Is the supremacy of the U.S. dollar under threat?

Source– The post is based on the article “Is the supremacy of the U.S. dollar under threat?” published in “The Hindu” on 24th April 2023.

Syllabus: GS3- Economy

Relevance: External economy

News- The topic of dedollarisation seems to be in discourse. Dedollarisation refers to the deposing of the U.S. dollar from the reserve currency status it enjoys globally.

What are the arguments given in support of dedollarisation?

The U.S. dollar has depreciated against most major currencies. It has declined by more than 10% in the past six months against the euro. Also, the price of gold has increased in the past six months despite the fact that the Federal Reserve raised interest rates relentlessly.

Russia and China are buying large amounts of gold. It has been cited as the reason for the increase in its price. The sanctions levied by the U.S. and its allies against Russia are responsible for it.

Countries would prefer to distance themselves from a currency weaponized by the government to serve a geopolitical agenda.

What are the arguments against dedollarisation?

The dollar depreciation against the euro and other currencies was preceded by a significant appreciation in the dollar during recent interest rate increases.

The Federal Reserve considered a pause after the collapse of the Silicon Valley Bank. The depreciation in the dollar can be linked to the temporary financial instability and the slowing down of interest rate hikes.

The sanctions levied by the U.S. against Russia are not unprecedented. The U.S. has a history of imposing sanctions on countries. Therefore, it is not logical to assume that the current sanctions against Russia would cause dedollarisation.

Why does the dollar still enjoy the status of reserve currency?

Chinese policies– The argument of the dollar being dumped in favour of the Chinese yuan is cited due to rise in Chinese lending and China’s dominant export sector. Countries borrowing from China are beholden to them. Example is Sri Lanka.

Furthermore, China does not allow the yuan to float freely against other currencies. It is said to engage in exchange-rate manipulation by routinely devaluing its currency.

China has controlled capital flows and does not allow its citizens and firms to leave the country freely. Chinese authorities banned Bitcoin because citizens dumped the yuan in favour of the cryptocurrency.

China’s export dominance stems from its significant labour capital. However, China’s population growth is declining. Thus, China does not currently pose a strong challenge to the U.S. dollar’s dominance.

Openness of the US economy– The United States enjoys unparalleled investor confidence because it is seen as an open society and democracy.

The open market is an attractive haven for investors across the world who prefer liquidity, minimal capital control and minimal political influence.

A real contender for world reserve currency would have to be an open society comprising democratic values.

An autocratic government with strict capital controls, opaque foreign exchange policies and restrictions on conducting business cannot overthrow the U.S. dollar.