The Future of the Global Reserve Currency: Is the Dollar’s Reign on the Brink?
– By Aashi Sharda
Introduction
Pre-Covid19, there were murmurs, occasional debates, wherein the academic discourse prophesied a future of “currency multipolarity”. Simply, it was said that the US dollar, the de-facto currency of the world, hitherto, shall have to give way to peers. However, the events of 2022 and 2023 have shown that idea remains just that: academic.
It is safe to say that texts and discussions around the rise and prevalence of the US dollar as the reserve currency of the world is enough to awaken us from the deepest of slumbers.
History says this wasn’t always the case. The British Pound was a reserve currency before World War I and II changed everything. Due to the amount of money the British Empire borrowed to win wars, they were forced to essentially sell their rights as a reserve currency to the US, in exchange for supplies (and eventually an alliance). The official surrender happened in 1944, with the signing of the Bretton Woods System, where the world’s developed countries decided to peg the exchange rate for all currencies to the U.S. dollar – as it held the largest gold reserves. By the early 1970s, President Nixon separated the dollar from gold.
Why are currencies other than the US dollar not suitable to be selected as the reserve currency?
The British pound is unlikely to become the world’s reserve currency in the future because even though the UK is a major global economy, it is smaller than some of the other major economies, such as the US and China. As a result, the pound may not have a significant global impact. The UK has also experienced extreme political uncertainty. It has limited diversification, its economy focuses heavily on services making the pound vulnerable to economic shocks.
The Chinese yuan on the other hand has gained a lot of importance as a global currency and is increasingly being used in international trade and finance. However, it still faces several shortcomings like limited convertibility and China limits its currency‘s use in international transactions. Further, the lack of transparency is another feature making it less attractive. China’s financial markets are still relatively closed to foreign investment, which limits the yuan’s use in international transactions and thus makes it less attractive.
Meanwhile, the euro has grown significantly in prominence and become one of the main world currencies. It is unlikely, nevertheless, to displace the US dollar as the global reserve currency anytime soon for a number of reasons. The European Union (EU) is primarily a political and economic union made up of 27 member states, each with distinct national objectives, interests, and ambitions. It is challenging for the EU to communicate its opinions on international economic matters as a whole because of this fragmentation. Further, it has experienced significant economic instability in recent years, with high levels of debt and unemployment leading to concerns about the long-term stability of the euro as a currency. While the EU has a single monetary policy under the European Central Bank (ECB), fiscal policy remains in the hands of each of the individual member states. The European Union finds it challenging to respond to economic difficulties in a coordinated and efficient manner due to the absence of a united fiscal policy.
Due to its decentralized nature, which eliminates governmental influence, Bitcoin has become extremely popular. It is still inappropriate, though, to choose it as the reserve currency. Volatility is the main cause. Because of its extreme value fluctuations, investing in Bitcoin is dangerous. In light of its volatility, Bitcoin is not a reliable store of value for investors or central banks. Absence of oversight and control presents an additional challenge. Since Bitcoin is decentralized, there isn’t yet a mechanism in place to prevent money laundering or fraud. This lack of regulation makes it less reliable and difficult to be chosen as the reserve currency.
Why is there still a long way for dollar to relieve down?
With the sole exception of the US, major combatants in World War II sustained catastrophic damage to their continental infrastructure. Except from the Attack on Pearl Harbour in the US by Japan, the US was the only country without any significant casualties to its mainland. The major infrastructure of every other country was destroyed, and their economies were left in utter disarray. In addition, a few countries reimbursed the US for the aid they received.
Prior to Bretton Woods, the majority of nations used the gold standard. This implied that every nation promised to repay its money for the equivalent amount in gold. Three-fourths of the world’s gold reserves were in the US. There was not a single other nation with sufficient gold reserves to replace it. As a result, the US dollar rose to the top of the currency market, and all other significant currencies were permitted to trade against it. Each participant in the Bretton Woods Agreement committed to redeeming their money in US dollars rather than gold.
Subsequently, talking about the present. In light of the Bretton Woods agreement, a large number of developing countries worldwide had borrowed money in US dollars from the World Bank and the IMF. For this reason, the countries would also repay their loans in US dollars. Consequently, exchanging US dollars in the open market would be required for any repayment of the current loan or attempt at stabilizing the national currency. Thus, there is still a long way for the dollar to relieve itself.
Conclusion
Over the years, the strength of the US economy cemented the position of the dollar as the ultimate backstop of the global financial system. Further, around 90% of forex trading involves the U.S. dollar. The dollar is just one of the world’s many currencies, but most of these currencies are only used inside their own countries. While countries such as China and Russia feel a new one-world currency, one not backed by any one nation, is overdue, recent reactions to the actions of the Federal Reserve have showcased that the dollar’s dominance will erode at best, only very slowly.
A key component of its appeal as a currency emperor lies in its issuer’s democratic privilege. Constitutional checks don’t allow for the government to unilaterally change the rules of the game. A philosophy that the outside world finds absent in the challengers, especially the Chinese yuan.
Hence, while theoretically any currency can become the world’s reserve currency, one can say, no currency is close to evoking as much trust and confidence as the “greenback”. That said, one shall be a keen observer should future events prove one wrong.
References:
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Harvard’s Emmanuel Farhi on a New Monetary System – IMF F&D. (2019, June 1). IMF. https://www.imf.org/en/Publications/fandd/issues/2019/06/new-monetary-system-farhi
Rothfeld, M. (n.d.). What could replace the US dollar as world reserve currency? Barchart.com.
https://www.barchart.com/story/news/16418162/what-could-replace-the-us-dollar-as-world-rese
Siripurapu, A. (2023, July 19). The dollar: the world’s reserve currency. Council on Foreign
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