Challenging the Almighty Dollar

In the absence of a clear contender, the dollar’s safe haven status continues to make it the overwhelming favourite in forex markets; particularly in volatile phases like the present one.

The US dollar rose to power as the global reserve currency by replacing the British Pound, following the World War. This is when many countries turned to the US for loans to curb their financial crunch, hence paving the way for the country’s currency to claim a dominant position. Since then, the US dollar has been dominating global currency markets as the predominant reserve currency and as a medium of common exchange between countries.

CHALLENGING THE HEGEMONY

The dominance of US dollar is difficult to overcome because of its large circulation. Many countries prefer the US$ as the reserve exchange, due to its deep regulatory framework and transparent transactions in the financial market, as well as for being the bearer of the most clear corporate governance frameworks. This implies that bringing an alternative of this exchange currency to the global forum shall also require a cordial settlement with the US.

This, however, brings to light the sanctions by Russia and China to start chipping away at the US currency’s dominance. Things may be falling into place for the Chinese Yuan, as can be seen through its increasing use in bilateral trade.

According to Richard Turrin, author of “Cashless: China’s Digital Currency Revolution”, many allied countries of China and Russia have reportedly agreed to carry out their trade in Yuan.

The attractive factor here for other developing economies, specifically Asian countries, is that if they intend to run large trade deficits currently, it may compel them to either increase their exports or increase their reserves. If Yuan is made the global trade currency, the Chinese intend to simplify trade agreements to curtail such issues of global trade with its allied countries. This shall easily win the confidence of its supporting countries and assert its good status, thereby shifting the balance vis-à-vis the US.

TAKING DOWN THE US DOLLAR

There are certain implications to be considered when it comes to abandoning the US dollar as a reserve currency: 1. Diverting global savings may lead to a collapse in exports, a dry spell in manufacturing and surge in unemployment. 2. Taking off the US as the runner

CHINESE CHECKERS?

Many countries have now been trying to prune their holdings of US dollars, firstly due to the recession and the Chinese ‘Yuan intervention’ creating bilateral trade agreements with its allied countries.

of current account and trade deficit will lead to a massive deficit, forcing world to reduce its collective trade. 3. Fall in world savings shall lead to income redistribution in many countries and political turmoil. 4. A majority of countries are strangled by large US dollar reserves. This can’t be turned away so easily. 5. Fiscal deficit may intensify if net foreign capital isn’t balanced by an extensive domestic investment, creating a huge disparity in household debt.

Factually, an increase in bilateral trade agreements may appear to be taking a toll on the US dollar as the reserve currency, but replacing it shall take many years. In the meantime, the US shall not sit back and let its holding drop beyond a point. It will endeavour to maintain its dominance either unilaterally or by forming alliances collectively. But, it will not take an easy fall. In the midst of this, it will be an interesting scenario to see the extent to which competitors like China and Russia can succeed.

NO CAKEWALK, THIS!

It needs to be noted that the dip in dollar reserves, as an IMF working paper states, has not led to an increase in reserves of other traditional currencies. A quarter of the shift has been towards non-traditional currencies. So, a real strong basket of contenders doesn’t seem to be emerging at the moment. Especially in volatile market situations, the dollar’s safe haven status continues to make it the overwhelming favourite.