The american dollar has enjoyed the status as the king of forex currencies for decades. Thanks to both the world wars, the US dollar emerged as the most preferred currency for international trade and investments. Ironically, yet another war, the ongoing war between the Russia and Ukraine may prove to be the catalyst required to end the dollar dominance.
Dollar Dominance And The Problem
The dollar dominance began as the aftermath of both the world wars. The Bretton Woods agreement consolidated its position as such(it is an large topic which would make us go off-course so I am unable to discuss it here). Although dollar faced periods of high inflation, it championed over it and maintained its supreme position. Stability, availability and ease of doing business has made dollar the most preferred foreign currency for trade and reserves. With dollar involved in some 90% of the total forex trading in forex market, its position as the king of forex remains unchallenged.
However, the rule of thumb is that monopoly in any field is bad news for the consumer. And it applies here too. The dollar hegemony gives US an 'exorbitant privilege', as pointed out by Valery D'Estaing(president of France 1974-1981). For example, if France wants to increase its oil import, it has to earn the extra dollars first. However, if US wants to increase its oil import, all it has to do is just print the required dollars. And this is the reason why the US can and does arm twist many a nation into submitting into its demands. It also gives US an unjust power to cripple or destroy economies(Iraq and Venezuela for example), which is unjust in a free world. It also forces many nations to alter their policy according to the whims of US, which many a times often clash with their own interests.
What is Forex Currency And Forex Reserve?
Foreign exchange currency is nothing but the currency required to make international payments possible. For example, in an Indo-american trade, India would need to pay US in US dollars if it wants to import something. Likewise, if US needs to import something from India it has to make payment in INR(Indian Rupees). This is what gives rise to foreign exchange(forex) and the currency involved in the trade or investment is termed as forex currency.
Now, the value of currency keeps on fluctuating constantly due to various factors such as the demand and supply owing to international trade, monetary policy of the country which the currency belongs to, etc. Though a normal fluctuation is given, a large scale fluctuation can adversely affect the economy of a country. Resulting disruption of the import-export balance, negative impact on foreign investments and interest rates, rise in inflation can potentially lead to destabilization of the economy. To insulate the economy from such catastrophe, nations maintain an adequate reserve of forex currencies which is called as forex reserve currencies. Forex reserve may also consist of multiple currencies, gold reserves, bonds and treasuries issued by governments of various countries etc. Special drawing rights(SDR, a pool of various international currencies), which is issued by International Monetary Fund(IMF) can also be a part of forex reserve of a country.
The Changing Times
The winds of change has been blowing for some time now. Countries have been trying to consciously cut down on its dollar dependence for some time, especially since the emergence of Euro. According to IMF's latest report, the share of US dollar in forex reserves is down to 59%, its lowest in the past 25 years. Share of Euro has rose to 21%, followed by pound and Yuan. Billionaire fund manager Stanley Druckenmiller warned in May 2021 that dollar may lose its dominance within 15 years. Well, if a man who predicted and made millions out of Pound Sterling leaving the European exchange rate mechanism is making a claim, I am definitely pondering over it.
One of the reason for dollar hegemony was that post world war 2, US was the manufacturing hub of the world. But today US contributes less than a quarter of global gross domestic product, it is imperative that other currencies will start gaining traction. Russia and India have already started trading in rouble-rupee exchange to bypass the sanctions imposed on Russia. Recently, Iran, yet another victim of US sanctions, too has offered crude oil to India worth 30 billion $ in an rupee-riyal barter which is being seriously considered. China and Kingdom of Saudi Arabia(KSA) are considering trading in chinese yuan, which will be a huge dent in dollar dominance.
The world is also getting increasingly wary of US's sanction happy policy. US recently sanctioned Russia, rendering its 600+ bn$ of its international reserves useless. It also froze half of Afghanistan's 7bn$ reserve. This actions has started raising huge doubts about the reliability of the dollar as dependable reserve currency. Also, many a nations have to sacrifice their own interests and submit to US demands, which are sometimes grossly inconsiderate of the nation's situation. The US, owing to its dollar dominance, on many occasions forcefully influences a nations foreign policy, which again is akin to challenging the sovereignty of the nation.
Although there is no immediate challenges to the US dollar, the situation is changing fast, especially amidst the ongoing war. Most of the countries, including the one with smaller economy, are diversifying their forex reserves. In-order to protect its economic and geo-political interests, dollar independent international trade is being mulled by many key players such as China, Russia, India and Saudi etc. While the fate of Ukraine-Russia war is undecided, the war may end up giving a new direction to the future of international currencies.