Dollar Dominance: The Unstoppable Surge Ahead of the U.S. Elections
Despite the ongoing
globalization
and
digitalization
trends, the U.S. dollar (USD) remains the
undisputed king
of the global
financial system
. As we approach the
U.S. elections
in November 2020, the USD’s dominance is set to continue, if not surge further. With
over 60%
of all foreign exchange transactions being denominated in the USD, it holds a unique position as the
world’s primary reserve currency
.
Why the Dollar’s Dominance Matters?
The dollar’s dominance is crucial for several reasons. Firstly, it serves as the benchmark for
international trade
, enabling countries to settle transactions in USSecondly, it is the currency that most countries hold as foreign exchange reserves. Thirdly, many international financial contracts, such as
bonds
and
commodity prices
, are priced in USD.
Why the U.S. Elections Could Impact the Dollar’s Dominance?
The outcome of the U.S. elections could potentially influence the dollar’s dominance in various ways. For instance, a change in administration might lead to
geopolitical shifts
, affecting investor sentiment towards the USAdditionally, fiscal and monetary policies could differ significantly between the candidates, possibly impacting the dollar’s value relative to other currencies.
The Future of the Dollar: Uncertain but Dominant
Despite these uncertainties, the dollar’s dominance is unlikely to be challenged in the near future. Its role as the world’s primary reserve currency provides significant advantages, such as attracting capital inflows and maintaining financial stability. However, the ongoing global trend towards
multilateralism
and
de-dollarization
could potentially pose threats to the dollar’s dominance in the long term.
I. Introduction
Significance of the US Dollar in the Global Economy
The US dollar is more than just a currency; it’s a cornerstone of the global economy. Its dominance extends beyond borders and influences various aspects of international trade and financial transactions.
Historical Context: US Dollar as World’s Reserve Currency
Since the end of the Bretton Woods system in 1971, the US dollar has served as the world’s reserve currency. This means that many countries hold their foreign exchange reserves in the form of US dollars. The reasons for this are rooted in historical context: the US economy is the largest in the world, and the country has a stable political environment, strong economic institutions, and a deep financial market.
Role in International Trade and Financial Transactions
The US dollar’s significance is also evident in international trade, where it is the most commonly used currency for invoicing and settling transactions. Nearly 88% of all foreign exchange transactions involve the US dollar. Additionally, it is the preferred currency for various financial instruments, including bonds and derivatives.
Implications for the US Elections
Understanding the US dollar’s dominance is crucial before major political events, such as the US elections. Given its role in the global economy, fluctuations in the value of the dollar can have far-reaching consequences for countries and markets around the world.
Understanding Dollar Dominance
Dollar dominance, also known as US dollar hegemony, refers to the preeminent role of the US dollar in the global economy. This dominance is evident through the use of the US dollar as a medium of exchange, unit of account, and store of value in international transactions.
Components of Dollar Dominance:
Medium of Exchange: Most international transactions, including trade and financial flows, are conducted in US dollars. This is due in part to the vast network of correspondent banking relationships that facilitate cross-border transactions.
Unit of Account: The US dollar is used as a common currency for pricing commodities, services, and assets in international markets. For instance, oil is priced in US dollars on the global market.
Store of Value: Central banks and other financial institutions hold large amounts of US dollars as foreign exchange reserves, making the dollar a store of value.
Historical Development of Dollar Dominance:
Post-WWII Bretton Woods System:
Established in 1944, the Bretton Woods system set the stage for dollar dominance. Under this system, countries fixed their currencies to the US dollar, which in turn was pegged to gold at $35 per ounce. This arrangement facilitated the use of the US dollar as a global medium of exchange, unit of account, and store of value.
1971: US Dollar Goes Off the Gold Standard:
In 1971, President Nixon announced the temporary suspension of the dollar’s convertibility to gold. This marked the end of the Bretton Woods system and set the stage for a freer floating exchange rate regime. However, the US dollar continued to maintain its dominant role in international transactions.
1980s: Volatility and the Plaza Accord:
During the 1980s, the US dollar experienced significant volatility due to factors such as rising interest rates and large US trade deficits. In response, major industrial countries came together in 1985 at the Plaza Accord to coordinate efforts to depreciate the US dollar against the Japanese yen and the German Deutsche Mark. Despite this agreement, the US dollar remained a dominant currency in global transactions.
Post-Cold War Era: Emerging Markets’ Dollarization:
In the post-Cold War era, many emerging markets adopted the US dollar as their primary currency for various reasons, including monetary stability and facilitating international trade. Today, numerous countries have partially or fully dollarized their economies, further solidifying the US dollar’s position as a dominant currency.
Benefits of Dollar Dominance for the US and Global Economy:
Seigniorage Benefits for the US:
Dollar dominance provides significant seigniorage benefits for the United States. Seigniorage refers to the revenue gained by a country from issuing its currency. With most international transactions conducted in US dollars, the US benefits from increased demand for its currency and the associated seigniorage income.
Global Financial Stability and Liquidity:
The US dollar’s dominant role in the global economy also contributes to financial stability and liquidity. A large, deep and active market for US dollars facilitates efficient price discovery and risk management, helping maintain a stable global financial system.
I Challenges to Dollar Dominance:
In the pre-election context of 2020, the dollar’s dominance as the world’s primary reserve currency is facing significant challenges on multiple fronts.
Emergence of alternative currencies and payment systems
One of the most notable developments is the emergence of alternative currencies and payment systems. Among these, China’s digital currency, DCEP (Digital Currency Electronic Payment), is gaining considerable attention. Although not yet fully launched, DCEP’s potential impact on dollar dominance cannot be overlooked. Furthermore, crypto-currencies like Bitcoin and Ethereum are increasingly being adopted as viable alternatives to traditional currencies, particularly in the context of cross-border transactions.
China’s digital currency, the DCEP
China, as the world’s second-largest economy, is taking bold steps to challenge the dollar. The People’s Bank of China (PBOC) plans to issue its digital currency, DCEP, which could significantly reduce China’s reliance on the US dollar. This move would not only strengthen China’s financial sovereignty but also potentially disrupt the global dollar payment system.
Crypto-currencies like Bitcoin and Ethereum
Crypto-currencies, on the other hand, are decentralized digital currencies that operate independently of a central bank or government. Their usage is growing rapidly, particularly in developing countries where traditional banking infrastructure is weak. The decentralized nature of crypto-currencies makes them attractive as alternatives to fiat currencies, and their adoption could potentially challenge the role of the US dollar as a dominant currency.
Geopolitical tensions and the role of central banks
Another challenge to dollar dominance stems from geopolitical tensions and the increasing role of central banks. The ongoing US-China trade war, for instance, has intensified efforts to reduce reliance on the US dollar in international transactions. Moreover, central banks like the European Central Bank (ECB) have responded to US sanctions on countries like Iran by setting up alternative payment systems, further diminishing the importance of the dollar.
US-China trade war
The US-China trade war has led to a search for alternatives to the dollar in international transactions. For instance, China and Russia have reportedly started trading in their respective currencies instead of the US dollar. This trend could continue to grow as countries look for ways to reduce their reliance on the US dollar and counter potential US sanctions.
European Union’s response to the US Iran sanctions
The European Union (EU) has set up its alternative payment system, INSTEX, in response to US sanctions on Iran. This system allows EU countries to trade with Iran using their own currency, bypassing the US dollar. The success of INSTEX could potentially pave the way for other countries to establish similar systems, further challenging the dominance of the US dollar.
Global economic conditions: The impact of the COVID-19 pandemic and low interest rates
Lastly, global economic conditions, particularly the COVID-19 pandemic and low interest rates, are contributing to challenges for dollar dominance. Central banks around the world have responded to the crisis by increasing their balance sheets significantly, leading to currency depreciation and debt issuance. These developments could potentially weaken the dollar’s position as a dominant currency.
Central banks’ response to the crisis and its implications for dollar dominance
Central banks around the world have taken unprecedented measures to stabilize their economies during the COVID-19 pandemic. These actions include large-scale asset purchases and low interest rates, which have led to an increase in their balance sheets. This expansion could potentially lead to a weakening of the US dollar’s position as a dominant currency, particularly if other countries successfully challenge it with their alternatives.
Debt issuance and currency depreciation
The pandemic has also led to a significant increase in debt issuance by governments worldwide. This trend, combined with the weakening of currencies due to low interest rates, could potentially reduce the demand for US dollars, further challenging its dominance.
Post-Election Prospects: The Future of Dollar Dominance
Potential policy changes under a Biden or Trump Administration
The outcome of the 2020 US presidential election will significantly impact monetary and trade policies, which in turn may influence the future of dollar dominance. Under a Biden Administration, we can expect a more multilateral approach to global economic issues, potentially leading to rejoining the Paris Agreement and other international organizations. There may also be a shift towards greater cooperation with US allies, particularly in Europe, which could result in renewed efforts to strengthen the transatlantic relationship and revitalize the World Trade Organization (WTO). On the other hand, a Trump second term could result in continued protectionist policies and a confrontational stance towards China and other trading partners, which may further undermine global economic cooperation and stability.
Adjusting to a changing global economy: The role of central banks, multilateral institutions, and international cooperation
In the face of currency volatility and financial instability, central banks and multilateral institutions will play a crucial role in managing the global economy. The European Central Bank (ECB) and the People’s Bank of China (PBOC), in particular, will need to coordinate their actions to ensure financial stability and maintain confidence in the global economic system. Additionally, international cooperation through organizations like the International Monetary Fund (IMF) and the G20 will be essential in addressing the challenges of digital currencies and other alternative payment systems.
Conclusion: Dollar dominance in a post-pandemic world
Despite the uncertainties surrounding the election outcome and the changing global economy, dollar dominance remains a fundamental aspect of the international financial system. In a post-pandemic world, the future of the US dollar as the global reserve currency will depend on how effectively governments and international organizations adapt to emerging trends and challenges. This may involve finding a balance between promoting economic growth, maintaining financial stability, and ensuring fair trade practices. Ultimately, the way forward for the global economy will require a renewed commitment to international cooperation, transparency, and innovative solutions to address the complex issues of our time.
