By having the US dollar as the dominant currency in world affairs, the American government has the following main advantages:
• This allows to increase national debt to finance massive spending without risking damaging its inflation. Whereas other countries need to first convert their local currency into the dollar to issue debt, which will trigger devaluations and then inflation.
• The ability to impose harsh economic sanctions on rival countries, because the international payment system is mainly in US dollars.
• The dominant currency in the world is by default the "most popular one". It is the most demanded currency because financial agents will get a feeling of security and resilience from the issuing country and this will make transactions more efficient. Central banks across the world would prefer then to hold US dollars as their main international reserve currency, which is a key tool to achieve macroeconomic stability for any country. This in turn increases the 'soft power' of the US to expand its influence around the world.
Since global capitalism started to develop in the 14th century, there have been six periods of major dominance for a single currency. Portugal with its world navigation had it until 1530 when Spain became stronger. Later on, the Netherlands emerged as a financial power with the development of major banks in the 17th century. Then France with its territorial expansion and world exploration dominated trade in the 18th century. In the 19th century, the British empire made the pound sterling the major reserve currency on the planet until the 1930s. And finally, the U.S. dollar completely displaced the British currency when the country gained world hegemony at the end of WW2.
Nowadays, the US dollar is responsible for more than 85% of the world's currency trade, more than 60% of the global debt issuance, and 59% of global international reserves. This preponderance was settled in 1944 when representatives of 44 nations met in Bretton Woods, US, to agree on the recovery of the economy after the war. The US, as the world’s largest economy, would fix the value of the dollar to the gold standard, and other countries would in turn peg their currencies to the dollar. By that, countries were forced to have dollars as international reserves to maintain their exchange rate, so very quickly the US currency became the dominant in the world.
The Bretton Woods system collapsed in the 1970s because the US no longer had sufficient gold to back its fiscal expansion and debts. Since then, the dollar operates on a flexible rate defined by global markets. But, because of the US global political hegemony, its strong and flexible financial markets, and dynamic corporate governance norms, the US dollar has managed to hold the position as the most desired currency in the world, even though most of the rest of countries are no longer obligated to fix their currencies to it.
Indeed, due to the emergence of new regional powers, the dollar’s share of global international reserves has been falling since 1999, from 70% to currently 59%. With the world becoming more and more multipolar, this is an expected outcome. However, talks about a dramatic de-dollarisation have received a big boost recently because a strong anti-US geopolitical bloc is forming.
After Russia launched its full-scale invasion of Ukraine, Western governments decided to freeze nearly half ($300bn) of Russia’s foreign currency reserves and removed major Russian banks from SWIFT, the interbank messaging service that facilitates international payments. As a result, the Chinese yuan has become a de facto main reserve in Russia, and Chinese leaders are now stating clearly that they want to boost the yuan as a world reserve currency. China’s economy and trade flows are almost as large as that of the US, enough to launch such a move. However, the country still needs to convince foreign central bankers to start holding the yuan, which only makes up 3% of international reserves in the world currently.
Nonetheless, China has been getting rid of its US Treasury bonds, which are among the tools countries use to keep dollar reserves. It now holds $870bn in US debt, the lowest amount since 2010, and has been negotiating deals with other countries to trade in yuans instead of dollars. One example of that is when China and Brazil reached a deal last month to trade in their own currencies, enabling the world's second-largest economy, and the biggest economy in Latin America to conduct their massive trade and financial transactions directly, exchanging yuan for reais and vice versa instead of going through the dollar.
Other examples include the Shanghai Cooperation Organisation agreeing to increase trade in their local currencies as well. The bloc consists of China, Russia, India, Pakistan, Uzbekistan, Kazakhstan, Tajikistan and Kyrgyzstan. Moreover, in December 2022, China and Saudi Arabia carried out their first big transaction in yuans. China also completed in March this year its first liquefied natural gas (LNG) purchase from France using a yuan settlement.
Finally, the BRICS countries (Brazil, Russia, India, China and South Africa) are working to build a common currency to avoid the US dollar in their international operations. The idea is that this new currency would be backed by gold and commodities.
India too has been trying to move away from the dollar. Recently, 18 countries, including UK, Germany, Russia and the United Arab Emirates agreed to trade in Indian rupees. In the long run, the Indian rupee could become one of the global reserve currencies in the world, because its system is more open than China's.
The Chinese yuan is not easily convertible because China’s foreign-exchange rate is closely managed and purposefully opaque, and the same applies for its capital markets. To change that, the political regime in China would have to become much less authoritarian, something that the Communist Party, led by Xi Jinping, is not yet ready to do.