Let’s not be misguided that the dollar will be displaced
It’s still the only currency that can anchor global trade but the US must not weaponize its privilege
Today, it has become fashionable for people to bash the dollar. The American currency has been blamed for many financial ills, and the Silicon Valley Bank (SVB) crisis was the proverbial icing on the cake, as it happened in the US. There are political and economic reasons for this.
On the political front, the Ukraine crisis was the trigger. In the past too, the US has used the threat of sanctions against countries for dealing with Iran, and everyone complied. But Russia is different, given its strength. It has large foreign exchange reserves locked in the US dollar and it now finds these funds frozen. Countries cannot make payments in dollars to Russia as the global payments system Swift (Society for Worldwide Interbank Financial Telecommunication) is controlled by the US. While the US would have liked all countries to not deal with Russia, that was not feasible, as Europe still draws gas from this country. Hence, the US has shown flexibility, which reeks of double standards. It has also made countries think seriously about using other currencies or even their own for dealing with other nations. A fear of retribution in the future for non-compliance is palpable.
The economic reason is also compelling, but surprisingly never came to the fore earlier. Why is it that the entire world gets impacted so heavily by the US Fed’s decisions? When the Lehman crisis struck, the world was in turmoil. When the Fed adopted quantitative easing (QE), everyone benefited as funds flowed freely to emerging markets. When the Fed started tightening, markets all over trembled. When the Fed raises interest rates, all central banks are agitated. At the same time, the US runs high deficits that analysts don’t tolerate of others. ‘The country is living beyond its means’ is the feeling today. And the clinching argument was the SVB fiasco. The bank invested in the safest of assets, US Treasury bonds. Yet, when it had to sell those securities to pay back deposit holders, it had to do so at a loss. Hence, even the safest asset proved toxic.
All central banks hold dollars as foreign exchange reserves, and if they were to do proper mark-to-market valuations, they would see themselves out of money. Ironically, the dollar is still the most sought after asset. The International Monetary Fund’s (IMF) data on holdings of foreign exchange reserves shows that after the Ukraine conflict, the USD’s share has not really changed and remains close to 60%, followed by the euro, at 20%. The yen and British pound come next. The renminbi has a lower share than the Swiss franc and Australian dollar.
But why should the world want an anchor? The reason is straightforward. As countries deal with one another, there needs to be a common standard for currency conversion. What started off as gold and then moved to the pound and later the IMF’s SDR (Special Drawing Rights) has settled for the dollar. The world cannot go back to gold, as it has limited supply and cannot easily be mapped to currencies. The euro was supposed to be an alternative and worked reasonably well till the euro crisis, which showed contradictions in having a joint currency for 20 nations with differing fiscal ideas. Germany is an epitome of fiscal rectitude, but that cannot be said of Italy and France. Yet, the eurozone currency has held on, although it does not seem to offer comfort as an anchor. It works because of a binding factor insofar as its users are democracies with market systems.
The lesson is that a country running the anchor has to be large. The US has had that strength. China is now the largest economy based on purchasing power parity (PPP). But does anyone trust China? It has historically been known for manipulating its currency and funding rogue regimes. Hence, just as ‘Made in China’ has low credibility for some goods, the same holds for the renminbi. India is the third largest country by PPP. Can the rupee reign supreme?
Riding a high horse of hubris might make us think so. The rupee’s acceptance will potentially be limited to countries that have a deficit with India. We would like to have rupee trade with other nations. But what will say Russia do with the rupees it gets from India? If it wants to import goods from China, will the latter accept rupees?
Therefore, while we have made a modest attempt at facilitating rupee trade, the idea will take time to gain acceptance. We need to enrol other trade partners that would be able to use their rupees to buy goods from India. The US and European Union are the major export destinations for India and the others would be oil exporting nations. Getting the latter into our fold sounds plausible, but their requirements from India are limited to refined petroleum products and a basket of food items.
This means that whether we like it or not, the dollar will continue to reign supreme. The anchor country has to run high deficits and spend more than it earns to ensure that the currency is available for others to invest. If not, what would countries do with their foreign exchange surpluses? The US has taken on this role, but should act more responsibly since it has been bestowed this privilege by global consent. Freezing Russian assets or cutting countries off Swift should ideally not be done, as it denudes the credibility of the USD. Politics and economics should not be mixed if we are to preserve the global economic order. This message should reach the White House, or else the world will struggle in search of alternatives. And that could prove disruptive.
Madan Sabnavis is chief economist, Bank of Baroda, and author of ‘Banking Trends and Controversies’
These are the author’s personal views.
