Future Status of the US Dollar

‘Will the dollar remain as the dominant international currency?’ This question continues to remain as hot subject of active debate among many economists and policy makers internationally. Historically the dominance of the dollar took off after the Second World War when the country surpassed Britain’s economy as from1872 and its sterling pound in 1945. As such the dollar has remained the artery of international currency. Questions to whether USA dollar strength are under attack are not new since “in 1990s, the question arose as to whether the dollar was in the process of losing its role as unrivaled international currency” just like the sterling pound had acted earlier (Chinn and Frankel, 2008).

The then observation and conviction was that the yen and mark had gained steadily specifically in “the 1970s and 1980s, as measured by shares in central banks’ holdings of foreign exchange reserves, at the dollar’s expense” (Chinn and Frankel, 2008). However, the prediction of dollar succumbing to the yen and mark did not materialize since many economic observers had significantly “confused a fall in the foreign exchange value of the dollar with a fall in its international role” (Chinn and Frankel, 2008). However, as reality would present itself, the Japanese and Germany economies together with their currencies had performed far behind the USA and its dollar.

The actual reality of the moment, which most people and economists missed was that the dollar’s share in reserves had actually rose throughout the whole period of 1990s and that the dollar at the same time was in demand in other respects. For example, the dollar became the transactions currency among nations of “Latin America and wherever else in the world people had lost faith in their own currencies” (Chinn and Frankel, 2008).

Nevertheless, events have changed since 1990s and as Chinn and Frankel put it, “is the dollar in danger of losing its exclusive role as premier international currency-the answer is yes” (Chinn and Frankel, 2008, p.3). Therefore, drawing from this history concerning the dollar and the new emerging events in the world, this paper will explore in broad sense the future status of the dollar, the current status of euro in international finance and trade, the current existing strength and weaknesses of the dollar as the leading currency and lastly look at the possibilities of the euro or yuan replacing the dollar as international currency.

The status of the euro in international finance and trade

Writing in 1997, Bergsten in conjunction with Peterson Institute for International Economics made predictions of how euro’s role would parallel that of dollar. The observation of the author and the institute was that emergence of euro currency as a unified European currency was to be one of the most important developments specifically with regard to evolution of the international monetary system (Bergsten and Peterson Institute for International Economics, 1997).

According to their initial observation, they asserted that, “a successful euro will be the first real competitor to the dollar since it surpassed sterling as the world’s dominant money during the interwar period, where as much as $1 trillion of international investment may shift from dollars into euros” (Bergsten and Peterson Institute for International Economics, 1997, p.1). Since its launch in 1999, euro’s role continues to be investigated and estimated by majority of international economists. For example, drawing evidence from the available sources of daily foreign exchange market turnover of 2001 it becomes clear that the euro’s role in foreign exchange markets increased to 19 per cent of all foreign exchange transactions (Issing, 2003).

Compared to the Deutsche mark of 1998, it can be seen that the euro exceeded by almost 4 per cent of the Deutsche mark which stood at 15 per cent (Issing, 2003). At the same time the BIS survey report of 2001 indicated that the dollar and euro became the most preferred traded currency pair which when combined constituted for 30 per cent of global turnover (Issing, 2003). With emphasis on the global debt securities market data shows that the accumulated operating amount of the euro-denominated issues by residents outside the EU geopolitical boundary rose steadily from19 per cent during the end of 1998 to almost 30 per cent during the third quarter of 2002 (). During the same period the USA share of the dollar stood at 44 per cent which was a slight decline emanating from the effects of the euro (Issing, 2003).

According to Chinn and Frankel (2008), upon been launched, the euro immediately established its wide use as denominate bond, and throughout Europe, the currency has been used as corporate bond, denominated in euros. Indeed, its accelerated usage has originated from the rapid integration of the money market, government bond markets, equity markets and banking (Chinn and Frankel, 2008). Further, the authors observe that outside Europe geopolitical jurisdiction, the euro has performed well.

And drawing from evidence and studies done by Detken and Hartmann in 2000, the authors assert that the two researchers investigated the intra-euro area holdings of euro and estimated the euro-precursor currencies for five years from1999, and their results showed that there was an increase in the supply of euro-denominated assets outside of Europe than there was an increase in demand (Chinn and Frankel, 2008). As a result of these studies, Chinn and Frankel observed that, “the stock of international debt denominated in euros increased from about 20 per cent on the eve of EMU, to 30 per cent in 2003” (Chinn and Frankel, 2008,p.5).

Further researches have confirmed that the international use of euro continue to grow especially when estimation of related criteria of euro transactions is made. For example, estimates shows that about 50 per cent of EU members’ trade transactions with non-EU members is facilitated and invoiced in the new currency (Chinn and Frankel, 2008). Furthermore, the euro’s share in international debt securities has risen to surpass the 30 per cent mark as compared to 20 per cent before the introduction of the currency (Chinn and Frankel, 2008). Other verifiable evidences have confirmed that “euro cash is increasingly accepted in retail transactions around the world, and dollar bills decreasing” (Chinn and Frankel, 2008).

Chinn and Frankel summarize the status of euro as international currency by noting that, “the euro is the number two international currency, ahead of the yen, and has rapidly gained acceptance, but is still well behind the dollar, which appears to most observers to be comfortably in the number one slot” (Chinn and Frankel, 2008, p.7).

The strengths and weaknesses of the dollar as the leading currency

Linda Goldberg notes that, ”the dollar is still the dominant international currency and that the dollar is used as a major form of cash currency, and is the main currency for exchange rate pegs and for invoicing foreign transactions; accordingly, network externalities create inertia-everyone uses the dollar because everyone else is using the dollar” (Goldberg, 2010, p.1). This statement by the author postulates that despite introduction and increasing role of the euro, the dollar for many people still holds its dominant role as powerful international currency. This dominance by the dollar can be attributed to the dollar’s strengths that are yet to be surpassed by other currencies.

The strengths of the dollar act in multiple forms, for instance: the dollar remains the main currency in the world and continue to perform a critical role in international trade and finance acting both as a store of value and main medium of exchange. This role is reflected in the fact that the dollar “is anchored as the main regime of exchange rate in many countries, dollar holdings make up large share of official foreign exchange reserve, the foreign currency deposits and bonds, in international trade, the dollar is widely used for invoicing and settling import and export transactions around the world” (Goldberg, 2010, p.1).

Another undisputable truth is that the dollar constitutes the dominant international currency whose banknotes are held outside USA in large scale. Current statistics shows that about 70per cent of numerous hundreds dollar notes and almost 60 per cent of twenty and fifty-dollar notes are stored by abroad countries while another 65 per cent of USA dollar notes have been circulating in majority of world’s countries as from1990 (Goldberg, 2010).

Notably the dollar remains the main form of exchange rate arrangements among many nations of the world. For example, numerous countries today possess dollar-based exchange rate arrangements, and when the Reinhart and Rogoff (2004) criterion is used studies indicate that about seven countries of the world operates on dollarized system while other 89 countries have their exchange rates aligned to the dollar (Goldberg, 2010). Concerning foreign currency, the dollar remains unbeatable as the currency that dictates the foreign exchange reserve accounts.

The 2009 statistics shows that the dollar assets remained unmoved as the dominant foreign currency reserve accounting for almost 65 per cent of “the total reserve assets possessed by the industrialized and developing countries” (Goldberg, 2010). Further, the dollar continues to dictate major international transactions where it remains as the principal transaction currency in foreign exchange markets. It accounts for almost 86 per cent of the total volume of international trade and financial markets which is twice more than the figure euro possess; the dollar remains comfortable the leading international currency widely used in the invoicing of international trade.

For instance, Goldberg and Tille (2008) observe that, “the use of the dollar in export invoicing is substantial and far exceeds what could be explained by country exports to the USA. Some of the countries with strong dollar use are in proximity to the USA” (Goldberg, 2010, p.1). Lastly, the dollar remains strong in acting as the principal currency in international debt markets where according to the European Central Bank report of 2009, “the dollar’s share remains the primary financing currency for issuers in the Middle East, Latin America, Asia, and the Pacific area” (Goldberg, 2010, p.1).

At the same time, the dollar has demonstrated numerous weaknesses; first, the criticism has been leveled at USA for solely determining the supply of the dollar. International trade transactions of most countries are pegged to the dollar and USA as an independent nation has been seen to abuse its privileges of having the powers of possessing the most powerful currency that dictates global financial and trade transactions(Global Research, 2009).

For instant USA has continue to oversupply the dollar around the world a fact that plays positive to the country but negative to recipient countries that have pegged their exchange rates to the dollar (Global Research, 2009). As a result of depreciating dollar, USA has established huge external debts but interestingly the negative consequences of these acts are not suffered by USA rather are passed to other nations whose in turn their economies have crumbled and deteriorated (Global Research, 2009). At the same time, the weakness of the dollar specifically concerning pegged economies has led to the fall or crumbling of the countries’ export-driven economies.

Can the euro supplant the dollar?

In 2007, Reuters reported that the USA-one time Federal Reserve Chairman, Alan Greenspan observed that,” for sure it is undeniable fact that the euro will replace the dollar as the dominate foreign reserve currency or will be traded as an equally important reserve currency” (Cross, 2009, p.1). At the same time, analysis by Frankel and Chinn using econometric data in 2008 indicated that the euro possess the potential to substitute the USA dollar as the major global reserve currency by the year 2020 if two important conditions are fulfilled: “depreciation trend of the dollar persists into the future; or if EU members such as Britain adopts euro by 2020” (Cross, 2009, p.1).

Heightened call for the replacement of the dollar as international currency has further been fostered by the BRIC countries (Brazil, Russia, India and China), which in unison have expressed the need for the establishment of a new international currency since most people and nations were fast losing confidence in the value of the USA dollar (Cross, 2009, p.1).

Looking at Russia, statistics indicate that it assumes the third position as the world largest country with foreign reserves where 50 per cent of the foreign reserves are denominated in dollars while the rest are denominated in euros and pounds. Russia as a country has personally called for the replacement of the dollar. Following in the footsteps of Russia is China whose central bank governor Zhou Xiaochuan in 2009 prior to the G-20 summit in London is quoted to have said that, “a new currency reserve system controlled by the International Monetary Fund-IMF is more stable” (Cross, 2009, p.1).

However, other economists and policy makers dispute this argument about the replacement of the dollar as international currency. For example, Goldberg notes that, despite the introduction of euro ten years ago, the importance and position of the dollar as international currency was still substantial possibly due to the, “inertia in currency use in certain transactions where the dollar has established a deep role in international markets thus making it difficult for users to shift to a less entrenched currency” (Goldberg, 2010, p.1).

According to Chinn and Frankel the USA dollar is still favored by three major factors that suit a currency to qualify for international currency status and which most countries are unable or yet to achieve. The three variables are: output and trade, where USA still possesses the word’s largest economy in terms of output and trade compared to any country; the country’s financial market, where New York remains as the largest avenue of financial market while London continue to benefit from the dollar and pound relative to the euro (Chinn and Frankel, 2008). This is in addition to confidence in the value of the currency; and lastly, network externalities, which seem to favor USA than any other country. Tremblay on his part note that euro ascendancy to the position of leading international currency is limited by the fact that euro’s political base is weak.

Not all Europe countries have embraced euro where only 50 per cent of these countries favor euro (Tremblay, 2010). This makes the euro to be vulnerable especially with regard to future where possibility of its dissolution is inevitable considering the economic hardship experiences it face. Kristopher summarizes the unlikelihood of euro replacing the dollar by noting that, “Europe has the potential but is not a country, it is a loose confederation of countries that is currently uncertain of their future together” (Kristopher, 2007, p.1).

Conclusion

Bad policies have weakened the dollar, causing dissatisfaction among world economies that have pegged their exchange rates to the dollar. Nevertheless, the calls for dollar replacement are likely to continue in the future especially with the rising of China economy and increasing integration of the EU economies. Euro possesses the necessary qualities to replace the dollar but geopolitical reasons continue to act as the barrier to the achievement of this.

On overall, for any currency to be accepted as international currency and to assume the role of acting as foreign reserve, it has to impact and inspire confidence among the users, it has to possess higher degree of liquidity, and it must be exchangeable into other currencies. Until any currency assumes these three elements on global scale, the dollar will continue to assume the role of international currency until the time when a viable international monetary system is designed to replace it.

References

Bergsten, F. and Peterson Institute for International Economics. (1997). The Dollar and the Euro. Web.

Chinn, M. and Frankel, J. (2008).The Euro May Over the Next 15 Years Surpass the Dollar as Leading International Currency. Web.

Cross, V. (2009). Foreign Currency Markets-The Dollar and Euro: Can the Euro Replace Dollar as Dominate Foreign Reserve Currency?  Web.

Global Research. (2009). US Dollar to Remain Dominant International Reserve Currency For Many Years. Web.

Goldberg, L. (2010). What is the status of the international roles of the dollar? Web.

Issing, O. (2003). The euro-a stable international currency. European Central Bank Press. Web.

Kristopher. H. (2007). Will the continued weakness of the dollar cause the end of it being the global currency? Will there ever be an alternative?  Web.

Tremblay, R. (2010). Nothing in Sight to Replace the US Dollar as an International Reserve Currency. Web.