An erosion in the greenback’s share of global foreign exchange reserves, combined with rising geopolitical tensions, has revived talks that the status of the US dollar as a global currency was coming to an end. These are exaggerated speculations. The outsized role played by the United States in capital markets, trade and debt reinforces the dollar’s dominance.
The US dollar started emerging as a currency of global trade after World War I. Until about 100 years ago, the British pound was the most coveted global currency. After World War I, as the US stockpiled gold reserves, the US dollar gained currency. The value of the US dollar is now dependent on its global demand and not on the assets held by the American government.
Efforts to dedollarise gathered pace following moves made by Russia and China in the past year. The profound economic disruption experienced by Iran, and more recently by Russia, have led many nations to consider imminent contingency plans. After the US and western nations imposed economic sanctions on Russia, froze $300 billion of Russia’s foreign currency reserves and expelled Russian banks from the Swift international payments system for invading Ukraine in February 2022, the ruble-yuan trade increased 80-fold. The central banks of Russia and China among others bought gold at the fastest pace since 1967 as they moved to diversify their reserves away from the dollar. India and Malaysia have started using the Indian Rupee to settle certain trades.
The BRICS collective is also mulling over creating a new currency to facilitate trade. All these activities give a narrative that the dollar is losing its “exorbitant privilege” (a phrase coined by the late French president Valery Giscard d’Eistaing). But dislodging of the dollar as a global anchor currency will not happen anytime soon. Here’s why.
Dominance of Financial Markets
The dollar accounted for 88 percent of all foreign exchange trading, according to the Bank for International Settlements in 2022. The Fed estimates that between 1999 and 2019 the dollar accounted for 96 percent of trade invoicing in the Americas, 74 percent in the Asia-Pacific region and 79 percent in the rest of the world. Banks used the greenback for around 60 percent of all international deposits and loans.
Transactions involving yuan jumped by a whopping 70 percent in the last three years, yet, it accounts for only seven percent of that total of international transactions. Besides, disclosures around China’s capital markets are not very straightforward.
If the world wants to reduce reliance on dollars, it would need to deleverage a part of the global debt. But that's a very slow process. According to BIS, dollar-denominated credit to non-banks outside the US stood at ~$12.8 trillion, which is ~60 percent of foreign currency debt. Barring the Euro, no currency has more than 2-3 percent share in foreign currency debt issuance, which also shows the supremacy of the US dollar. The sheer size of the US economy and other critical elements such as trust in an asset as a store of value, size and depth of financial instruments available to investors, standardisation of capital markets, ease of accessing capital, the highly liquid nature of dollar, easily convertibility and the vast worldwide circulation together make the dollar the heart of world finance.
Demographic Advantage
The demographic profile of the US, with its growing population and the influx of immigrants, gives it the advantage of a flexible and trainable workforce. The country’s ability to attract immigrants has been an important reason for its continuing prosperity, over 2.2 million people have immigrated from Mexico, India, and China in the last decade. Of the Indian migrants, 80 percent were in the working age group and highly educated. Every year over two lakh Indian students enrol at American universities and spend over $10 billion annually (at $50,000 per year per student). Almost 90 percent of these students want to live in the US permanently and choose to do so. This gives the US a huge demographic advantage, allowing it to grow its talent pool and keep domestic consumption robust.
The US economy is built on the strength of domestic consumption, with private consumption accounting for 70 percent of its GDP. Importantly, income distribution across income brackets in the country is healthy with a median household annual income of more than $70,000.
Boost From Tourism
International travel plays a critical role in the US economy. Tourism in the US is not just about leisure or business, even medical and educational tourism contributes to the GDP. Tourism contributes $1.9 trillion to the US economy, supports 9.5 million American jobs and accounts for around 3 percent of the US GDP. International travellers spend more in the United States than any other country, and that's about 14.5 percent of international travel spending globally.
Financial System to Support Entrepreneurial Culture
The US provides an environment that promotes and nurtures entrepreneurial spirit. The country has a well-developed system of equity finance, including angel investors who are willing to finance startups, and an active venture capital market that helps finance the growth of those firms. Many successful startups have been funded by universities and endowments. Silicon Valley successes like Facebook, Cisco and others inspire further entrepreneurship. The US is home to about 54 percent of unicorns in the world, and when they spread their wings globally, it further boosts the US dollar.
Also helping the dollar is the fact that the top 9 of 10 companies by value are American, 80 percent of the top 100 global hedge funds are from the US, American corporate balance sheets are stronger than ever (top 15 companies have over $1 trillion of net cash) and American household balance sheet has seen substantial improvement over last 15 years.
To summarise, the dollar will remain dominant till a very large economy may be like India with size can pose some challenges. For that, the qualified country needs to have a demographic advantage, strong GDP growth, robust physical and education infrastructure, and a strong corporate and sovereign balance sheet. Above all, it should be universally acceptable to most countries.
Vikram Kotak is co-founder and managing partner, Ace Lansdowne Investments. Views are personal, and do not represent the stand of this publication.
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