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Is US Dollar diminishing its ground as a reserve currency?

The US dollar, needless to say, is an international medium of exchange in trade and commerce to a great extent. After World War-2, it becomes the most powerful global currency officially termed as the reserve currency or vehicle currency. The ground, dominance and confidence in the US dollar are significantly diminishing – what is going to happen to the exporting or importing countries?

With time evolve, many global currencies dried and many of them even died due to a shortfall of political and economic relevance to the world. In 1900, USD was 0% whereas pound sterling stood as 62% in the total redeemable reserve of the global currencies. Comparing to other currencies, the USD reserve stands close to 60% now in the central banks of countries over the world. Central banks have to hold reserve currency for meeting liquidity demand, exchanging their own currency for international transactions, and diversifying portfolios to avert gloomy economic times.

Scope of the write-up

In history, at least for the last 600 hundred years, once the dominant currency gets weak, state itself gets weak or vice versa. Currency and capacity of global influence have a critical correlation that one enforces another to grow or fall with. Acknowledged, there must be some other interconnecting factors with the global influence.

  • Scope out: Though quite relevant and, the components are intertwined, yet – the writer will refrain from the discussion of the ideologies, civilizations, and their systems (state, politics & culture). A slight comparative dynamics would be seemingly apparent as requires showing the rise and fall of a currency.
  • Scope in: It will present the rise and fall of the global currency in the existing financial sub-system of the total systems. The financial subsystem of an economic system plays a major role shaping the total systems of a state and, henceforth the world. A global currency acts as an international medium of exchange in trade and commerce – here, the writer will limit the scrutiny.

Rise & Fall of Major Currencies in Brief

Six major world reserve currencies were found dominant since 1450 as – a) Portugal 1450–1530, b) Spain 1530–1640, c) Netherlands 1640–1720, d) France 1720–1815, e) Great Britain 1815–1920, and f) the United States from 1921 to till now. The average tenure of a currency was 94 years if we carefully notice the span of the rise and fall. The USD as a reserve currency has already surpassed 78 years (though the mere average was not taken in cognizance in analysis). Due to the reckless jump of the money supply in the current years and incapacity of creating value accordingly, it is inevitable to plummet its’ authority in the global storyline.

Global-Reserve-currencies-political-strength-countries
Figure 1: Global Reserve Currencies with relative political strength among countries.

Here we see the rise and fall, and most importantly, the intersection points between the power transitions among the global reserve currencies. The currencies of Spain and the Netherlands could not even exist after the 1860s. The US currency intersected and beat the British currency in the 19920s. The Chinese currency and the US currency are going to intersect each other in the near future, maybe by the next few years. It is long been said that China was economically and politically suppressed by the West and exploited by Japan from 1840 to 1949. They termed it as a “century of humiliation” for the Chinese nation that pulled china’s influence down in the global power dimensions.

The USD: The might and fight for leading the global financial system

USD had a first mint of money in 1914 with the establishment of the Federal Reserve Bank by an act of 1913. The WW-1 broke out in 1914 while European countries had to pay the large military expenditures. The UK and other European countries suspended the gold standard to print money on a massive scale. Later on, the UK completely abandoned the gold standard in 1931. They started to create money without any material base having no intrinsic value. Due to the massive production of money, the extremely devalued British pound lost its global dominance that paving the way for the USD to be replaced. The cycle of global leadership transition would keep the USA’s position drowning likely the UK had faced 100 years ago.

During WW-2 the US provided war materials to the allied countries. The countries were required to pay the USA in gold. This significant event made the USA a big gold reservoir in that period. Right after the war, the countries connected their currencies to the US dollar, those consequently connected to the gold reserve. Currencies were acted as promissory notes exchangeable or redeemable with gold – the gold standard retained.

Rise-fall-world-order
Figure 2: Rise and fall (the cycle) of world order.

If we notice the right side of the cycle, the money supply (printing money and credit) gets rampantly climb up to fight back the fall of the entire economy. In this position, the USA stands now right after the boom of the financial markets.

Some can argue that the USA faced alike situations earlier and returned back strongly. Yes. Because they had an undeniable political hegemony and an economic superiority in the world – these two major forces helped the financial sub-system out of fall. The situations are not that in favor of the US now and onward; a new world order has been approaching.

Global wrongful consensus for USD

In 1944, the representatives of 44 influential countries reached an agreement at Bretton Woods, USA to accept the USD as a global reserve currency backed by the sufficient gold reserve. Countries started to reserve USD other than the gold. It was fallaciously said – USD backed by gold – other currencies backed by USD; as if all currencies backed by gold.

The US, like its predecessor the UK, completely nullified the Gold Standard in 1971. The then US President Nixon provoked that it was a decision for a time being. He promised to go back to the Gold Conversion again but they never back. They denied the claimants of gold in exchange for currencies. Then the USD and other currencies are no more promissory notes, rather just colorful papers and authoritative signatures in the balance sheets of the central banks.

USD is in an adverse state of affairs

There were sheer similar periods of currencies (rise, fall and intersection points) in history. In addition, some unprecedented events would gear the fall of the dollar quicker. The Covid-19, China’s rise, war or military expense and the Russia-Ukraine (the US & west backed) war could expose the blunt deficiency of US dollar in day light. The USA stays now in a substantial dilemma – if they don’t inject a lot of currency in markets, they can’t recover the damages and if they do so, the dollar will lose its’ functional confidence. Currently, the West – Russia economic conflict will surely deepen the jeopardy for dollar in particular. The US and allied western countries hauling Russian reserve, issuing trade embargo, other financial sanctions and instituting mistrust among countries – would bring counterproductive results in return. These recent developments are triggering the plunge against the US dollar.

Federal Reserve Bank’s Balance Sheet
Figure 3: The Federal Reserve Bank’s Balance Sheet.

The graph above was drawn taking the data in 2020, the asset in the balance sheet is now close to 8 trillion dollars. Presently more than 60% of all foreign bank reserves are being denominated in US dollars in the world. Almost 40% of the global debt lies in US dollars. In the last 75 years, the global dominance for USD was prevalent. What will be the next?

The US treated the fiat currency as a ‘store of value’ instead of a ‘medium of exchange’ though unjustified. They quantify currency likely the commodity. In the name of quantitative easing, abrupt amount of money has been injecting to boost economic activity. Practically, a large share of those money don’t go to the economic programs rather to the financial instruments. Whether it is floating in cash or in debt, it has an enormous consequences to the economies connected with dollar. Henceforth, the price of dollars is not an asset they show in the balance sheet and in practice.

The value of US dollar was required to be determined by its’ equivalent goods or services having intrinsic utility. The magnitude of difference between the value of the dollar and its floating price misled global people and businesses. The quicker it flies upward the fall will follow. A massive injection and issuance of dollars those technically termed as M-1 and M-2 money supply (both in liquid or cash and bond, treasury, securities, etc.) must drag its power down sharply.

Federal-Reserve-Bank-Liquid-Money-Markets
Figure 4: Federal Reserve Bank Induced Liquid Money in the Markets.

Furthermore, the USA has been losing the strengths in its political, economic and human capital orbits.  As the very nature of capitalism, they put heavy emphasis on the financial economy than that of the real economy. Financial instruments, where most assets were kept in – like bonds, credits, securities, dividends, insurance, equities, mutual funds, hedging, derivatives, futures contracts, and other alluring financial schemes, will not be able to protect against the slip down.

Breathing Corner for USD

One negative strength can only help lead the US dollar for the next few years.  Other top reserve currencies (though insignificant in global reserve) like Renminbi 2.5%, Euro 21%, Pound 6.5% and Yen 6% – these currencies were unintentionally backing the US dollar to stay strong. The countries of these currencies have big businesses with the USA since USD alone held 59% of the global reserve. This negative support historically could not last long in the case of other currencies. The confidence in the USD is going to erode dramatically in near future will magnify the Chinese Renminbi as a reserve currency. In this existing financial system, other competing currencies will also undergo similar problems like USD.

The global dominance of the USA has begun to go down along with its currency. However, the US dollar having the status of “the reserve currency” can descend earlier before the tumble of the US hegemony.

Part -1 Ends.

Part-2 & 3: In this critical financial situation, what the textile and apparel industry can do – coming in the next issue. The fall of the US dollar must pose an agony both for exporting and importing countries. An economic catastrophe is way ahead. Yet, manufacturing countries like Bangladesh would perform better – how?

– The writer is an Innovation Strategist.

If anyone has any feedback or input regarding the published news, please contact: info@textiletoday.com.bd

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