Dollar’s reserve currency status in jeopardy

By Aftab Ahmad

According to a report published in the Financial Times recently under the caption ‘Obama under fire over falling dollar’, ‘the falling US dollar is giving ammunition to the critics of the Obama Administration and fuelling broader concerns about the potential erosion of America’s reserve currency status’. According to the report, the US dollar had fallen 11.5 per cent on a trade-weighted basis, over the past six months.

About a fortnight ago, the World Bank President Robert Zoellick was reported to have warned that ‘the United States would be mistaken to take for granted the dollar’s place as the world’s predominant reserve currency’. The aforesaid warning has come in the wake of falling US dollar, mounting US budget deficit and growing US indebtedness.

Some other nations including those having large foreign exchange reserves in US dollar had, also, recently expressed their concern over the dollar’s weakness. The US Administration had, therefore, considered it necessary to explain that it fully understood the responsibilities that go with the issuing of world’s reserve currency and that it would do every thing in its power to meet those responsibilities. The US Treasury Secretary Tim Geithner had said at the week-end that he knew how important it was for the US to have a strong dollar.

Earlier, during the year (2009), China’s Central Bank had suggested replacing the dollar as the main international reserve currency with one linked to a basket of currencies, under the IMF supervision. In a G-20 meeting held during the year, China had proposed creation of a new international reserve currency based on the Special Drawing Rights (SDR), introduced in the 1960’s by the IMF for its various transactions with member nations. China had reportedly planned that its currency Yuan should become the fifth currency of the SDR, joining the US dollar, the Yen, Euro and pound sterling, with an equal 20 per cent weight for all the five currencies.

Besides the above, the heads of the emerging BRIC economies – Brazil, Russia, India and China – had reportedly held a meeting in June 2009 in which the Russian President had called for creating a ‘supranational means of payment’ other than in dollar. Also, China had reportedly provided Yuan to central banks of selected countries to be used in trade with China. The aforesaid arrangement had been made by China for trade with Argentina, Hong Kong, South Korea, Malaysia and Indonesia etc. In the presence of such an arrangement, there was no need for these countries to use the US dollar as an intermediary currency in trading with China.

Despite the aforesaid developments and a falling dollar, the US dollar is so entrenched as an international reserve currency, at present, that it does not seem possible to replace it with any other currency, in the short run. According to the IMF, the dollar’s share in the world’s central banks’ reserves stood at 72 per cent in 2002, which came down to 64 per cent in 2007. The share of Euro in these reserves had gone up to about 25 per cent from 18 per cent in 1999.

As in case of central banks’ reserves, the US dollar is also the leader in the international currency transactions. It reportedly had 86 per cent share in the daily currency transactions of an estimated $3.2 trillion around the world until 2006-07, according to the Bank of International Settlements. The share of the US dollar in the world’s currency transactions was as much as 90 per cent until 2001, which registered minor decline in the following years.

Likewise, the role of the US dollar has also been vital in the international trade. The US dollar remains the medium of exchange in nearly every commodity from sugar to wheat to oil. According to some reports, US geopolitical rivals had been trying to break away from the dollar. According to these reports, Russia was setting up a commodity exchange, where future contracts for oil and other commodities would be settled in roubles instead of dollar. Iran was reported to have lauded the aforesaid Russian plan, saying that it was an effort to liberate the world economy from the slavery of dollar.

However, the efforts to break away from the US dollar and bring some other currency in its place have not gone very far. In case of oil, the analysts and experts had expressed the view that oil prices were currently based around three types of oil, that is, West Texas Intermediate, Brent crude and Dubai crude. Since all these are denominated in US dollar, any plan to replace the dollar with some other currency was likely to pose a big challenge.

Nevertheless, despite the strong position of the US dollar as an international reserve currency, as explained in the preceding paragraphs, economic indicators in the US have been deteriorating ominously during the last couple of years. As stated above, the US dollar had declined by 11.5 per cent on a trade-weighted basis over the past six months. The unemployment rate in that country had recently gone up to 9.8 per cent, meaning that some 15 million people in the US are without a job, at present. The US budget deficit, which is the main culprit behind the weakness of US dollar, is expected to jump to $1.4 trillion in the current fiscal, due to expenditure on the stimulus package and the war on terror. The budget deficit will come down gradually in the following years, according to analysts. As a result of the above, it is feared that US indebtedness will go up to 70 per cent of the GDP from the present level of 40 per cent of the GDP. This is an alarming scenario, which does not augur well for the US economy or US currency.

The US has been a land of innovations and high-tech resources are abundant in that country. It has, therefore, the ability to overcome its economic difficulties and re-emerge even as a stronger economy in the coming years. However, in case its economic woes persist or aggravate further, the position of the US dollar as an international reserve currency may be affected adversely, in future.

A Chinese official had reportedly expressed the view in May 2009 that the Yuan could be a reserve currency by 2020. Some western analysts see a change within the next 10 to 15 years. According to Ken Rogoff, a Harvard Professor and former IMF Chief Economist – quoted in the above-mentioned Financial Times report – ‘the financial crisis probably has brought forward the day when the dollar is no longer dominant – may be from 75 years to 40 years’.