Arindum Soni ( Director, SAARTHI IAS)
The role of the United States dollar as the world’s reserve currency is being called into question as a result of developments in China, India, and Russia regarding alternative currencies for use in international trade. It is highly unlikely that the dollar will lose its status as the reserve currency of the world.
What is the status of the dollar as a forex reserve?
- According to reports from the IMF, the percentage of foreign exchange reserves that are held in dollars has decreased from 80% in the 1970s to 60% in 2022.
• Twenty percent of this fall’s available space has been filled by the euro.
• The majority of the shortfall of 20% in foreign exchange reserves has been filled by smaller currencies such as the Australian and Canadian dollars, the Swedish krona, and the South Korean won, while the remainder has been filled by currency from China.
Rise of the Dollar: Some Historical Context
The rise of the United States as a powerful economy with a robust financial system and a stable government has coincided with the rise of the dollar as the world’s preferred currency. The United States dollar has been able to withstand competition from other currencies, including the British pound and the euro.
How did the dollar manage to keep its status as a reserve currency? “DOLLAR BIAS”
• The economic power of the United States The United States has both a robust economy and a reliable government. Because of this, the dollar is widely used as a reserve currency and as a currency for international trade.
• Demand for the United States Dollar: The stability offered by the U.S. government’s debt to other countries’ reserves against the effects of currency fluctuations. There are a lot of currencies that are tied to the dollar, and some countries actually use it. This indicates that a significant amount of United States dollars are held in foreign locations.
• Premium on the dollar: Because of the demand from around the world, the United States government is able to issue debt at the lowest possible interest rate. This relaxes the fiscal constraint, which enables the government that issues debt to borrow more money without having a negative impact on the economy. This is characterized by the dollar premium.
• There is no serious competition: Despite the fact that other currencies have occasionally attempted to unseat the dollar as the primary currency of the world, none of these attempts have been successful. The only competitor that can be considered serious is the euro, which comes in a distant second.
Issues surrounding American Dollar
- Concerns Regarding the US Dollar Global competition: The euro, the Chinese renminbi, and even cryptocurrencies are competing with the US dollar as more countries move away from using it. This may result in a lower demand for US dollars.
- The United States’ persistent budget deficits and steadily increasing debt have been a problem for many years. Inflation and a decline in the value of the dollar could result if investors become concerned about the ability of the United States government to pay its debts.
- Risks related to geopolitics: political unrest on a global scale could pose a threat to the reserve currency status of the US dollar. For instance, sanctions imposed by the United States could prompt other countries to look for substitutes for the dollar in international trade.
- Emerging technologies such as digital currencies and blockchain technology may pose a threat to conventional currencies such as the US dollar. It’s possible that the demand for the US dollar as a global reserve currency could decrease thanks to crypto currencies.
MERITS OF DOLLAR BEING A RESERVE CURRENCY
- The United States Dollar has the status of the world’s reserve currency because governments and central banks around the world keep large amounts of it in their reserves of foreign currency.
- The United States’ large and liquid financial market is attractive to investors from other countries.
- During times of widespread economic unease, the United States Dollar is frequently regarded as a haven of sorts due to the widespread acceptance of the apparent stability of the political and economic systems of the United States.
- As a low-risk investment option, US Treasury bonds are purchased by governments and investors from other countries.
- Petrodollars Because the US Dollar is the currency used for trading oil on a global scale, countries that wish to purchase oil from OPEC are required to possess US Dollars in order to make payments. The demand for US Dollars is consistent.
- Military and Political Influence: The United States of America uses its military and political power to its advantage in international trade negotiations and within financial institutions such as the International Monetary Fund and the World Bank.
• India and China have begun conducting trade with RUSSIA in rupees and yuan, which has sparked discussion about the possibility of de-dollarizing the existing order in international trade.
• Brazil and China have begun conducting trade in yuan, which will help the Chinese renminbi become more accepted internationally and pose a challenge to the dollar.
• India is also looking to move away from the dollar. Trade in Indian rupees is now open to 18 countries, including the United Kingdom, Germany, Russia, and the United Arab Emirates. A forecast made by Nouriel Roubini in February suggested that the Indian rupee might one day serve as a reserve currency for the entire world.To further facilitate trade, BRICS is also considering the creation of a new currency. At the annual summit, which will take place in South Africa in August, the new financial agreement might be discussed.
INNOVATION “the way ahead”
Since that time, the dollar has been in a strong position. It gives the United States a disproportionate amount of influence over economies around the world. The United States has long relied on sanctions as a tool in its foreign policy.
Both Russia and China have rejected the dominance of the dollar. De-dollarization lessens the importance of the dollar on a global scale. It entails dealing in commodities like oil and other goods using US dollars.
The United States dollar will keep its role as the world’s reserve currency. The only serious contender is the euro, which is currently in second place but has a long way to go. It is extremely unlikely that the Chinese currency or any other widely used currency will become a serious contender. The current system should be improved, but it is unrealistic to believe that a common currency between China, India, and Russia or any reciprocal trading arrangement will eventually replace the dollar as the world’s reserve currency.