The Future of Dollar as Global Currency

THE U S of America today is in the midst of a severe economic crisis. It did not face such a severe financial crisis since the Great Depression of the 1930s.The present crisis started in the year 2008 but it was believed that the bailout packages given by the government would end the crisis and the economy would be rejuvenated once again. However, the slowdown of the economy continued and the unemployment rate reached an all time high of 10 per cent.There is no sign of recovery of economy and it is feared that the US would get entangled into another bout of economic crisis.

Today we are in a strange situation and we cannot close our eyes to the problems of the USA. Even today, the US is the biggest economy of the world, and has business transactions with all most all countries of the world. The economic situation of US will therefore have an effect on the economies of all other countries. TheUS currency –– dollar –– is the primary reserve currency of the world and countries of the world stock up their foreign exchange mainly in US dollars. If there is erosion in the value of the dollar because of a slowdown of the American economy, it will have an effect on the financial transactions of all other countries. In the recent past, the Standard & Poor has reduced the credit rating of the US by one step –– from the top rating of AAA. This has seriously battered the prestige of the US as the superpower of the world.

It is in this background that serious attempts are being made for a replacement of the US dollar with an alternative currency. Many proposals have come forward for this replacement. Britain’s pound sterling was the reserve currency before 1944 but after the fall of the British empire, the US emerged as the strongest economy of the world and the US dollar became the reserve currency for the world. The US government’s assurance that the countries of the world could sell their US dollar reserves for gold at a fixed rate laid a strong foundation for making dollar as the global currency. However, after the economic crisis of the 1970s, the US could not keep its promise and expressed its inability to pay for the dollar in gold. The US then declared that the dollar’s value would change from a fixed exchange rate depending upon the market conditions. Even after this, dollar continued as the global currency as no other currency was in a position to replace dollar as reserve currency.

After the formation of the European Union (EU) in 1999, euro became the currency of the EU and it was thought that euro could replace dollar as reserve currency. The increase in the exchange rate of euro gave fillip to the idea of euro replacing dollar as reserve currency. The exchange rate of euro was 0.8 dollars in 2000 and it increased to 1.6 dollars by April 2008. Euro image was further enhanced, as it was not the currency of a single country but the group currency of many countries. Euro became popular as strong countries like Germany and France encouraged it. Many countries started storing up their foreign exchange reserves in euro. As a result, the share of euro in the total foreign exchange reserves increased to 27 per cent in 2009 from 17 per cent in 1999. However, the crisis in European countries like Greece,Portugal and Spain has thrown the EU into a financial mess and this resulted in the devaluing of the euro. The responsibility of continuing the value of euro does not rest on any one country. This has to be done by the central bank of the European Union and this is a collective affair. A sovereign country would protect the value of its currency by using its sovereign power. But euro is not owned by any particular country and it belongs to many countries. Its position as group currency of EU enhanced its image and popularity earlier. Now this very same status of group currency has spoiled its image and is responsible for its downfall. In this situation, no one is thinking of replacing dollar with euro as the reserve currency.

Japan is another big economy but it got stuck up in economic recession long before a crisis engulfed the US and Europe, and the idea of yen replacing dollar as global currency was given up a long time ago. Though the economies of India and China are growing rapidly, it is not possible right now to think that the currencies of these two countries would be able to replace dollar.

However, gold can be used to replace dollar as global currency. The demand for gold is increasing rapidly in the background of the decline of euro and vicissitudes in the value of dollar. The central banks of many countries are using their foreign exchange reserves to buy gold and, as a result, the price of gold is increasing. It is because of this that the price of gold has touched an all time high of Rs 27000 per 10 grams. However, the chance of gold replacing dollar as global currency is bleak. This is because today all currency transactions are done through computer networks and with a click of a mouse, money in crores of units is transferred from one corner of the globe to another corner. If gold is accepted as global currency, there will be a need to transport huge quantities of gold from one country to another. This will not be practical in these modern times, and we cannot go back to the Middle Ages.

There is a proposal to make the Special Drawing Rights (SDRs), in use by the International Monetary Fund (IMF), as global currency. However, this is not a specified and definite currency but only an accounting unit. Its value changes depending on the exchange rate of some currencies. At present, the rate of the SDRs is determined on the basis of exchange rate of euro, yen, pound sterling and US dollar. SDRs were introduced in 1969 and these are distributed by IMF based on the quota for the respective countries. These SDRs can be transformed into the currencies of the respective countries and can be used or kept in reserve, depending upon the foreign exchange needs of the respective countries. In 1972, 930 crores of SDRs were distributed and then another 1210 crore SDRs were distributed in 1979-81 after an oil shock. In September 2009, after the current bout of economic crisis broke out, 2140 crores of SDRs were distributed. Today 20,400 crores of SDRs (equivalent to 31,700 crore US dollars) are in circulation. These SDRs are not sufficient for carrying out the economic transactions of the world. By the end of 2008 itself, the value of foreign exchange reserves were estimated at 670,000 crores of dollars. Compared to this, SDRs are very small in quantity. It has been proposed to release SDRs in a larger quantity to make it a global currency. However, this has to get the approval of the IMF. The USA, which has higher voting rights in the IMF, may not agree to this proposition. Other rich countries too may not agree to this suggestion, as that will take away the special position their currencies are enjoying. Another aspect is that, like euro, SDR is not the currency of a single country and will be under the control of an international organisation. Thus SDRs will have the same limitation as euro has.

When we analyse all the above aspects, we see that at present there is no immediate alternative to the US dollar as the reserve currency of the world. US dollar has the status of a global currency because of the enormous political, economic and military power the US enjoys in the affairs of the world. Because of this, 60 per cent of the foreign exchange reserves are kept in US dollars even now. Even if there is a weakening of the US’s power in all these areas, the emergence of an alternative is still in the realm of future.

Posted in: Basics