The almighty US dollar might be losing lustre as a global currency

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 The almighty US dollar might be losing lustre as a global currency

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Read more on - Polity | Economy | Schemes | S&T | Environment

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• US dollar as global reserve currency: US dollar’s depreciation, US Federal Reserve’s accommodative monetary policy, rising gold prices and increasing inflation expectations have raised concerns over reliance about the dollar’s dominance as the global reserve currency.
• ‘Death of dollar’ speculations could be misplaced: Current weakness of the dollar is due to short-term cyclical factors. In the long term, the dollar may or may not lose its primacy.
• Short term factors: 

1. Dollar weakens when market risk tolerance is high and investors invest in high-risk instruments. This explains the high value in Feb-Mar driven by Covid-19 panic but a revival in April with Fed’s stimulus measures. 
2. The Fed has activated currency swap lines to increase dollar liquidity. Foreign currency inflow is now putting downward pressure on the dollar. 
3. US has not managed the pandemic as efficiently as some other countries have. Public-health failures and economic woes are further weakening the dollar. 
4. US external deficit has been high. Dollar was appreciating before the pandemic. Interest rates were not sufficiently high to finance the deficit with capital inflows. Reviving trade competitiveness required dollar depreciation. 
5. In the absence of a V-shaped recovery and timely vaccine, panic may strengthen the dollar again in the short term.

• Medium-long term factors in favour of the dollar: 

1. System of flexible exchange rates in the US, and deep liquid bond markets. 
2. No alternative currency can serve as a unit of account, means of payment, and store of value. Export-driven markets like EU, Japan and China would not want the large current-account deficits associated with a strong currency. 

• Factors that threaten dollar’s dominance over time: a) Large external deficits b) Geopolitics c) Weaponization of the dollar for US sanctions d) Rival Chinese currency
• Continued large external deficits: There is a growing risk of rise in inflation due to large external deficits. If US economic policies do not address this, the dollar will lose its attractiveness.
• Geopolitics: Global leadership of the US is one of the reasons the dollar is the preferred currency for trade globally. If China continues to gain global power, the US may lose its leadership position.
• Taking advantage of the dollar’s dominance for sanctions: China, Russia and their allies are diversifying their holdings away from dollar-dominated assets. If the US continues to use dollar’s dominance as a tool to enforce sanctions, more countries will break away.
• Rival Chinese currency: China is making its exchange rates flexible, creating stronger debt markets, encouraging trade partners to use the renminbi, and building an alternative to the international payment network SWIFT (Society for Worldwide Interbank Financial Telecommunication system). Other countries could readily adopt robust payment platforms of Chinese giants (Alipay, WeChatPay).
• Summary: Talks of the dollar’s demise may be premature since in the short-term the weakening dollar is due to cyclical factors and in the long-term there is no viable alternative to the dollar as the global currency reserve. However, large external debt, China’s geopolitics and its economic rise are some factors that threaten the dollar’s dominance.

Read more on - Polity | Economy | Schemes | S&T | Environment

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