While a combination of economic, geopolitical and technological forces shaping the international monetary system will erode the US dollar as the dominant international currency, its role will likely persist. — China Daily
The Federal Reserve’s (Fed) aggressive stance on inflation fighting and recent extraordinary steps to stem contagion in regional banks turmoil through increasing the amount of US dollar in its banking system as well as increase the use of US dollar swap lines among central banks to boost the flow of dollars within global financial markets, will likely buttress the dollar’s dominant position.
For decades, many have long predicted that the United States’ unsustainable budget deficit and debt level, the structural changes in the world’s economic and financial order, China’s increasing dominance in the world economy as well as the evolution of financial technology and digital currencies have threatened the dollar’s stature as the world’s reserve currency and have weakened the US dollar’s market share in global cross-borders payment systems.
Talks of reducing the dependency of the US dollar have resurfaced: Argentina and Brazil are in early talks to create a common currency, as part of a coordinated bid to reduce their reliance on the US dollar.
Saudi Arabia declared its openness to trade in other currencies other than the greenback for the first time in 48 years.
In Asia, Prime Minister of Malaysia has proposed to revisit the Asian Monetary Fund (AMF), stressing the need to reduce reliance on the greenback as well as the US-backed International Monetary Fund (IMF).
While a number of countries have had the potential to become a reserve currency, they haven’t been able to displace the US dollar as in the case of Japan in the 1980s and the euro in the 2000s. China yuan is now presenting a compelling case as it has a lot of metrics working in its favour.
As the international monetary system undergoes a transformative shift towards dedollarisation to reduce reliance on the US dollar as a reserve currency, medium of exchange, and unit of account, the developing countries must carefully weigh the potential benefits and risks associated with this transition. The economic and financial costs of such transition will have broader effects on exchange rate, trade, investment and capital flows.
Is there an end of the dollar’s dominance?
A slow decline in the dollar’s dominance since 2000, with its share of global reserve currency has been shrinking to 58.4% as at end-4Q22 from 62.2% in 2010; 71.1% in 2000 and 65.1% in 1997.
The US dollar accounts for more than 75% of all trade outside of Europe, about 60% of all international deposits and loans.
Almost all commodity contracts, including those for oil and wheat, are priced and settled in dollars. The dollar is used to denominate and settle a majority of international financial transactions.
Have there been any significant shift into other reserve currencies? It is observed that the reduced share of the US dollar hasn’t been matched by significant increases in the shares of other traditional reserve currencies: the euro (4Q22: 20.5%, 2000:18.3%); Japanese yen (4Q22: 5.5%, 2000: 6.1%); and pound sterling (4Q22: 4.9%, 2000: 2.8%). The share of yuan held as reserves more than double to 2.7% in 4Q22 from 1.1% in 4Q16.
While a combination of economic, geopolitical and technological forces shaping the international monetary system will erode the US dollar as the dominant international currency, its role will likely persist given its appeal metrics: deep and liquid assets class and instruments; tradability and convertibility; and financial network effects and payment system.
Creating a viable alternative reserve to the US dollar must have the requisite degree of stability, liquidity, and acceptability, underpinned by a resilient economy, deep and liquid financial markets, and credible monetary and fiscal management. So far, no single currency fully meets these criteria although the Chinese yuan has made some strides.
Revisiting the AMF
Malaysia proposes to revive the 1997-98 Asian Financial Crisis’ decades old idea to create an AMF so as to enhance Asian-governing regional financial arrangement while reducing reliance on the US dollar.
The AMF, which was mooted by Japan did not receive much support then (Asean and South Korea have expressed support for the proposal, Hong Kong and Australia remained neutral, and China voiced no opinion).
Nonetheless, the discussions have eventually brought about the Chiang Mai Initiative Multilateralisation currency swap arrangement between Asean+3 members, which came into effect on March 24, 2010.
Is it time ripe for the establishment of the AMF?
Countries in East Asia is recognised as a third major pole of the world economy. Amid a tectonic shift in global realities, the region is a position of strength and resilience to face challenges.
East Asia region needs its own institution to determine its own future with policy responses best suited.
Debates over the AMF proposal will evolve around distributive political issues rather than economic efficiency.
While an AMF arrangement allows the Asians to assume greater decision-making influence and may be more effective in dealing with regional contingencies, it must not compromise in the distributive nature of liquidity provision versus moral hazard trade-off such as good governance and structural reforms.
An AMF could be created with a structure whereby the power would be shared more equally than the status quo in the IMF.
It can provide a valuable regional financial resources and liquidity line of defence complementing the IMF, and would respond immediately on Asians’ needs.
How to make the regional orientation AMF work? Asia needs a reimagined regional financial architecture (reserves) that is not largely in the dominance and influence of single country’s authority.
It cannot merely replace dependence on the dollar with a reliance on other currencies, such as the yuan.
Can the yuan be a viable contender to the US dollar?
China has been making efforts to internationalise the yuan as a formidable competitor to the greenback through a wide and deep economic integration in the world economy.
China accounted for a 18.6% of aggregate global growth in 2021 and took up 14.7% of the global export market.
Increasingly, the yuan has evolved over time as a unit of exchange and global payment currency in the international trade and financial markets through deepening its cross-border applications.
By end-2021, the People Bank of China had signed bilateral currency swap agreements with over 40 central banks and monetary authorities involved a total value of over four trillion yuan.
With China retaining its position as Asean’s largest trading partner since 2009, the yuan cross-border inter-bank payment system (CIPS) now covers all Asean countries. In 2021, an extra 16 financial institutions in Asean countries became indirect participants of CIPS, with the total value of China-Asean cross-border yuan settlement hitting 3.3 trillion yuan (RM2.1 trillion). China is also exploring ways to use the digital yuan in cross-border transactions.
As a reserve currency, the yuan’s share in the IMF’s special drawing rights (SDRs) basket rose from 10.92% in October 2016 (the year the yuan was included in the SDRs basket as a fifth currency) to 12.28% in May 2022.
Will yuan’s rise challenge the US dollar’s dominance?
Although the share of yuan held as reserves more than double to 2.7% in 4Q22 from 1.1% in 4Q16, its increasing share is constrained by the country’s relatively closed capital account.
The yuan is not fully convertible, which means that it is convertible for trade and foreign companies’ conversion of profits to their home country currencies under the current account.
But it is not freely convertible under the capital account, which covers portfolio investment and borrowing. China has said it would eventually make the yuan fully convertible, but only after the authorities acquire adequate capabilities to regulate the financial markets.
China’s financial markets, especially the Treasury market, are not yet as liquid as the US dollar markets.
Clearly, China has positioned the yuan as a potential reserve currency status. The path ahead for the yuan’s wider international acceptance is a formidable challenge.
Lee Heng Guie is Socio-Economic Research Centre executive director. The views expressed here are the writer’s own.
