US dollar and euro banknotes are photographed in Frankfurt, Germany. , Photo Credit: Reuters
AAs China, India and Russia join hands in trade using partner currencies for payments instead of the US dollar, various media are rife with speculation about the demise of the dollar as the world reserve currency. How much truth is there in this claim? not much.
rise of the dollar
The status of the US dollar as the preferred currency and reserve currency for international trade is not the result of any purposeful policy or international agreement. The rise of the dollar as a world currency is closely tied to the rise of the US as one of the world’s strongest economies with a deep financial system and a stable government. This is not to say that there were no competitors. Starting with the Great Britain pound to the emergence of the euro as the currency of the European Union, the dollar’s position has been challenged from time to time. However, the dollar continues its dominance unabated.
According to International Monetary Fund reports, the dollar’s share of foreign exchange reserves has fallen over time from 80% in the 1970s to about 60% in 2022. this fall. Smaller currencies such as the Australian and Canadian dollars, the Swedish krona and the South Korean won have claimed their share of the portfolio of foreign exchange reserves of various countries, making up most of the remaining 20% gap, with the Chinese currency making up the rest.
China runs a closed capital account, which explains why it is still not a major option in which to maintain reserves. Russia holds most of the renminbi reserves held outside China. In fact, both these countries store each other’s currency in the form of foreign exchange reserves. From this point of view, the trade arrangement between China and Russia is more important. However, even though India’s largest supplier of oil is Russia, followed by Saudi Arabia and Iraq, according to recent data, its largest trading partner is still the US. Furthermore, Russia’s importance as an oil supplier is a result of the heavy discounts offered by its oil suppliers to Indian refiners. Such relaxation will not be sustainable for long. This casts some doubt on the long-term viability of a common currency or a reciprocal trade arrangement between China, India and Russia as geopolitical compulsions push India closer to the US.
dollar-denominated assets
As well as general acceptance as a medium of exchange for international trade, demand for dollar-denominated assets around the world has also led to demand for the US dollar. Debt issued by the US government is purchased by many countries around the world as a hedge against currency fluctuations affecting the valuation of reserves. US government debt and other dollar-denominated assets also serve as quality collateral in international transactions. Additionally, many currencies are pegged to the US dollar and some countries use the dollar as their currency. This means that a large proportion of US dollars reside outside the US. China has substantial reserves of US dollars earned from its trade with the US over the last three decades, which in turn has increased its economic power around the world. It has used these dollar reserves to finance its strategic investments abroad. All this fueled the demand for the dollar and strengthened its importance in the international financial system. Any currency competing for the US dollar’s status as an international reserve currency must also provide these additional services. This is not a trivial task which can be accomplished in a short amount of time.
Countries fighting to replace the US dollar as the world currency with their own currency is understandable. Being the supplier of international reserve currency confers a distinct advantage over the issuing government – the ability to borrow at a lower interest rate. As the US government debt is in high demand across the world, it is issued at the lowest interest rate. It lowers the fiscal constraint substantially, increasing the debt-issuing government’s ability to borrow more without having to deal with the negative effects of such borrowing on the domestic economy. This phenomenon is often referred to as a dollar premium and is something that many other governments would like to access, including those of China and Russia.
Thus, the use of the US dollar as an international reserve currency is not over. The only serious contender at this point is the Euro, which is second but a long way off. The chances where the Chinese currency or any other common currency could become a serious contender are slim and far-fetched at this point. This is not to say that the current system is optimal and should not be improved. However, to expect a common currency or any such mutual trade arrangement between China, India and Russia would be an exaggeration.