Every few years the world witnesses a familiar phenomenon in which politicos and experts present a draft for the obituary of the dollar. Curiously the confluence of phraseology is remarkable – of those hopeful of a decline in the domination of the dollar and those despairing about its decline.
The fact is the dollar continues to be the most dominant currency in transactions, trade denomination or invoicing and as a store of value. One factoid underlines the dominance – the average daily turnover of US dollars on one side of the transaction is around $6.6 trillion. Its performance across material metrics is better than perceived alternatives and rivets its status as an international aka reserve currency for the past seven decades.
The domination of the dollar in geo-economics has fuelled angst and anger and influenced geopolitics. It has periodically triggered visceral existential sentiments, particularly from those influencing the evolution of balance of power. Indeed, the Chinese Foreign Ministry declared the “hegemony of the U.S. dollar is the main source of instability and uncertainty in the world economy”.
The political urge for de-dollarization resurfaced following the war in Ukraine. Countries with a complicated relationship with the United States and the West have been trying for seek alternate routes. Last year, following the sequence of war and sanctions, the United States seized $ 300 billion out of Russia’s $ 640 billion reserves.
Many countries are troubled by the ability of the United States to do this. The US is able to do this because it holds the key to the global financial platform SWIFT. The SWIFT system (Society for Worldwide Interbank Financial Telecommunication) is owned jointly by G10 countries and the ECB connects 11,000 financial institutions across 200 countries and carries 5 billion messages in a year.
As of June there are 38 groups and countries such as Iran, Venezuela, Russia and Belarus under sanctions. While voting rights at SWIFT are equal the US influences decisions and uses it for executing sanctions by denying groups and countries the right to access dollar assets. For sure there are alternatives such as India’s UPI Russia’s SPFS and China’s CIPS have grown their footprint; they are far behind thanks to the network effect of SWIFT. The US based CHIPS is the largest private sector USD clearing system in the world, clearing and settling $1.8 trillion in domestic and international payments per day.
Those aspiring to accelerate the derailment of the dollar have not been shy of articulating their views. Last year Saudi Arabia announced that it was considering accepting Chinese currency Yuan instead of dollars against sale of oil. A few months later, on a visit to Saudi Arabia, President Xi Jinping of China, underlined the potential and asked leaders at the Gulf Cooperation Council to use the Shanghai Petroleum and Gas Exchange “to conduct oil and gas sales using Chinese currency”. The challenge is that if a country wants to buy oil they need to do it in dollars because global crude oil contracts are invoiced in dollars and paid for in dollars. It bears mention that this movie was screened before – in the earlier decades, the Deutsche mark, yen and euro have all held hopes of emerging as the petro currency.
In April this year, the President of Brazil, Luiz Inácio Lula da Silva, speaking at the New Development Bank (aka the BRICS Bank) in Shanghai, lashed out at the IMF, criticised the domination of the dollar and added his voice to that of Xi Jinping in a reflective tone. “Every night I ask myself why all countries have to base their trade on the dollar.” Last month the foreign ministers of Brazil, Russia, India, China and South Africa convened in Cape Town and asked the NDB to provide guidance on how a new shared currency might work and how it could shield members from sanctions.
The idea – optically attractive given that the bloc accounts for nearly a fourth of global GDP – is lopsided in its construct. The fact is the nature of the economies is vividly different to present a picture of cohesive concept. Two of the five, Brazil and South Africa, are essentially commodity economies. Then there is the pace of growth, the state of inflation, interest rates, the stability of currencies and varying size of the economies. India is the fastest growing large economy, growth in China has spluttered, Russia is under sanctions, Brazil and South Africa
A reserve currency must be backed by credibility of the underlying value. It is unclear how this would be engineered and what would be the basket of currencies or assets which would enable legitimacy and embolden trade. At a geopolitical level the concept is mired in competing contradictions. India and China, bitter adversaries, are unlikely to trust the other given the background of the history and recent border conflicts. Indeed, the Reserve Bank of India has expressed serious doubts about the idea itself. It is not surprising that the CFO of the BRICS bank revealed that there are no immediate plans to launch a common currency.
Typically the stature of international or reserve currency is scaffolded by three critical functions – as a medium of exchange, as a unit of denomination or pricing and as a store of value. A good way to understand this is to use real-life transactions. In 2022 India’s imports from China were worth $ 118.5 billion and exports were worth $17.4 billion. Although the transaction was between two sovereigns with no involvement of the United States the receipts and payments were made through international banks. The Basel-based Bank of International Settlements estimates that the dollar accounts for nearly 90 per cent of all international transactions making it the single most traded currency in the world.
Now how is trade priced between two countries? India and China denominate or price their imports and exports in dollars although the cost of goods is in Chinese Yuan and Indian Rupees. The US dollar is the denominator of all trade in the world. The US greenback is the chosen denomination for global trade -- 96 per cent in Americas, 74 per cent in Asia Pacific and 79 per cent in the rest of the world, is invoiced in dollars.
Now what does the producer of goods in China and India do with the foreign exchange earnings? They exchange it for local currency with their banks through the People’s Bank of China or the Reserve Bank of India. Now what happens to the reserves in PBOC or RBI? A part of the reserves are stored in dollar assets. In terms of store of value the dollar continues to be the preferred choice for countries to store their foreign exchange reserves.
As per IMF data of the 11.15 trillion reserves of countries over $ 6.5 trillion (roughly 59 per cent) is parked in US dollar reserves and the second largest tranche of $ 2.2 trillion, or a fifth of all country reserves, is parked in assets denominated in Euros. China holds a third of its $ 3.2 trillion or over $ 1.03 trillion of its reserves in US Treasuries. For sure in recent years the US dollar has lost some of its allure for countries storing their reserves. But the decline is more a reflection of diversification rather than the rise of a competitor.
History offers many chapters to learn from. The Euro came to be a common currency for 27 countries in the European Monetary Union in 1999. Despite the architecture of an economic and monetary union, open border trade et al the Euro is a distant second behind the US dollar across metrics – it is used in 31 per cent of trades, 22 per cent of international debt securities and less than 20 per cent of foreign exchange reserves of countries is parked in Euro assets. Following the Euro are the Yen at 17 per cent, the British pound at 13 per cent and the Chinese Renminbi aka Yuan at 7 per cent.
The dollar’s domination is far from an accident. Its rise stems from the post-war superpower status of the United States. The Bretton Woods agreement signed and agreed upon by 44 countries in July 1944 in New Hampshire established the dollar as the anchor currency with developed economies agreeing to maintain a fixed peg with the US dollar which was pegged to gold. In 1971 US President Richard Nixon, facing inflation and the need to devalue the dollar for growth as Japanese and European exports became more competitive, announced a new economic policy and ended dollar convertibility to gold.
The dollar’s dominance is also the consequence of agility and reflexive policy action. In 1974 following the oil embargo by Arab members of OPEC’ inflation was sky high, the stock markets crashed and the economy was in a tailspin. On June 8 Nixon dispatched Treasury Secretary William Simon, formerly a bond trader at Salomon Brothers, and his deputy Gerry Parsky to Jeddah in Saudi Arabia. The deal: the US would buy oil from the Kingdom and provide military aid and equipment. The Saudi regime would park their revenues in US treasuries helping the US fund its spending. Nixon and Kissinger followed up with a trip to Saudi Arabia. Verily this is the context of the coinage “petro dollars”. Over the years US governments ensured the suzerainty of the dollar with policies.
The dollar is by no means the first international anchor currency. In the past five centuries there have been global reserve currencies. For nearly 150 years the Dutch Florin also known as Guilder, was the currency of international trade. The Bank of Amsterdam, set up in 1609, provided financial services to European traders from London to Gdansk. The Florin/Guilder crashed out following extractive policies by the city and the war with Britain.
>From the early 1800s to the 1930s the British Sterling or Pound was the preferred currency for international trade. It was a reflection of the strength of the British economy – Britain imported raw materials and foods and its industrial produce was in demand the world over. The sterling was not only the international currency but also a safe haven for savings for future needs and mimicked the function of gold and reserves were invested in London and earned interest. The Sterling lost its perch and as the US economy strengthened and the dollar made its presence felt as an international creditor.
The stature of the world’s reserve currency is not guaranteed. The currency is but a reflection of the underlying strength of a nation and its ability to reflect and react to challenges. It is possible that the US may lose its top dog position and good old ‘Benjamin’ could be toppled. That will require the US to blunder and a new super power to capitalise. It is also possible that the world may gravitate towards an innovation, a new avatar of Bancor, the supranational currency, operating on a multilateral clearing system, conceptualised in 1942 for the post war world by John Maynard Keynes and Ernst F Schumacher.
The future is a known unknown. For now perceptions of the decline and demise of the dollar, to paraphrase Mark Twain, are largely exaggerated.
