Rarely does a day go by when you cannot find interesting news circulating in the cryptocurrency sector. Some of the strangest news happens on weekends for some unknown reason. A case in point is a recent speech given by Bank of England Governor Mark Carney on Friday, August 23, 2019. Carney made the speech at the Economic Policy Symposium being held in the U.S.
Most of Carney's speech was unremarkable. However, one point he made did garner a lot of discussion that continues today. Carney suggested that it was time to replace the U.S. dollar as the world's reserve currency. He went further to suggest that cryptocurrency, in one form or another, could be that replacement.
Carney has gone and done it. He has raised the specter of a single cryptocurrency becoming a dominant world currency capable of functioning within a global economic system comprised of sovereign nations still wanting to hold onto their own sovereignty. Carney's comments, even if unintended, showed support for the idea of globalism over nationalism.
More about reserve currencies
A reserve currency is a currency held in large quantities by a central bank for the purposes of having cash for investments, transactions, and debt obligations. Sometimes reserve currencies are also held as a means of controlling domestic exchange rates. The thing about reserve currencies is that they can be any currency at all.
It just so happens that the U.S. dollar is the world's most preferred reserve currency. As such, most of your commodities - think gold and oil here - are priced in U.S. dollars. Most of the world's central banks hold large volumes of U.S. dollars with the understanding that as the U.S. economy goes, so will the rest of the world's.
How it happened
So how did the U.S. dollar become the world's reserve? In a phrase, economic output. The U.S.-led victory in World War II opened up the country to a tremendous amount of economic opportunity. While many of Europe's biggest economic powerhouses had decades of reconstruction ahead of them, the U.S. was perfectly positioned to start manufacturing and selling to them.
The U.S. quickly became the most dominant economic power in the world. At one time, the country was so strong that its GDP constituted 50% of the entire global output. It was the sheer size and scope of the economy that led central banks around the world to latch on to the U.S. dollar.
It didn't hurt that, in 1944, some 44 nations agreed to adopt the dollar as a reserve currency. The formal agreement that made it official is known as the Bretton Woods Agreement. Almost instantly, nations around the world began linking their exchange rates to the dollar. After that, the whole thing just took on a life of its own to bring us to where we are today.
Too much economic influence
Central bank leaders like Mark Carney know all too well that the U.S. economy still exerts a tremendous amount of influence on the economies of the rest of the world. Though pragmatic, many of these leaders are still unhappy about it. They believe the U.S. has too much influence. They want that to change, but there are very few avenues for facilitating such change. Carney seems to think that adopting a new world reserve is the best way to go.
Carney specifically mentioned in his speech a world economy that is being reordered. He also noted that while the Bretton Woods Agreement collapsed in the 1970s, when then-President Richard Nixon decoupled the U.S. dollar from gold, the dollar still remains the world's reserve. Carney, like other world leaders, believe it is time that the reordering includes finding a different reserve.
Carney did suggest looking at other fiat currencies, but he gave more attention to the cryptocurrency idea. He mentioned the creation of a Synthetic Hegemonic Currency (SHC) as another way to go. His vision of an SHC is essentially a digital currency created by a consortium of central banks working together. Carney said that "an SHC could dampen the domineering influence of the U.S. dollar on global trade."
What it would look like
Let us just assume that Carney's vision was made reality within the next five years. What would the world look like? How would this new digital currency work? For starters, whatever coin the central banks came up with would have to be a stablecoin.
To make this easier to talk about, let us call this new stablecoin Carney's Cryptocurrency (CCC). It would be a digital currency in every respect. However, it would not be a true crypto in the same league as Bitcoin, Litecoin, etc. The key difference is centralization.
CCC would be centralized by the mere fact that it is created and controlled by a consortium of central banks. It would never offer any of the same benefits of decentralization that come with Bitcoin and its competitors. For the crypto purist, that is a big strike against CCC.
Next, the currency would have to be tied to some sort of asset with tangible value in order to protect it from huge price fluctuations. There are a couple ways to approach this. The first approach is the one Facebook intends to use with Libra: back the coin with a basket of national fiats and securities. The other approach is to back it with gold.
Both options have their pros and cons. And of course, the central banks that created CCC could tie it to something else entirely. It wouldn't have to be fiat currencies or gold. With that said, here's what CCC would be used for:
- Exchange Rates - Individual nations would tie their exchange rates to the value of CCC. That would be reflected in the Forex markets, where currencies are bought and sold.
- Settlements - CCC would be used to facilitate international settlements between nation states, businesses, etc.
- Investments - Governments would use CCC to facilitate their own investments, be they buyers or sellers. For example, a government-issued bond would be based on CCC.
- Debt - Governments would utilize CCC to borrow and then pay off loans.
- Purchases - CCC would be used by governments to make international purchases.
Adopting CCC as the world's reserve wouldn't have much of an effect on the daily lives of consumers. Unless, of course, you live in a country with a national currency so unstable that you prefer to use U.S. dollars. A new reserve could mean your dollars are worth less, regardless of what that reserve might be.
Why it's unlikely to happen anytime soon
While Mark Carney and other World Bank leaders might not be happy about the fact that the U.S. dollar remains the world's reserve, it is what it is - and there are plenty of valid reasons for it. Furthermore, it is highly unlikely that the dollar will be replaced as the world reserve unless, and until, those reasons are addressed.
First and foremost is the issue of confidence. The U.S. dollar became the world's reserve because the world was confident in the U.S. economy during the postwar years. Whether Carney likes it or not, that confidence still remains. The world looks to the U.S. economy for strength and guidance. That's why world markets explode every time the U.S. economy sneezes.
The next issue is control. Just looking at the ongoing saga that is Brexit makes it clear that there are plenty of European nations that cannot seem to get along. If the EU and UK can't even hammer out a Brexit deal that's fair to both sides, how in the world are central banks going to come together and figure out an equitable digital currency to become the world's new reserve?
Last but not least is the issue of backing. In order for a cryptocurrency to become the world's new reserve currency, it has to have a very solid backing. Just tying it to gold or a basket of fiat currencies will not be enough. Why? Gold and fiat currencies, unlike GDP, are static. Both are just objects that only have value because people agree to that value.
On the other hand, GDP is ever-changing. It's almost like a living creature in the sense that it grows and changes with a variety of influences. That's why the U.S. dollar remains the world's reserve. A dollar itself is just a piece of paper. It is just an object, like gold. What gives the dollar its value is the economic output behind.
If the world's central banks attempted to replace the U.S. dollar with cryptocurrency, they would be asking the world to trust what, exactly? There is no economic output behind a stablecoin issued by multiple central banks. And if they attempted the tie it to national economies, it would be too unstable. The only solution would be to unite those national economies into a single economy which, as evidenced by the EU and Brexit, doesn't work.
Carney has raised the specter of a new cryptocurrency replacing the U.S. dollar as the world's reserve. While it is possible, and perhaps even plausible, to replace the U.S. dollar with some other fiat considered equally strong, replacing it with a cryptocurrency created by a consortium of central banks seems quite unlikely.