The U.S. dollar is the primary reserve currency for the global economy making it the world’s most traded currency. A global currency is the recognized and accepted cash for universal transactions. It is also called ‘reserve currency’. Some currencies are also used for international transactions such as the euro, and the yen.
The sterling surpassed the guilder in 1860 becoming the global reserve currency after Britain became the center of international trade, amassing 30% of exports. Britain during the period was in colonial power, making it easy to coerce colonies into adopting sterling in transactions.
The beginning of the displacement of a pound by the dollar was after the signing of the Federal Reserve Act in 1913. The dollar which was hardly recognized internationally became a threat to the reign of sterling in the late 1920s. The dollar value gained prominence in 1931 after Britain stopped exchanging pounds for gold.
The U.S economy has been able to strengthen the dollar value making it the most powerful currency. The U.S. in 2018 had $1,671 billion in circulation with more than half the value of the figure estimated to be in circulation abroad.
A good example of a country influenced by the dollar is Nigeria. A higher percentage of citizens are transacting more with the U.S. dollar. This is a result of the increasing inflation and poor purchasing power of the naira.
Silas Ozoya, Founder/CEO of SUBA Capital LLC, in an interview with Nairametrics, stated that ‘many Nigerians are beginning to dollarize their spending, investment, and asset holdings to hedge against the ever-increasing inflation rate and our strong economic romance with recession’.
All efforts to curtail the country’s rising reliance on the dollar have yielded little results. The U.S. dollar has become a regular means of transaction in Nigeria. This is also a result of high dependence on imports which demands the use of dollars.
The dollar remains the king currency in the foreign exchange market as about 90% of forex trading involves the U.S. dollar. The International Standards Organization List reveals there are 185 currencies in the world of which the dollar is just one of them. However, the largest parts of these currencies are used locally, in their specific countries.
Although any of the currencies can replace the dollar globally, it, however, would be a significant challenge presently as they are not as widely traded as the dollar. It is said that nearly 40% of the world’s debt is issued in dollars thereby making it inevitable for foreign banks to operate without a large number of dollars.
The 2008 financial crisis revealed the extensive use of the currency as Non-American banks had $27 trillion in international liabilities denominated in foreign currencies. $18 trillion from the amount was in U.S. dollars. The U.S. Federal Reserve had to go with the option of raising its dollar swap line as it was the only means to protect the world’s bank from running out of dollars.
The financial crisis also increased the usage of the dollar. The banks of Germany, France, and Great Britain held more liabilities denominated in dollars than in their own currencies. Several governments invest their reserves in foreign currencies of which China and Japan are worthy examples. These countries buy the currencies of their main export partners.
The dollar continues to gain stature as the widely used currency for global savings, the widely used currency in the period of crisis, and the major fork of exchange for commodities such as oil making it the strongest world currency. Economists have stated that it may continue to maintain the standards of the top global currencies for a long period.
According to Mark Blyth, an international political economist at Brown University, “there is no alternative to the dollar. We’re stuck with the dollar, which gives the United States astonishing structural power.”
Giant countries including China and Russia are still contending the position of the dollar. These countries rather posit that a new one-world currency, not backed by any one nation should be adopted in a rising integrated global economy.
China in an attempt to improve the position of its currency, the renminbi, to be recognized as a currency of world power installed foreign exchange arrangements with some countries such as Canada, Britain, and Brazil for decades now.
China’s $1 trillion collections of global infrastructure projects referred to as the Belt and Road initiative endorsed by President Xi Jinping is one of the policies to intensify the global use of the renminbi. The country has already established a trading system in Shanghai which authorizes the purchase of oil in the Chinese currency.
The Chinese renminbi in the fourth quarter of 2016 became one of the world’s reserve currencies. The International Monetary Fund(IMF) revealed that as of the first quarter of 2020, the world’s central banks held $221 billion worth of renminbi.
There are nevertheless some hindrances to this great country as China’s economic downshift has been exposed revealing its rising debts and apprehension from neighbors who have concluded that the country’s investment is rather a new form of colonialism. Also, IMF has revealed that China’s currency is just about 2 percent of total reserves which is still a meager sum.
The considerably close competitor to the dollar in a long while is the euro which is the second largely prominent currency. This makes up 21% of central bank reserves.
The dollar, as a global currency is used for half of all cross-border transactions making it a necessity for central banks to keep the dollar in their reserves in payment for transactions. The outcome of which 61% of these foreign currency reserves are in dollars.
Jean-Claude Juncker, president of the European Commission last year while addressing the State of the Union expressed grief over the bloc as 80% of its energy imports were paid in dollars even though just a meager 3% came from the United States.
Mr. Juncker in his speech declared that “we will have to change that. The euro must become the active instrument of a new sovereign Europe.”
This is presently unrealistic as the most trusted euro-denominated investment, German government bonds, are in extremely short supply. Germany which is well known for its revulsion to debt maintains strict caution in the area of financing spending by selling bonds.
This in effect has propelled investors seeking highly stable places to amass savings to hardly consider the euro currency as a profitable option. American savings bonds on the other hand have almost boundless supply.
A succession of crises within the 19 countries that share the euro has elicited further controversy than harmony, uncovering a foundational defect. The euro is a common currency with no united political structure that can lead to a strong outcome in the occurrence of an economic crisis.
It is also doubtful that bitcoin could put back the dollar and emerge as the new world currency. The value of the currency is too volatile as there’s no central bank to regulate it.
The National Affairs newspaper gave some of the necessary conditions for a country’s currency to become a major reserve currency. The primary requirement, to begin with, is the currency must have assets for investors and other governments to purchase.
There must be a sufficient amount of those assets for sale. This is often referred to as ‘depth’, which means that an investor’s purchase of an asset denominated in that country’s currency would not displace the market for their assets in that currency.
Secondly, the country must have a robust export sector. The United States is the largest export partner in China, and second-largest in Japan.
Thirdly, modern reserve currencies are partly sustained through the domination of specific markets, especially commodities and distinct goods that can assist as inputs for final products. Some of which are globally traded commodities like oil, priced in dollars.
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Also, a country must have institutions well strengthened and supported by the rule of law with sufficient transparency that aids a robust and healthy financial system. This typically comprises possessing an autonomous central bank alongside a political obligation to abstain from expropriating foreign assets.
Establishing a new reserve currency will be an enormous task, but if solidified, would become very difficult to dislodge. Moreover, the dollar is yet to demonstrate underlying weakness. Between January 2008 and 2020, the dollar strengthened by 30%, rising from 89.2 to 115.
The U.S. economy is still recognized as the most powerful in the world. Investors bank on the U.S. government to back their currency. Although there are economic events that could cause a collapse, this, however, cannot happen without a corresponding incident that triggers uncertainty in the dollar.
The dollar collapse would also come with its tragic event of which majorly is global economic turmoil. Investors would scramble to other currencies, especially the euro, or maybe other assets such as gold and commodities.
Treasury market would drop, followed by an increase in interest rates. U.S. import prices would soar at an all-time high leading to inflation. Unemployment would also be heightened, leading to a recession or maybe a depression.
It should be noted that there is no permanent dominance in the global economy. The staggering question is not whether other currencies will emerge, but when. There might be changes in the future, but presently the dollar remains and continues to be the dominating currency in an unstable global economy.
Most assuredly, the dollar dominance is rather viewed with satisfaction by the majority of investors than contempt.