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There has been much discussion in recent times on the prospect of the US dollar (USD) losing its global dominance. The US dollar almost for eight decades has dominated global trade, finance and reserve portfolios of central banks around the world. This is not just because the US is the largest economy (24 per cent of global GDP now compared to 32 per cent in 1980) but also as the Financial Times pointed out commodity markets (including oil) are based on the USD and mineral companies such as the iron ore giant Vale (the largest producer of iron ore and nickel in the world), keep most their transactions denominated in the USD.
The USD also plays an outsized role in global trade, capital markets and debt further reinforcing its role as the dominant global currency. The USD is also called a vehicle currency because it is often used as an intermediary to accomplish trading between two other currencies, e.g. between the Bangladesh taka (BDT) and the Brazilian real (BRL). If a Bangladesh importer of Brazilian goods want to swap the BDT for the BRL, it will be cheaper to complete the transaction via the USD than to do so directly.
However, notwithstanding the current economic and trade relations, which make the USD, the most dominant currency in the global economy, calls to move away from relying on the dollar for trade and the reserve currency are increasingly growing. More and more countries from Brazil to Southeast Asian countries are openly talking about to displace the dollar by a rival currency both as a reserve currency in central banks around the world as well as the currency that is used in global trade and financial transactions.
It is not only leaders like Brazilian president Luiz Lula or Malaysian prime minister Anwar Ibrahim are calling to move away from the dollar but a business executives like Tesla CEO Elon Musk have warned that the threat of de-dollarisation is real. Even as back as in 1965 Valery Giscard d'Estaing, then France's finance minister, also riled against the power of the USD in the global economy and the corresponding privilege that goes with it.
In early May this year, US National Security Adviser Jack Sullivan in an address to the Brooking Institution on the subject of "renewing American economic leadership" spent some time on the decline in American economic power. Therefore, the current situation calls for, Sullivan urged "we forge new consensus" which would be in effect an alliance of major powers under the leadership of US against those who did not toe the line, above all China. For all practical purposes, US economic policy is now simply directed to confront China using the pretext to ensure national security.
Also, former US Treasury Secretary Larry Summers commenting on the weakening economic position of the US told Bloomberg Television that it was "troubling" that the US was losing influence. He then further added, "There is a growing acceptance of fragmentation, and - maybe even more troubling - I think there is a growing sense that ours may not be the best fragment to be associated with".
It is also suggested that the growing chorus against the global dominance of the USD is also due to the US's increasing weaponization of its currency during geopolitical conflicts as happened with Russia last year. So far, the US and its allies have frozen US$300 billion of Russian financial assets including foreign currency reserves. This forced Russia to switch trade to other currencies and increase gold in its reserves.
Even Financial Times foreign affairs columnist Gideon Rachman noted in a comment around the middle of April that "The US dollar which has gained international credibility as a 'safe haven' currency, now looks less safe to those who fear they might one day be on the wrong side of a geopolitical dispute with Washington". This means if countries that disagree with US foreign policy may find their assets are confiscated or frozen. Therefore, countries need to have alternative places to put their assets. The US's proclivity to use its dollar supremacy to achieve its geopolitical objectives is now giving rise to opposition to it.
The Economist (April,29) also opined that "high inflation, fractious geopolitics and the sanctions imposed by America and its allies on countries such as Russia have lately caused dollar-doubters to become vocal once again".
However, empirical studies suggest that there is no evidence of financial sanctions having on the currency composition of reserve portfolios. The reason is likely to be that the US coordinates sanctions with other countries including countries whose currencies are also used as reserves such the EU, the UK, Japan and Canada. Therefore, countries seeking to bypass sanctions usually might diversify towards gold. But another likely direction for reserve diversification is towards the Chinese renminbi (CNY). The Bank of Russia now holds nearly a third of all renminbi reserves reported by central banks around the world.
The IMF conducts the Currency Composition of Official Exchange Reserve (COFER) at the end of every quarter the aggregate data for the previous quarter. COFER data for the 4th quarter, 2022 place the Chinese renminbi at 2.69 per cent of the allocated world total. During the same quarter the USD accounted for 58.38 per cent, followed by EUR 20.48 per cent, JPY 5.50 per cent, GBP 4.94 per cent, CAD 2.37 per cent, AUD 1.96 per cent and CHF 0.23 per cent. If one also adds the South Korean won (KRW) and the Singaporean dollar (SGD), clearly the US and its allies accounted for 95per cent plus of total global reserve portfolios by the end of 2022.
The US dollar remains the most dominant foreign currency reserves even though its share has dropped from 71.9 per cent in the 1st quarter, 1999 to 58.38 per cent in the 4th quarter of 2022. Data clearly indicate that the majority of shift away from the USD has been towards non traditional reserve currencies such as the CAD, the AUD and the like.
It is estimated that China's internationally traded assets and liabilities are only about 4 per cent of global total. China also has restrictions on the capital account hindering cross-border capital flows. This means that money cannot be freely moved into or out of the country. Also, China runs current account surpluses which give rise to accumulating financial claims on the rest of the world but not on China. In summary, China does not have enough assets and liabilities to constitute a credible alternative to the USD.
While China has become the world's second largest economy and has become the major trading nation establishing comprehensive trading ties with rest of the world, but its financial integration with the rest of the world is still in its infancy. Therefore, the Chinese renminbi does not constitute a serious alternative to the US dollar. However, as China's economic strength continues to rise, it will exert more influence on global finance and trade in the future. Also, as China's volume of trade continues to grow, especially with emerging markets and developing countries, these countries' willingness to hold the Chinese renminbi as reserves will also rise.
Even the euro, which now accounts for 20.48 per cent of global reserve currencies, has its ongoing problems. As the Economist (April 29) pointed out "The euro zone is fragile and its sovereign-debt market is mostly fragmented between its member states". The EU is also not a fiscal union and very limited supply of safe collaterals such as German Bunds which are accepted by the ECB as collateral for credit operations make the euro less appealing. The EU is now facing serious political dissensions centred on the Russia-Ukraine conflict and other political and economic issues preventing its successful integration with implications for the future of the euro.
Despite the slow erosion of the US's economic and political hegemony, most analysts believe the USD is not expected to be replaced in the foreseeable future. Simply because there are not any alternative currencies to replace it now. Also, if there are a drop in foreign central banks and other financial institutions investing in US Treasury bills and Treasury securities that will only mean the US government will have to find alternative sources of funding without having any impact on the economic growth of the US.
One of the major factors underlying drops in the USD shares in central banks reserves is linked to central banks very often sell the USD which is the most liquid intervention unit to purchase their own currencies when such a need arises. Such an intervention reduces USD reserves. Also, a gradual decline is not a collapse and the process of decline is very slow.
Given that 90 per cent of global trade and financial transaction are now carried in the USD coupled with its dominant position as the reserve currency, attempts to replace it will trigger fresh global economic disruptions in the absence any credible alternative currency. In fact, there is no credible alternative currency now to replace the USD. Deleveraging the global USD debt-based system would also be an extremely painful process making de-dollarisation an unrealistic proposition.
So long as there is another currency system or economy willing to step up to that international reach of the USD with well-functioning free floating convertibility enabling global trade and financial flows to continue smoothly as well as willing to assume the full responsibility of a reserve currency, talks of the USD's demise have been rather exaggerated. However, the Economist (April 29) pointed out that "Although a shift to a multipolar system of currencies is not imminent, it could occur later this century as America's share of the world economy shrinks".
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