Introduction:
Roughly over a century ago during the interwar years, the US dollar overtook the UK’s Pound Sterling as the world’s preeminent international currency (Subramanian, 2011)[1]. In this last century, the international financial system has seen the use of the gold standard but also its abolishment in 1971 often referred to as the ‘Nixon Shock’, in this entire timeline the US dollar has remained the primary currency of the international monetary system. Since the 2008 financial shock, there has been a growing debate about the role of the US dollar and its dominance in our financial systems. The topic of ‘de-dollarization’ as a term has become popular. However, I think this is much of an overblown myth and perception.
Certainly, there have been other factors such as endogenous and exogenous shocks to our systems such as Covid-19, the Russia-Ukraine conflict etc, along with the rise of other reserve currencies such as the euro, Chinese renminbi, the Japanese yen that bring to question the dominance of the dollar. To that fact I would argue the absolute decline of the dollar touted popular is not true. Rather I would like to acknowledge that the US dollar is not in an absolute but in a relative decline.
Reasons for US Dollar Dominance:
There are certain fundamental principles or conditions I think that have enabled the US dollar to be where it is at. For any currency to be successful, I would like to argue that it needs to fulfil the conditions of a) being a medium of exchange b) being a storage of value c) velocity of its usage.
Of all the reserve currencies currently in the world no other currency matches the dominance of the dollar yet. A Fed Note by Carol Bertaut, Bastian von Beschwitz, Stephanie Curcuru has served as a major resource for this issue of the blog.
a) Medium of exchange:
In terms of foreign exchange transactions, for long the US dollar has been the choice of the international markets and users across the world as a medium of exchange for their transactions. As one of the primary reserve currencies of the world, the dollar in that sense has been used widely for invoicing of international trade and across other financial market transactions across the world. The following data and graphs prepared by the US Federal Reserve [2] below, are reflective of the dollars usage across these different use cases.
Figure 1: Share of export invoicing (1999-2019)
Source: US Federal Reserve
Figure 2: Share of over-the-counter foreign exchange transactions (2001-2019)
Source: US Federal Reserve
The dollar in other cases, whether from the issue of debt financing in dollar terms or holdings of securities by foreign investors remains the currency of choice. But simply acting as a medium of exchange is not the only reason.
b) Storage of Value:
Beyond the condition of merely acting as a medium of exchange, any currency that aims to dominate the monetary system needs to act as a store of value for its holders. The dollar in the regard has remained and been a store of value. This can be analysed in the form of indicators of foreign exchange reserves, holding of assets in the form of securities (e.g., US Treasuries), government debt etc. It is true in recent times in the case of foreign exchange reserves the dollar’s share in the world and across different countries as a part of the mix of their reserve basket has fallen.
Data gathered by Carol Bertaut, Bastian von Beschwitz, Stephanie Curcuru for the Fed [3] and the IMF’s COFER database[4] shows that the US dollar has remained to be a preferred store of value in the last 20 years, over the euro, yen etc.
Figure 3: Latest FY 2022-23 and 2023-24 Q1 Data
Source: IMF COFER
Figure 4: Foreign exchange reserves (At current exchange rates terms) 2000-2020
Source: US Federal Reserve
c) Velocity:
Another factor that enables any currency or mechanism to gain traction in the world is the volume of the scale of its usage and its adoption. This creates a velocity of use of the currency in the system that I am referring to. Given the US dollar to be the primary reserve currency of the world, it has meant in the case of shocks and crisis the role of the US financial system and governance bodies have been crucial in their speed of response.
The US Treasury Department and the US Fed have indeed played their role in this regard. The economic historian Adam Tooze in his last two books “Crashed”[5] and “Shutdown”[6] has argued the US Fed’s support in terms of central bank swap lines during the 08 Crisis, Eurozone crisis of 2010s, Covid-19 pandemic was consequential for the stabilisation of financial markets and systems across the world. The intervention especially in the case of the swap lines only has grown in volume, scale and the timing of its response in every case. A report of the New York Fed (a key branch of the Federal Reserve System) written by Michael J. Fleming and Nicholas J. Klagge notes, around December 2008 that was the peak of the crisis in 08, the Fed had swaps in amounts of a value amounting to more than 580 billion USD in support to other central banks (Fleming & Klagge, 2010) [7]. In the case of Covid-19 during the peak in 2020, support to to other central banks amounted to 450 billion USD .
Thus, the velocity in this context is not merely regarding its usage but also the supporting governance structures and interventions, as FIAT currencies such as the dollar are backed by the government and the central banks of the globe.
Challenges and a Post-dollar World:
As I have noted earlier, the US dollar is in decline, but is that decline absolute ? I would like to argue, the challenges to the US dollars dominance in the international monetary system are real, but for the foreseeable future that decline will be relative in nature.
A post-dollar world is certainly a possibility that no one can rule out, what thus becomes important are US actions themselves in contributing to a world that shifts away from the dollar. The US weaponization of the dollar and its financial system in that instance post the greatest challenge I think to its financial and economic dominance.
As Carla Norrlöf has observed, countries like China and Russia have been pushing for and coming up with alternative mechanisms to reduce their dependencies on a US dominant financial system [8]. Their success as alternatives still remains to be seen and is a topic up for debate. Barry Eichengreen and Masahiro Kawai in a paper for the Asian Development Bank Institute in 2014 had argued the Chinese renminbi internationalization has seen a progression in addressing issues pertaining to the internationalisation of a currency. But issues of financial market liberalisation and independent monetary policy making still remained main roadblocks to renminbi internationalization (Eichengreen & Kawai, 2014)[9] . This still remains to be the case for the renminbi.
At the end of this issue, I would like to leave you with this wonderful graph that sums up the state of the US dollar in the international system at the end of 2022 prepared by Mathias Drehmann and Vladyslav Sushko writing for the Bank of International Settlements [10].
Figure 5: The international role of the US Dollar
Source: Bank of International Settlements
Conclusion
In many ways as long as the US has deep and open financial markets, independent monetary policy making and meets the necessary reasons of an international currency, it will remain the most dominant in the international system. A post-dollar world though without a shadow of a doubt cannot be ruled out, and one that policy makers need to prepare for. But when that time will come still remains the question.
References and Citations
[1] Subramanian, A. (2011). Renminbi rules: The conditional imminence of the reserve currency transition. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1928138
[2] The international role of the u. S. Dollar, accessible data. (n.d.). Board of Governors of the Federal Reserve System. https://www.federalreserve.gov/econres/notes/feds-notes/the-international-role-of-the-u-s-dollar-accessible-20211006.htm#fig5
[3] Bertaut, C., Beschwitz, B. von, & Curcuru, S. (2021). The international role of the u. S. Dollar. https://www.federalreserve.gov/econres/notes/feds-notes/the-international-role-of-the-u-s-dollar-20211006.html
[4] IMF COFER- https://data.imf.org/?sk=e6a5f467-c14b-4aa8-9f6d-5a09ec4e62a4
[5] Tooze, J. A. (2018). Crashed: How a decade of financial crises changed the world. Viking.
[6] Tooze, J. A. (2021). Shutdown: How COVID shook the world’s economy. Viking, an imprint of Penguin Random House LLC.
[7] Fleming, M. J., & Klagge, N. (2010). The federal reserve’s foreign exchange swap lines. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1597320
[8] Norrlöf, C. (2023, February 21). The dollar still dominates. Foreign Affairs. https://www.foreignaffairs.com/united-states/dollar-still-dominates
[9] Eichengreen, B., & Kawai, M. (2014). Issues for renminbi internationalization: An overview. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2382420
[10] Drehmann, M., & Sushko, V. (2022). The global foreign exchange market in a higher-volatility environment. https://www.bis.org/publ/qtrpdf/r_qt2212f.htm
India and the World | Hritik Bhasin 