tried to apply financial market sanctions in ways that are totally counterproductive in terms of our purposes. For example, one of the things I’ve written about is so-called capital market sanctions, which went into hiatus for a long period but is now coming back again as a very, very popular way to bludgeon China. In other words, to try to stop Chinese companies from raising capital in the United States. I wrote extensively about that twenty years ago, so I was surprised to see how it has come back. And here’s the problem, Chinese companies typically list domestically or in Hong Kong first and then they come to the U.S. markets—Nasdaq or the New York Stock Exchange. And they’re mostly using that as number one, a branding tool. But there are alternative branding tools to listing on a U.S. exchange and the second, to acquire retail order flow. In other words, retail participation in the stock, which is again is primarily a branding tool because overwhelmingly stock investment, particularly in this country, is institutional.

So two decades ago, I had looked at a major capital market sanctions campaign against Petro China, which a number of prominent congressmen were trying to stop from listing on the New York Stock Exchange. Now Petro China was also listed in Hong Kong, so I investigated. I first had meetings with large institutional investors to find out if they were investors in Petro China—they did, Petro China was eventually allowed to list on the New York Stock Exchange—to find out where they bought it. And overwhelmingly they told me they bought it in Hong Kong, they would not buy the shares in New York. Why? Because that’s where they were liquid. I found that the biggest international investor in Petro China’s shares was Warren Buffett. So I investigated—where did Warren Buffett buy his shares? 95 percent of the shares he bought in Petro China were bought through Hong Kong, not through the New York Stock Exchange. So to the extent that we are successful in stopping Chinese companies from listing in the United States, we will encourage American institutional investors to go to China to buy those shares where their transparency, of course, will be considerably less, and they will be able to buy them in alternative currencies like RMB or Hong Kong dollars or something else, non-dollar alternatives. So we’re actually promoting less transparency in terms of the behavior of these Chinese companies, and we are encouraging American institutions to go abroad to bypass our own system in order to participate in this financing. So we need to think in a more sophisticated way about how we use this tool.

TYSON: So I will go to another question. But I would just want to do an “unless” to what you just said. Unless another administration sometime in the future decides not just to prohibit purchases of certain products from China, that prohibit—

STEIL: That’s right.

TYSON: —institutional investors in the United States from investing in those companies. And I added within the realm of at least I’m sure configuration of some.

STEIL: That can happen. I would just point out that those institutions have international businesses. Of course they can simply redomicile their investments to London or to Paris or to Amsterdam or to Dublin. It’s very difficult in an environment of mobile international [inaudible].

TYSON: Very difficult. Okay, how about the next question because I do want to give some more members an opportunity. So we have another question.

STAFF: We will take the next question from Tara Hariharan.

Q: Thank you so much. My name is Tara Hariharan. I work for a hedge fund based in New York. And my question is actually a direct extension of the previous question. I just wanted to drill down further on the sanctions issue. So how do you all weigh the risks near-term of the U.S. effectively cutting off Chinese financial institutions’ access to the global dollar payment system, because the Chinese media has been mentioning this risk quite often nowadays. And we’ve even been hearing that systemically important banks in China and Hong Kong are preparing for such a contingency. So how likely do you think this is? I mean, it is a nuclear option, but how likely? And does China have the resources and capacity to be able to weather that kind of situation? Thank you.

TYSON: Thank you. So Carmen, I’ll start with you there and ask if there are any historical analogies as well to this notion of trying to control those kinds of capital flows for geopolitical reasons.

REINHART: So let me flag two recent examples where I think even with sanctions, you run into the problem of lack of alternatives or limited alternatives, okay. Russia, you know, we know that if you look at Russia—one of the things Russia has done to try to move away from the dollar is more reserves are held in the form of gold. Okay, that is one alternative. Again, and this is not just Russia, we also see that in China to some degree but that is a market that also, you know, has its liquidity limitation.

TYSON: Liquidity problems.

REINHART: Another thing that China has done, for example, in recent years, in trying to wean itself from having had almost its entire stock of international reserves in dollars. And this is not in the context of sanctions, but as we all know in the context of the trade frictions and trade war that we’ve seen in recent years, it shifted more to other alternatives. One, we’ve seen China’s holdings of JGB bonds skyrocket, okay. Certainly, there’s no lack of those. But, you know, that is one venue. But another venue that they explored is a lot iffier at the moment, they also started diversifying much more into emerging market debt in their reserve holdings. At the moment that does look like an awfully risky proposition and what I’m getting at, and I take Benn’s point full stop that if you use the same weapon time and time again people are going to find alternatives. But I do want to hark back to the point that whether it’s China or Russia or any other case, the alternatives at the moment are still, you know, can only give you limited diversification because we also initially when U.S. rates started to plummet, I’m not talking about COVID, I’m talking about the global financial crisis once a well, you know, U.S. fixed income looks less attractive, right? But this meant simply a shift from U.S. fixed income to U.S. equity. We saw that in, you know, sovereign wealth funds and so on that there was a reshuffling but still within the so-called dollar block.

TYSON: Eswar, you’ve sort of started your comments with “it’s all relative,” do you see, and you also have talked in your work about going into more international payments, how would you answer the question that our member raised—Tara—what are the options here for the system to respond if the U.S. is trying to move people out of U.S. capital markets?

PRASAD: So let me first supplement Carmen’s important point. I think there are alternatives out there as reserve assets. But if you think about the providers of net reserve assets, countries that are willing to provide safe assets to the rest of the world and not shun those, that’s really just the U.S. The Swiss, the Japanese, the Europeans don’t want safe-haven inflows coming into their economies because that causes their exchange rates to appreciate and their economies are not willing to tolerate that. So it’s really the U.S. as a net provider of safe assets that remains, that has become even more dominant in some ways.

But there is an important game changer on the horizon. It’s not China’s digital currency. Most international payments are already digital, and as both Benn and Carmen have pointed out, the digital currency for electronic payments of China’s [inaudible] is meant for domestic use. What is the game changer is China’s Cross-Border Interbank Payments System, the CIPS. That is a part of an important aspect that Benn alluded to, the notion that there are countries around the world, that at this stage, are tired of U.S. sanctions, not only direct sanctions imposed against geopolitical rivals of the U.S., but indirect sanctions so that European firms, Chinese firms that engage in any form of business with companies and those countries are on the U.S.’s sanctions list, get sanctioned, and this throws a very broad net. So now you have a situation where China’s Cross-Border Interbank Payments System can, in principle, talk to other countries’ payments system, once it gets to the European payment system, so you could have a lot more payments being channeled through these alternative payments systems that bypasses the dollar-based financial system. So I think they’re going to see a bit of a bifurcation with the dollar’s role, especially if the U.S. continues using this bludgeon, the dollar’s role as a payments currency declining. But as a reserve currency, I don’t think any of this is going to make the least difference.

TYSON: Thank you. That’s, I think, a really important observation which was clearly implied by the panelists, but I think it’s important to underscore. I think we have time for a couple more questions. So next question, please.

STAFF: We will take the next question from Teresa Barger.

Q: Hi, thank you. So I just wanted to raise my hand earlier, I just wanted to go back to this capital markets nationalism, and I’m interested that Benn had already done work on it. Just today we had a Chinese company that’s an ADR listed in the U.S., announced that Goldman Sachs and Morgan Stanley were going to arrange its new listing in Hong Kong and it went up 13 percent. And I don’t think that this is a matter of waiting for an administration to change because there was an unanimous vote in the Senate for the “Holding [Foreign] Companies Accountable Act” that basically gave companies three years to cure the fact that the U.S. couldn’t audit the auditors. But when the secretary of state wrote to universities, he said, “Hey, you’ve got two years,” because he was referring to what might be an executive action on it. So I think there’s a bipartisan push here, and I’m just wondering, especially maybe Benn’s crystal ball, if $1.8 trillion of ADRs leave the U.S., go into China, some of those will list both in Shanghai and Hong Kong. And then, you know, to the extent that Hong Kong is not independent and gets more and more drawn into China where erosion of the rule of law follows things like the very bad enforcement of corporate governance. Then are we really speeding up this plan that China had to become the second most powerful capital markets force in the world, but with this major blockage they have which is capital controls and a controlled currency? Where does that go?

TYSON: So Benn, I think that’s directed largely to you to follow up with.

STEIL: Yes, with regard to Shanghai and Hong Kong, I had again twenty years ago seen them as being indistinguishable in the long term, because the Chinese government was eventually going to determine that one or the other, for political reasons, was going to be the international hub. And there was no reason why it had to be Hong Kong anymore. And, of course, now that Hong Kong has been totally absorbed into the Chinese legal system, there really isn’t any compelling reason to give it space in the international arena. Shanghai and Hong Kong already have an electronic interconnection that can at almost a moment’s notice be transformed into a complete merger. So we need to understand, first of all, that when we talk about equity markets, for example, being located in different national jurisdictions, these aren’t geographical distinctions anymore. These are pure legal distinctions. An institutional investor in the United States doesn’t have to go anywhere to trade abroad, it’s simply a different window on the screen. That window, of course, that separate window represents an entirely different legal and political infrastructure, but it is still remarkably easy for investors to switch their jurisdictions as the rule base changes.

So I do believe that the Chinese government is actually welcoming this aspect of American decoupling policy, because they know perfectly well that U.S. institutions who dominate our equity markets don’t give a damn about whether the security is available on the New York Stock Exchange or Nasdaq. They’re going to go where the security is most liquid, and as you yourself pointed out, Laura, we could eventually, and this is the way sanctions always work, right? It’s whack-a-mole, okay. We can go after the institutions and say, aha, you institutions can’t go abroad to invest anymore. And guess what, within a few months they’re Dublin-based financial institutions, they’re no longer American institutions. So really, I think we have to take a deep breath and ask ourselves what it is we’re trying to accomplish, and whether a capital market sanctions are really helping us get towards our geostrategic goals, or whether they’re impeding the achievement of these goals.

TYSON: So I believe we may have time for one more quick question and I’d like to try to do that. So let’s see. Do we have one other question we can end with?

STAFF: We will take our last question from Anders Aslund.

Q: Thank you very much. I wanted to follow up on a Laura Tyson’s last question to Carmen about debt. You are traditionally a fiscal conservative, and you recently written a couple of articles warning for the big debt burden in the world. Now the IMF came out and said, “Take more debt, invest in infrastructure, the interest rates are so low now.” How do you balance this? Thank you for your good presentations.

TYSON: Great, Carmen to you.

REINHART: So, one tiny follow up on the previous discussion, I wanted to say that the very relevant literature to that discussion is an old literature on financial transactions taxes, in which every time an equity market introduced the transactions tax, what you would see as diversion, and in effect, mark the end of the Osaka Exchange in favor of other regional alternatives and so on, so it’s very germane to that.

Now turning to Anders’s question. So I think the view that I’ve expressed on the current situation is that we are at—Anders—we’re in the middle of war, okay, so, you know, you first worry about winning the war, and then you worry about how you pay for the war. Now, you know, the timeline of course, is very different across countries, I think, you know, the emerging market, the low income, the emerging market prices is very much at the very, you know, close end. And so, you know, how do you reconcile? You reconcile that at the moment—I’m not talking about fixed investment in terms of, you know, this is the time to engage in grandiose, you know, infrastructure investments and other investment—but certainly, there’s huge emergency spending needs that, you know, can’t be denied. And so ultimately, I think, for many of the emerging markets, the next step is debt restructuring meaning engaging in a process that is very familiar to us, for those of us that lived through the ’80s and went through the ’80s.

I think, now, for the advanced economies, the advanced economies, of course, have much longer rope than the emerging markets, but I don’t think that, you know, I’m not talking about taking advantage of low interest rates and that narrative, I’m talking about, you know, if you need to have a bigger deficit now because, you know, the share of population living below the poverty line has skyrocketed and they don’t have any kind of social safety net and you have all kinds of issues, you have to cope with that. And then that restructuring is likely to follow, but you know, that’s I think where we are given the depth and breadth of the crisis we’re in.

TYSON: So, I think that’s a terrific note on which to end, and I want to thank all of the members for joining us today. And special thanks, of course, to our outstanding panelists. You know, each of these people has written extensively on these issues, and I would encourage all of you to visit their websites, visit the Council’s website, and to read what they have been saying as well. Please note that the transcript and the audio of today’s meeting will be posted on CFR’s website so you can go back and revisit the answers if you want. And, again, thanks very much. I learned a tremendous amount. Thank you so much for taking time out of your very busy lives, my distinguished panelists, and taking time to work with us and with the members of the Council. Thank you.

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