Today it has become fashionable for people to curse the dollar. The US currency has been blamed for many financial ills, and the Silicon Valley Bank (SVB) crisis was icing on the cake, as it happened in the US. There are political and economic reasons for this.
On the political front, the Ukraine crisis was the trigger. In the past as well, the US has used the threat of sanctions against countries to deal with Iran and all have complied. But Russia is different considering its strength. It has large foreign exchange reserves locked in US dollars and now finds these funds frozen. Countries cannot pay Russia in dollars because the global payment system SWIFT (Society for Worldwide Interbank Financial Telecommunication) is controlled by the US. While the US would like all countries not to deal with Russia, this was not possible, as Europe still receives gas from this country. So, America has shown resilience, which smacks of double standards. This has forced countries to seriously think about using other currencies or even their own currencies to deal with other countries. The fear of future retribution for non-compliance is palpable.
The economic reason is also strong, but surprisingly never came to the fore. Why is it that the whole world is so affected by the decisions of the US Fed? When the Lehman crisis hit, the world was in turmoil. When the Fed adopted quantitative easing (QE), everyone benefited as money flowed freely into emerging markets. When the Fed started tightening, the markets started trembling everywhere. When the Fed raises interest rates, all central banks get excited. At the same time, the US is running high deficits that analysts cannot tolerate for others. ‘The country is living beyond its means’ is the feeling of today. And the decisive argument was the SVB failure. The bank invested in the safest asset, US Treasury bonds. Yet, when he had to sell those securities to pay deposit holders, he had to do so at a loss. Therefore, even the safest property turned out to be toxic.
All central banks hold dollars as foreign exchange reserves, and they will find themselves out of money if they hit fair mark-to-market valuations. Ironically, the dollar is still the most sought-after asset. International Monetary Fund (IMF) data on holdings of foreign exchange reserves show that after the Ukraine conflict, the share of USD has virtually not changed and remains close to 60%, followed by the Euro at 20%. The yen and the British pound come next. The renminbi has a lower share compared to the Swiss franc and the Australian dollar.
But why does the world need anchors? The reason is simple. As countries deal with each other, there should be a common standard for currency conversion. Which started as gold and then moved to pound and later IMF’s SDR (Special Drawing Right) was fixed to dollar. The world may not go back to gold, as it has a limited supply and cannot be easily mapped to currencies. The euro was considered an alternative and worked reasonably well until the euro crisis, which showed the contradiction of having a common currency for 20 countries with different fiscal views. Germany is a symbol of financial stability, but the same cannot be said about Italy and France. Nevertheless, the eurozone currency has persisted, although it does not offer comfort as an anchor. It works because of the binding factor that its users are democracies with market systems.
The lesson is that the country running the anchor should be big. America had that power. China is now the largest economy based on purchasing power parity (PPP). But does anyone trust China? It has historically been known to manipulate its currency and finance rogue regimes. Therefore, just as ‘Made in China’ has little credibility for some goods, so does the renminbi. India is the third largest country by PPP. Can Rupee Reign Supreme?
We can think like this while riding on the high horse of the ego. The acceptability of the rupee will likely be limited to countries that have deficits with India. We would like to trade rupees with other countries. But what will Russia do with the money it receives from India? If he wants to import goods from China, will China accept the rupee?
So, while we have made a modest effort to facilitate rupee trade, it will take time for the idea to gain acceptance. We need to enroll other trade partners who will be able to use their rupees to buy goods from India. The US and the European Union are the major export destinations for India and would be other oil exporting countries. Bringing the latter into our fold sounds laudable, but their requirements from India are limited to a basket of refined petroleum products and food items.
This means that whether we like it or not, the dollar will continue to dominate. The anchor country has to run high deficits and spend more than it earns to ensure that currency is available for others to invest. If not, what will countries do with their foreign exchange surpluses? America has taken up this role, but it must act more responsibly because it has been given this privilege by global consensus. Freezing Russian assets or cutting off countries from SWIFT should ideally not be done, as it undermines the credibility of the USD. Politics and economics should not be mixed if we are to maintain the global economic order. This message must reach the White House, or else the world will struggle to find alternatives. And it could prove disruptive.
Madan Sabnavis is Chief Economist, Bank of Baroda and author of ‘Banking Trends and Controversies’
These are the personal views of the author.
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