Dollar Dominance and the Rise of Unconventional Reserve Currencies: Has the Dollar's Sun Begun to Set?

Has the sun of the dollar begun to set?

●      Part One

-        In ancient times, and since the beginning of international trade and finance, there have been global reserve currencies, such as the Dutch guilder, which prevailed during the period from the 17th century to the early 19th century..and was followed by the pound sterling, which dominated in the 19th century and until the early 20th century, then came the dollar , which acquired dominance after the Second World War.

-        The United States dollar ascended the throne of international financial markets... as an official reserve currency since 1944, when it was regarded in that position.. as the official reserve currency by the countries participating in the "Bretton Woods" agreement, and it remained throughout these decades until recently, forming basically the reference for monetary dealings in the world, for more than 85% of international financial transactions, and about 66% of the reserves held by the world’s central banks were, until recently, in dollars.... Many countries also peg their exchange rates to those global reserve currencies that dominate the basket of other currencies that make up central bank reserves of foreign currencies..and they are widely used, outside their home countries, in physical transactions, as well as by international financial markets, in contracts, trading and financial instruments. The dollar also features in most global debt transactions, international credit, payment of dues, and international settlements..and in the dealings of international financial institutions, such as the International Monetary Fund, and the World Bank, in which nearly all countries of the world and their financial entities participate..and the dollar is widely used in pricing commodities and global trade..etc.....until the dollar became the eagle of currencies, and of the global financial markets..even after the dollar was freed from the gold cover as collateral in 1971..!

●      However, in the last three decades, the dominance of the dollar has become a matter of debate, due to shifts in economic power balances, and the rise of China as a strong competitor to the United States, technological changes that facilitated digital financial transactions, the rise of cryptocurrencies, in addition to geopolitical tensions that have caused some countries to look for alternatives to the US dollar. The debate resurfaced recently with the Ukraine war and the severe sanctions imposed by the United States and Western countries on Russia..

●      The discussion about seeking an alternative to the dollar is not limited to states hostile to the United States; there are voices from within the West itself that began this debate early, such as Britain and Europe...For example, Mark Carney, Governor of the Bank of England (former), in a speech he delivered in 2019 before a meeting of central bank governors in the American town of Jackson Hole, called for ending the dominance of the US dollar over the global financial system as the main reserve currency. He said that this dominance had reached a stage that had become an obstacle to a sustainable global economic recovery...!

●      He was referring to the fact that many countries around the world hold huge amounts of foreign exchange reserves in dollars to secure themselves in turbulent times, which means the hoarding of large sums of money that could have been used in the cycles of global trade and the global economy. In addition, the dollar is used as a payment system for at least half of international trade invoices, and therefore many countries become exposed to indirect repercussions, from fluctuations in the US economy and in the value of the dollar.!

●      Carney saw that the dollar could be replaced and a global digital currency adopted by central banks in different countries could be used. He said that such a digital currency "could blunt the dominant influence of the US dollar on world trade." If the share of trade invoiced in this new digital currency rises, then shocks that occur inside the United States would have less powerful effects (on other countries).!

●       He also mentioned that a global digital currency backed by a large group of countries would unleash the funds that governments currently store in dollars as a form of insurance in troubled times. He likened the shift from the dollar to a new global digital currency to the end of the pound sterling’s dominance in global financial markets about 100 years ago...!

●       Since Carney’s speech, which attracted wide interest, many have spoken about digital currencies and the future of the US dollar. In early February 2022, the Managing Director of the International Monetary Fund, Kristalina Georgieva, delivered a speech at the Atlantic Council research body in Washington on the future of money and the rise of the concept of digital currencies. She said the world has passed the stage of discussions about the idea and has reached the stage of experimenting with digital currencies..!

●       As for Europe, the European Union created a set of mechanisms to which EU countries resorted to bypass the US sanctions mechanism imposed on some countries, including the Instrument in Support of Trade Exchanges (INSTEX), which the European Union developed to preserve channels of trade with Iran after the United States withdrew from the Joint Comprehensive Plan of Action..!

●       The excessive use of sanctions based on the global presence of the dollar has granted the United States a powerful tool in foreign policy, but this excessive use of sanctions carries significant long-term risks, because it may encourage even US allies and trading partners, as noted above, to reduce their dependence on the dollar. It can also lead to the creation of an alternative financial system, which is happening now, undermining the objectives and mechanisms through which the current sanctions system operates. One expert pointed to the adoption of a set of mechanisms that countries have resorted to in order to bypass the US sanctions mechanism, as we noted above, and although those mechanisms may fail to achieve tangible economic results; they reveal a growing trend to create a parallel financial architecture that excludes the dollar. While that mechanism is a public phenomenon, the more dangerous development is China’s pursuit of creating a state-backed cryptocurrency that can hide its identity, thereby protecting participants from sanctions, providing an alternative means for goods and funds to move across borders, which offers companies a reliable alternative to the international financial system and undermines a primary advantage of the dollar’s reserve status..

●      The current situation of the dollar

-        Practically speaking, the dollar’s share of global foreign exchange reserves began to decline two decades ago, but it is still used more than all other currencies combined..!. The US dollar has long played a major role in global markets. But although the currency’s presence in world trade, external debt, and non-bank borrowing remains far greater than the United States’ share in trade and bond issuance, and in international borrowing and lending, central banks do not hold the US currency in their reserves to the extent they once did....!

-        Recent reports and international statistics have stated that about 59% of foreign currency reserves are currently held in dollars..about 20% in euros, 6% in Japanese yen, 5% in pound sterling, while the share of the Chinese yuan or "renminbi" is less than 3%..

-        This is what the financial statistics and data issued in the past few months of this year (2022) indicate, as they showed that the dollar’s share had fallen from global foreign exchange reserves to less than 59% in the last quarter of last year (2021), its lowest level in 25 years, continuing the declines over the past two decades, according to the official currency composition of foreign exchange reserves data issued by the International Monetary Fund. COFER)  )

-        There is an example of a broader shift in the composition of foreign exchange reserves: The Bank of Israel recently disclosed a new strategy for its reserves of more than $200 billion. Starting this year (2022), the share of the US dollar will be reduced and portfolio allocations will be increased to the Australian dollar, the Canadian dollar, the Chinese renminbi, and the Japanese yen.

-        As stated in annexed documents in a recent International Monetary Fund working paper, the reduced role of the US dollar was not matched by increases in the shares of other traditional reserve currencies such as the euro, the yen, and the pound.! Moreover, while there was some increase in the share of reserves held in the renminbi, this accounts for only one quarter of the shift away from the dollar in recent years, partly due to China’s relatively closed capital account. Furthermore, the data update referred to in the working paper shows that, as of the end of last year 2021, one country, namely Russia, held almost one third of the world’s renminbi reserves.!

-        By contrast, currencies of smaller economies, which have not traditionally appeared prominently in reserve portfolios, such as the Australian dollar, the Canadian dollar, the Swedish krona, and the South Korean won, account for three quarters of the shift away from the dollar., This was explained by the fact that there are distinguishing factors for such currencies, including that they combine higher returns and relatively lower volatility, which increasingly attract central bank reserve managers.., In addition, new financial technologies make trading the currencies of smaller economies cheaper and easier..!

-        There is another and more logical factor, which is that these unconventional reserve currencies are issued by countries that have open capital accounts and records of pursuing sound and stable policies.!

-        Serkan Arslanalp, Barry Eichengreen, and Shima Simpson wrote an article titled "Dollar Dominance and the Rise of Unconventional Reserve Currencies" on the "IMF Blog"...dated 1-6-2022, which stated:

·       The debate about the future of the international monetary system will not cease, especially with the intensification of the struggle for international influence, the expected attack on the dollar in the coming era of digital currencies, and the increasing moves among a number of countries, including Russia, China, and India, to conduct their mutual trade in the ruble, the yuan, and the rupee. !

·       The reality is that dollar dominance has been questioned for quite some time; several countries have already diversified their currency reserves by turning to the euro, the pound sterling, the yen and, recently, the yuan. The dollar’s share in global foreign exchange reserves fell from about 70% at the start of this century to about 59% by the end of last year, as we mentioned earlier, but so far there is no alternative that can be said to displace the dollar..!.. Even the yuan, which relies on China’s enormous economic might, does not constitute an alternative in the view of most global financial circles, owing to the traditional concerns that the nature of centralized authority in Beijing means it can issue decisions that lead to currency price volatility, in addition to a lack of transparency.!

·       For example, by the end of January (Kanun al-Thani) 2022, Russia’s foreign currency reserves were estimated at about $469 billion. President Vladimir Putin had hoped that this reserve would provide his country with a safeguard against the effects of any Western sanctions, after the lesson received following his invasion of Crimea in 2014. But his calculations were not accurate, as the sanctions this time were harsher and included the Russian central bank’s reserves held abroad, which deprived Moscow of half of its foreign exchange reserves and placed serious obstacles before its international trade...!

·       This situation did not affect Russia alone, but sent signals to other countries such as China, which are watching the war in Ukraine and its repercussions and recognize that they might be targeted by American sanctions in the future, amid the escalating rivalry between it and Washington over influence and primacy in the global economy. The freezing of Russia’s foreign reserves means that these reserves do not provide a safe haven, and therefore other countries may consider that diversifying foreign currency reserves gives them greater assurances than putting alltheireggsinthedollarbasket...!!

·       Some believe that the strongest challenge to the dollar may come in the future from digitalcurrencies. At present there are 100 countries studying the possibility of using digital currencies, and these countries represent almost 90% of global GDP.!

·       Meanwhile, amid the rise of the digital economy, virtual encrypted currencies have gained more attention from investors through digital transactions....The issuance of cryptocurrencies by companies has encouraged some countries to consider issuing encrypted currencies as an alternative to the traditional banking system. Last year, Bank of England Governor "Mark Carney" proposed that central banks jointly create a virtual currency to serve as the global reserve currency as an alternative to the dollar!

·       Sources: IMF Blog, IMF experts, advanced research centers, researchers, specialized internet pages, and related articles by writers and economists...

·       To be continued, part two ....