Hirt: Several scenarios point to this possibility, but the probability and potential impact for each is different.
The first and most likely is what we call the “rising tide” scenario, where, over the long run, other nations continue to deepen their capital markets, improve their institutions, and procure currency adoption. Because of the long timeframe involved in this scenario, the world would likely adjust to the change gradually, leading to minimal transition costs, and overall is likely a positive outcome for the global financial system.
The second scenario is what we call the “innovator’s dilemma,” which entails technological innovation that outpaces payment and regulatory innovation and leads to a situation where trust in technology replaces trust in sovereign nations.1 Recent advancements in cryptocurrencies and their exciting blockchain technology are an example. However, beyond cryptos’ lack of oversight, there are some fatal flaws in their monetary economics that, in our view, prevent them from being adopted and widely accepted as a medium of exchange and as a store of value at a large scale.
Tokenization—in this case, anonymous transactions—seems to be cryptos’ main appeal, but that is not needed for large international reserve transactions. Meanwhile, the supposed benefit of substituting a central issuing authority with a fixed algorithmic rule governing its supply actually introduces wild volatility in its value. Supply can’t keep up with wild swings in demand and investors’ sentiment. In addition, the major central banks are starting to leverage blockchain technology to develop their own digital versions of official currencies, without the shortcoming of private cryptos. We believe the probability of this second scenario to be low.
The third potential scenario would involve mismanagement of the economic or political environment in the U.S. This could involve a fiscal crisis or an unprecedented loss of trust in our political system. We call this scenario the “unforced error” and see it as the most negative potential shock, particularly as a transition could come quickly and a financial market penalty would be costly. Given the potential consequences, we expect the probability of this scenario to be low.
Aliaga-Díaz: The reason the dollar is so heavily used as a reserve currency comes down to trust and alternatives. Each of these scenarios describes either an erosion of that trust or advances in alternatives, just by a different impetus and over a different timeline. But people still have a tremendous amount of trust in the U.S. dollar and in the democratic institutions backing it. That’s clearly evident by its continued, widespread global use.
