In the mid-1960s, Valéry Giscard d’Estaing, French Minister of Finance to President General Charles de Gaulle, coined the phrase “exorbitant privilege” to describe the phenomenon of international hegemony of the US dollar. Is this exorbitant privilege disappearing lately? Or has the dollar been weaponized in the context of the current war between Russia and Ukraine? Consider the following phenomena.
First, on January 18, 2022, the US Senate, in its “Ukrainian Sovereignty Defense Act”, effectively threatened to cut off Russia (including major Russian banks and energy companies) from access to US dollars due to his aggression.
Second, in mid-March 2022, US sanctions on Russia froze nearly half of Russia’s $640 billion in gold and currency reserves.
Third, as part of the sanctions, several Russian banks were disconnected from the SWIFT system, severely limiting their ability to communicate with other global banks.
Fourth, there are reports that China is trying to buy oil from Saudi Arabia in yuan, and Russia is demanding to denominate its oil trade in rouble. Similarly, in India, there is speculation as to whether the days of the rupee-ruble trade are back.
Finally, there are speculations that cryptocurrencies could be used to minimize penalties on dollar trading. All the issues take on importance in the current context.
Why is the dollar so much more than the currency of the United States? Ultimately, the dollar is an international currency to such an extent that economic agents from all walks of life are ready to accept the dollar. An airport carrier, a terrorist organization, a hedge fund, a central bank, an importer or exporter, a global bank or even a local grocery store – the list of those economic agents willing to accept dollars seems endless.
Nobel Prize-winning economist Paul Krugman has developed an interesting classification scheme of the various dimensions of holding an international currency. Krugman grouped the benefits of holding an international currency separately for private and official agents; for each of the two agents, the phenomenon of universal acceptability of an international currency can be sought under three headings: (a) medium of exchange; (b) unit of account; and (c) store of value (table).
Key roles of the dollar
Regarding the current war between Russia and Ukraine, which of these six functions of the dollar is being diluted?
To appreciate the role of the dollar as an international currency, the following trends can be noted for the pre-Covid world. First, at the end of 2018, the US Fed revealed that more than 45% of dollar bills were held outside the United States. Second, IMF data indicated that at the end of 2019, the dollar tended to play an important role in determining the exchange rate in 38 countries that do not have freely floating exchange rates; the euro comes second with a list of 25 countries, many of which belong to French-speaking Africa.
Third, the dollar has always been the most important billing currency. Fourth, the central bank’s triennial survey of foreign exchange and over-the-counter (OTC) derivatives markets by the Basel-based Bank for International Settlements (BIS) found that in terms of currency composition, the dollar alone accounted for almost half of the total transactions on the foreign exchange market in 2019; far behind comes the euro with a share of around 16 percent.
Fifth, according to the 2019 edition of the Monetary Composition of Official Foreign Exchange Reserves (COFER) of the IMF, since the beginning of the new millennium, almost 60% of the world’s foreign exchange reserves have been invested in US dollars.
All of these numbers, however, are history. Interestingly, despite the insular policies of the current American Trump, the world has witnessed a “flight to safety” phenomenon with countries and companies flocking to the dollar during the Covid pandemic, such as during the 2008 global financial crisis. How do we see the supremacy of the dollar playing out in the post-Covid world tormented by the geopolitical tensions triggered by the Russian-Ukrainian war?
In terms of Krugman’s 3×2 matrix, three comments are in order. First, the role of the dollar as (a) a private vehicle of exchange; and (b) a private billing currency might have been slightly shaken by now. Secondly, and above all, the importance of the dollar does not seem to have faded in its official role as a medium of exchange, a unit of account and a store of value. Finally, there is not much evidence to infer that countries have moved their foreign exchange reserves significantly away from the dollar.
The process of internationalizing a currency takes time and involves an interaction of economic, political and strategic forces. Typically, such locomotion occurs at a slow pace with some tipping point. It took no less than two world wars for the pound sterling to lose its status as the main international currency. But are we still at the time of such a change? Can the current war between Russia and Ukraine and the somewhat wavering role of the United States as a military power lead to such a tipping point? Or can technology and the emergence of cryptocurrency push the world towards multiple standard currencies?
While it is difficult to hazard a prediction in the current conjuncture, recent developments are unlikely to be of such magnitude, calling for tectonic shifts in the global status of the dollar. It is perhaps premature to write the epitaph of the dollar.
Ray is Director of the National Institute of Banking Management, Pune and Pal is Professor of Economics at IIM Calcutta. Views are personal
April 24, 2022