The Future of the US Dollar

Of late, the future of the United States (US) Dollar (USD) has been a topic of discussion, with some concerns that the currency might be losing its global influence. In what is being referred to as de-dollarisation, some important countries have signalled their intention to settle some of their bilateral trade in their own currencies rather than the USD.

For example, on 1st April, India and Malaysia announced that they had agreed to settle their bilateral trade in Indian rupees. Similarly, in late March, China and Brazil – two major emerging economies, reportedly arrived at a deal to trade in their own currencies, abandoning the USD as an intermediary.

For context, central banks around the world hold roughly 60 percent of their foreign exchange reserves in USD. Furthermore, approximately half of international trade, loans and global debt securities are conducted in USD.

For over 60 years, the USD has been the world’s primary reserve currency and the backbone of the global economy. It has also been a major part of US foreign policy, since the reach of the USD has allowed the US government to execute sanctions on those countries which run afoul of the US.

It is perhaps this latter point which is seemingly placing added pressure on the USD now. In the immediate aftermath of Russia’s invasion of Ukraine, the US and its allies imposed sweeping financial sanctions on Russia. Currently, the US has about 38 sanctions programmes in place, affection countries such as China, Cuba, Ethiopia, Iran, Lebanon, Nicaragua, Zimbabwe and Venezuela.

Increasingly, countries are becoming wary of being caught up in US sanctions diplomacy, made easier by the sheer global dominance of the USD. Of course, for a multiplicity of reasons, it is highly unlikely that dollar dominance will disappear overnight.

According to Carmen Reinhart, Vice President and Chief Economist, World Bank Group, the USD is close to or at its peak as a global reserve currency. Here, it is important to recall that the USD is a major reserve currency for central banks, it is also the currency that much of the developing world denominates its debt in, and it also plays an important role in exchange rate policies in terms of the currency that emerging markets anchor their currencies in.

Reinhart has expressed her scepticism of the belief that a replacement for the US is around the corner. She has noted that financial institutions and investors typically hold debt in USD, and that the liquidity and the depth of the US Treasury market at the moment remains unparalleled. As such, Reinhart does not consider the USD to be at an immediate threat of losing its dominance.

Furthermore, according to Eswar Prasad Tolani, Senior Professor of Trade Policy, Cornell University, the depth and breadth of the US financial markets, and the institutional framework that supports the currency, makes it hard to envision a rival to the dollar.

However, this does not necessarily mean that the USD is going to be as dominant in terms of the global economy, as it has been in the past. For example, China and India are fast advancing in terms of their share of the global economy. Tolani also observes that in the last few years, there has been a re-jiggering of the relative importance of the second-tier currencies such as the Euro. Therefore, while the USD’s position remains dominant, so-called second-tier currencies are likely to play a bigger role in the future.

In terms of the impact of current efforts towards de-dollarisation, especially on small countries, they may increasingly be required to trade in the currency of their trading partner.

Therefore, as the trade of Caribbean countries for instance grow with countries such as China, then the Yuan might play a bigger role in the region’s trade. Lenders outside of the US and international financial institutions such as the International Monetary Fund (IMF) may also demand that borrowers accept their currencies. Altogether, any such developments may require central banks to expand the range of currencies they have in reserve to facilitate these kinds of transactions.

Joel K Richards is a Vincentian national living and working in Europe in the field of international trade and development.
Email: joelkmrichards@gmail.com