Hegemony of the US dollar and finding an alternative

ByHindustan Times
May 02, 2023 06:43 PM IST

This article is published by Mehdi Hussain, doctoral candidate, Centre for South Asian Studies, Jawaharlal Nehru University, New Delhi.

The US dollar is in a dominant position in global trade and has a significant role in the international financial market. An indication of its strength is its huge share in the global foreign exchange reserves which is about 58% in fourth quarter of 2022 in comparison with 20.47% of the Chinese renminbi (RMB), 5.51% of the Japanese yen and 4.95% of the pound sterling. However, there has been a debate asking for an alternative currency to US dollar.

US dollar (Reuters)
US dollar (Reuters)


Economist Gita Gopinath argues that the global trade is ‘heavily invoiced’ in dollars which makes it a dominant currency. She and others have shown that, in terms of currency’s share as an invoicing currency in global exports, US dollar has 4.7 times its share in global exports. It indicates that even non-US exporters use dollars as invoicing currency for their exports. However, the euro’s shares 1.2 times the share of euro country exports. Then percentage wise India’s invoicing of exports in dollars is about 86% of its total exports but it exports 15% of its total exports to the US, while its invoicing of imports in dollars is about 86% of its total imports but it imports about 5% from the US Japan uses the yen for invoicing of exports of about 40% and the UK uses the pound for about 51% for the same. The US carries out its invoicing in dollars for about 97% of its exports and 93% of its imports. Dollar invoicing is applicable to several items of global trade.


Therefore, Gopinath establishes that the strength of the US dollar is a key ‘predictor’ of global aggregate trade volume and consumer/producer price inflation. She and others called this a ‘dominant currency paradigm’. If the US sneezes in terms of its domestic monetary policy changes, the entire world catches cold i.e., fluctuations in global trade prices and quantities reflective of the dominance of the dollars. The reverse impact of monetary tightening in non-US countries on US inflation is minimal.


Then, the US dollar continues to carve a niche position in the international finance. Dollars as a ‘safe haven’ along with its low cost of borrowing is preferred by investors and financial institutions (both banking or non-banking). They see dollars for its effective currency hedge in times of downturns compared to other international reserves. According to a study in the Bank of International Studies Quarterly Review for December 2022, as a ‘vehicle currency’ in global banking dollar dominates with 88% of about $97 trillion in the foreign exchange outstanding of all currencies at end-June 2022. Thus, in a foreign exchange swap, an investor or bank interested in swapping from Swiss francs to Polish zloty would swap francs for dollars and then dollars for zloty. The study further states that in outstanding dollar positions, non-banks – such as pension funds, insurance companies or hedge funds – outside the US borrowed $26 trillion dollar at end-June 2022 (for dealer banks it was $52 trillion) up from $17 trillion in 2016. The increased in dollar debt follows their preference to hedge their borrowings in dollar receivables and investments since dollar is the dominant international currency.


For an alternative currency, the internationalisation of the Chinese RMB is limited with 2% of all global cross-border payments and 3% of central bank reserve assets, according to an International Monetary Fund (IMF) paper. However, since its inclusion in the Special Drawing Rights in 2015 by the IMF, we could see a growing of RMB footprints as international currency. The IMF study in 2023 states that the RMB is becoming an ‘anchor’ currency in East Asia and finding its way in emerging markets such as Chile, Turkey, and Argentina. It studied 125 economies for RMB usage, which increased from 0% in 2014 to 20% 2021).


An increasing internationalisation of the RMB is related to the usage of US dollar as a geopolitical tool against countries like Iran and Russia, both find it easier to trade with China in RMB. It encourages nations to seek for alternative currency to bypass US dollar and the global payment system. The US sanctions against Russia in the wake of the Ukraine-Russia war since February 2022 and the US-China trade war encourage Russia and China to use their own currencies in bilateral trade without US dollars. Similarly, Russia and Iran discussed for introducing crypto currency backed up by gold for bilateral trade. Both countries started a new bilateral trade system based on their currencies on July 19 last year that could shun dollars.


Increasing financial integration has led to a fear of probable foreign currency liquidity shocks. Besides, cross-border trades are settled in US dollar which can expose emerging economies to vulnerability of shortages of dollar currency. A global effort to cushion liquidity shocks is in the form of Global Financial Safety Net (GFSN). It is a set of institutions and mechanisms securing liquidity supply in the face of economic crises caused, for instance, by the Covid-19 pandemic and others. It is composed of four liquidity sources: International reserves of countries, bilateral swap arrangements, regional financial arrangements and the IMF.


According to an IMF paper published in 2021, GFSN amounted to about $18.5 trillion at end-2020. Out of this, gross international reserves stood at $14.3 trillion, bilateral swap lines (BSL) at $1.9 trillion, regional financial arrangements at $1.3 trillion and the IMF at $1 trillion. We can see a significant contribution coming from bilateral swap lines whereby central banks enter into agreements facilitating currency exchanges to enhance liquidity in financial markets. BSL increased by about $640 billion from its end-2015 level. During the pandemic, several countries entered bilateral swap arrangements with China. China signed BSL with Lao PDR; while increased its BSL size with Chile, Pakistan and Hungary; as well as included Egypt, Mongolia, Argentina and Thailand in it separately. Similarly, during the crisis regional financial arrangements were seen, for instances, the European Stability Mechanism in Europe and the Chiang Mai Initiative Multilateralization in Southeast Asia.


Given the Chinese limited liquidity abroad, bilateral currency swaps with Canada, the European Central Bank and the UK are promoted by the People’s Bank of China (PBC). According to an IMF study in 2023, an estimate of about 4 trillion RMB worth of 38 BSLs (generally signed for three years) outstanding are there as of 2022. And, PBC has started offshore clearing banks (27 in number as of 2020) in 25 economies in order facilitate RMB payments. It is a significant expansion since its first offshore clearing centre in Hong Kong in 2009 to settle trades in RMB with Hong Kong, Macau and the Association of Southeast Asian Nations.


Overall, RMB global usage is still limited by its lack of financial market development and capital account restrictions, despite having a remarkable share in global trade and its economic size. China’s financial integration globally is sluggish given its tight capital mobility and closed capital accounts. Thus, the RMB has limited convertibility into a foreign currency and vice versa. The US dollar is still a currency hegemon having far-reaching implications on global financial stability and trade, capital flow movement and macro-economic policy. However, it is predicted that the RMB will become a major currency of trade settlement in international market in the medium-to-long term. The debate surrounding alternative currencies also revolves around the restructuring the international finance system which is more inclusive to emerging economies.


This article is published by Mehdi Hussain, doctoral candidate, Centre for South Asian Studies, Jawaharlal Nehru University, New Delhi.

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