IN the walk An aggression that drew international condemnation sent Russian officials panicking that their dollar-denominated assets, which were within reach of the United States, were at risk of being suddenly confiscated, sending shockwaves through their options. The invasion did not take place in 2022 or even 2014, but in 1956, when Soviet tanks entered Hungary. The event is often cited as one of the reasons why the Eurodollar market has begun – a network of dollar-denominated deposits outside the United States and beyond the direct reach of its banking regulators in general.
The irony is that the desire to keep the dollar outside the US has only strengthened the greenback’s heights. As of September, banks outside the country reported liabilities of about $ 17trn dollars, which is double the equivalent of all other currencies in the world. Although the euro dollar deposit is out of Uncle Sam’s direct control, the United States can still block access to a target in the dollar system by illegally trading with them, as it has done in its latest move against Russia.
The new outbreak of the financial crisis has raised questions about whether the dollar’s dominance has been tarnished and whether the Chinese yuan could play a major role in the emergence of a multifaceted monetary system instead. To understand what the future might hold, it is worth considering how the role of the dollar has evolved over the past two decades. America’s economy is large and its dominance reflects more than its government is strong. The fluidity, flexibility and reliability of the system have also helped, and will probably help maintain its global role. In the few cases where the dollar has lost value, the features that make it king are still being sought by holders and users – and not the yuan.
Eurodollar deposits illustrate the role of greenbacks as a global resource. But that’s not the only thing that makes the dollar a truly international currency. Its role as a unit of account, in most world trade shipments, may be the most irresistible area of its dominance. According to research published by IMF By 2020, non-Americans and more than half I Exports are marked in dollars. Shares in Asian emerging markets and Latin America rose about 75% and about 100%, respectively. With the exception of a slight increase in euro invoicing by some European countries that are not part of the currency union, these figures have changed little over the last two decades.
Another pillar of the dollar’s dominance is its role in cross-border payments as a medium of exchange. The lack of natural liquidity for small currency pairs means that it often acts as a vehicle currency. An Uruguayan importer can convert a Bangladeshi exporter to his peso into dollars and convert those dollars into rupees without paying them directly into currency.
So far, little has changed since the greenback: only one in five transactions registered in February. Swift There was no dollar leg in the messaging system, an image that has only changed in the last half decade. But moving away is not impossible. Smaller currency pairs can become more liquid, reducing the need for intermediaries. Ishwar Prasad of Cornell University confidently argues that alternative payment networks, such as China’s cross-border interbank payment system, could weaken the role of greenbacks. He further suggested that greater use of digital currency would ultimately reduce the need for dollars. In particular, a direct link between the national payment systems created by central banks could be facilitated.
Probably the best example of global financing where the dollar is going to lose real and measurable central bank foreign exchange reserves. A study published in March by Barry Eichengreen, an economic historian at the University of California, Berkeley, shows how the presence of the dollar in central-bank reserves has declined. Its share has fallen from 71% of global reserves in 1999 to 59% in 2021. The phenomenon is widespread across various central banks, and cannot be explained by exchange rate movements.
The results reveal something compelling about the new competitors to the dollar. The lost share of Greenback basically translates into a large part of what Mr. Eichengreen calls the “unconventional” reserve currency. The yuan makes up only a quarter of the group’s share in global reserves. The Australian and Canadian dollars, by comparison, account for 43% of this. And the currencies of Denmark, Norway, South Korea and Sweden make up another 23%. The things that unite these unequal small currencies are clear: all are floating and issued by countries with comparatively or fully open capital accounts and are governed by a reliable political system. In contrast, the yuan does not tick any of those boxes. “Every reserve currency in history has been a leading democracy with checks and balances,” said Mr Eichengreen.
Royal troops
Although the debate over whether the dollar could be replaced by the yuan captures the zeitgeist of the great-power competition, the reality is even more shameless. Capital markets in countries with predictable legal systems and convertible currencies have deepened, and offer better risk-consistent returns than many treasuries. This has allowed reserve managers to diversify without compromising on policies that make reserve currencies reliable.
Mr. Eichengreen’s research speaks to a simple truth with a broader application: a pure economic downturn is almost not enough to build an international monetary system. Even where the dollar’s dominance seems to be the most likely to be cut, the yuan’s appetite for even a small portion of its space seems limited. Whether or not the greenback retains its leading role in the international monetary system, global currency holders and users will continue to provide liquidity, flexibility and reliability. Not every coin can afford them. 3
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This article was published in the Finance and Economics section of the print edition under the title “Once and for all the future king”