The End of an Era: Is the US Dollar Losing its Global Dominance in 2023?

The US dollar has been the premier international currency for decades, but experts are now questioning whether it is losing its dominance.

So has the de-dollarization started? Will dollar remain the main currency in which majority countries hold their forex reserves and carry out international trade? Will it continue to the main currency in which forex transactions are carried out?

Every few years, questions are raised on the high privileges of the dollar. Recently, an Indian banker termed the dollar as the biggest financial terrorist in the world", where what he meant was that a reserve currency like the dollar, has disproportionate power.

Why such exorbitant privileges?

Let`s go back to history.

By mid 1944, during the World War ll, it was more or less clear that the Allied powers were likely to defeat Adolf Hitler led forces. At this time, countries came together to design a new financial system for the world.

And that`s how Bretton Woods system came into being where, the US dollar was established as the world's reserve currency, and all other currencies were pegged to the US dollar at a fixed exchange rate. In turn, the US dollar was pegged to gold at a fixed rate of $35 per ounce. It made the dollar the premier currency of the world and the only one that could be converted to gold.

US-Saudi Deal

In 1945, US made a deal with Saudi Arabia, which had the largest discovered oil reserves at that time, where in return for full American military support to the ruling clans of Al-Sauds, Saudi decided to price oil in dollars.

Given that the dollar can be converted into gold and the fact that most countries imported oil, dollar became a premier currency in the international markets.

De-pegging of Dollar

In 1971, Richard Nixon decided that the link between gold and dollar needed to be suspended. Essentially, the dollars that the countries held could no longer be converted into gold. But the did not disturb dollar`s position and people were more willing to hold dollars that were not backed by gold than they ever were willing to hold dollars that were backed by gold.

This gives dollar extraordinary powers which continues even today. Other countries need to earn these dollars in order to pay for commodities whereas the US can simply print it.

In fact, these privileges were of help to the whole world when US Fed printed dollars in the aftermath of 2008 financial crisis and managed to rescue financial institutions across the world. On the flip side, when the Fed printed money post COVID, it created bubbles in stocks, real estate, bonds, cryptos etc.

The Doubt

Recently, collapse of Silicon Valley Bank, Signature and First Republic Bank, raised questions about the stability of US dollar.

Another reason is Russia-Ukraine war, where US has used its privileges to make things difficult for Russia. The access of 10 Russian banks to SWIFT was cut off, which makes it very difficult for a country to carry out international trade, given that a major chunk of it is carried out in dollars.

Its not the first time when US has made such a move. In the past too, sanctions have been slapped on countries like Venezuela and Iran.

It perhaps led the Brazilian president to recently say in China: " Every night I ask myself why all countries have to base their trade on the dollar... Why can`t we do trade based on our own currencies? "

Facts and Figures

As of December 2022, more than 58% of the global forex reserves were in dollars. Now, if we want to build a case where the world is moving away from the dollar then we can say that in 1995, 59% of forex wee in dollars and in 2022, its 58%. The nuanced position is that the world is moving away from dollar but at very slow pace.

The Problems

This certainly does not mean that there is no problem.

• First, every time US uses its privileges as sanctions, it incentivizes countries to look for alternatives. For example, recently, central banks are buying alot of gold to move away from dollars.
• Then, 16% of Russian exports were paid for in Renminbi, further Cross-Border Interbank Payment System, China`s alternative to SWIFT is picking up.
• Also, many countries are working on central bank digital currencies to make payments for bilateral trades.
• Even, Saudi seems to gradually move away from pricing oil in dollars.

The China Challenge

China has grown at a very fast pace and its GDP in 2021 stood at $17.7 trillion against US GDP at $23.3 trillion. But, Chinese economy continues to be largely a closed one where capital cannot move in and out freely. US satisfies this condition with different types of investment assets being available in dollar. Plus there is great liquidity in dollar denominated assets.

This explains why as of December 2022, only 2.7% global forex reserves were in Renminbi.

China cannot let money move freely primarily because Chinese growth model rests on the government channelizing mass domestic savings into infrastructure projects. Allowing money to move freely increases the risk of domestic savings moving out of China.

Finally as far as India is concerned, what should we choose? Going towards US dollar or make up our minds with Chinese renminbi?

Ofcourse, a Non-Aligned Movement kind of stance won`t work well here, atleast.