The Impregnable Greenback.

                “The dollar is strong because of the U.S economy and because people want to hold dollar and the safety of the dollar,” said Steven Mnuchnin, the U.S Treasure Secretary. The U.S. dollar, also known as greenback because of its colour, is patently the most powerful currency in the world. In fact the dollar is powerful that the U.S has been able suppress its enemies without any form of military action by using it as an asset. It has been a common policy of the U.S Presidents to take advantage of the dominating position of the dollar and the Trump administration has increased the use of this tool by making tariffs their primary weapon when dealing with its enemies like Venezuela, Democratic People’s Republic of Korea, Iran etc. This raises a question, as to how did the U.S dollar become so powerful that now it is the world’s reserve currency? This article intends to give you a comprehensive idea of the dollar, its past, present and the future.

The Inception:

Before World War 1, the countries followed the gold standard, which means that the country’s currency is directly linked to gold. During the World War 1, many of the developed countries abandoned this gold standard and started paying their military expenses in paper money. Eventually the U.S dollar, which was still tied to gold, overtook the British pound to become the world’s leading currency. During World War 2, the United States supplied weapons to its allies and in return accepted payments in gold. By the end of World War 2, the U.S had 70% of the world’s total gold reserve.1 Due to this, in 1944 the leaders of 44 developed countries came together to peg their currencies to the U.S dollar which was pegged to gold. This came to be known as the Bretton Woods Conference of 1944 which marked the beginning of the U.S’ economic dominance.

How did the U.S. dollar keep its position?

When so much power is given in one country’ hands, nefarious activities can be expected. By 1965, the major economies like France had started objecting the dollar’s dominance. In February 1965, Charles de Gaulle, the then President of France, sent France’s U.S. dollar reserve to exchange it for gold. To counter the growing protests, the then U.S. President, Richard Nixon, made the startling announcement on 15th August,1971 that the U.S. dollar’s convertibility into gold and other reserve assets will temporarily be suspended. This introduced the system of floating exchange rate and as we can see, in the long run, the dollar has only gained from this decision.

The exorbitant privilege:

Exorbitant privilege refers to the benefit which the U.S. has due to its own currency being the international reserve currency.

As of June 10, 2020, there was $1.91 trillion worth of Federal Reserve notes in circulation. Out of this almost 2/3 of $100 bills and half of $50 bills are outside the U.S.2  

When it comes to international trade, almost all the countries prefer carrying out trade in U.S. dollar.  Last year 88% of all foreign transactions were done in the U.S. dollar.3

Why do all the countries prefer dollar?

The U.S. dollar is the most stable currency in the world. There might be several reasons for it but the major factor is the strong U.S. economy. Even during the coronavirus pandemic, the dollar has gained in value by 5% in the first two weeks of May.4 In times of crisis, the investors tend to resort to “safe havens” and the U.S. dollar is considered to be one.

As the currency is stable, the prices of the goods are determined in the dollar and hence the payments are also made in dollar. The amount of money that the countries agree to pay each other right now will not change much in the future but had they been decided in the Turkish Lira, it would have been a completely different story. Another reason is, that dollar is very liquid which means we can sell and purchase things anywhere in dollar.

How the U.S. uses the dollar as a weapon:

As most of the international trade is carried in the U.S. dollar, almost all the payments made touch the U.S. soil. The United States has a really efficient banking system which ensures that these go on smoothly. When the U.S. wants to suppress any country like Iran, it imposes sanctions and restrictions. The U.S. restricts that country from carrying out transactions in the dollar. Due to such restrictions, that country’s international trade reduces significantly. Now obviously there are other ways to carry out trade but the other countries rarely encourage that. In this way the U.S. has the power to obliterate any economy. The Trump administration has been using this tool too frequently which has infuriated numerous countries including the European Union.

Why are the other stable currencies not used?

Considering the fact that the U.S. dollar is not the only stable currency in the world, why are the others like the Swiss Franc or the Singapore dollar not used, both of which come from politically and economically stable countries too? Even though these points are valid, those other countries have far less economic power and far less influence too. The U.S.’ military presence all over the world also has a considerable impact on the other nations. So when the economic tools do not work, it can always dominate using its military.

The pandemic’s impact on the dollar:

Due to the current coronavirus pandemic, the Federal Reserve, which is the central bank of the U.S.A, also commonly known as the Fed, has printed a lot of new currency to support the global economy because 40% of the total debt in the world is given in the U.S. dollar.5 If we go by the economic laws, the dollar should depreciate but that is not the case. The only logical explanation for this is the fact that during a pandemic, the investors have resorted to the dollar because of which its demand has increased significantly which seems to counter the negative effects of new currency. Though this might seem to be a really positive phenomenon, some fear it has its negative effects as well. In a recent note from Credit Suisse: “The dollar’s status as the currency of global trade, foreign companies- could be borrowing in dollars from their local banks to cover payments to suppliers that they would otherwise miss.” So even when the world markets are crashing, the currencies are depreciating, the U.S. seems to be in a better position. The Dow reached its highest ever during this pandemic.

Can the U.S. dollar hold its status?

This is no secret that the U.S. has often tried to use its economic dominance to suppress its enemies and obviously, there have been repercussions. China and Russia have been actively appealing to the IMF to develop a reserve currency and check the growing power of the U.S. dollar. These two countries have been planning for a long time to counter the dollar. The EU is using a separate portal for payment to carry out trade with Iran.

China’s move to introduce a Cryptocurrency has raised suspicions that it is planning a big move and it is no secret if the Chinese yuan is the dollar’s replacement, then China stands to gain a lot. It has been increasing its influence in the Asian subcontinent and that has caught the U.S.’ attention. It would not come as a surprise if China becomes the new superpower. Its “Belt and Road Initiative” is a really bold move and if this becomes a reality, then no one can gainsay that china will gain an edge over the U.S.

                Even though the U.S. economy looks strong and the dollar remains unharmed, we cannot deny the fact that the dollar’s future might have some impediments. The growing unrest due to the activities of the Trump administration and the frequent threat of sanctions seem to make the world leaders angry and China might actually succeed in its efforts to unite the world to remove U.S. dollar as the reserve currency. But is it actually possible to boycott the U.S. dollar? Is it really possible to find an alternative? Would it not be a foolish move to trust China over the U.S.? As these are some of the questions we need to answer, right now the dollar seems just as powerful as ever with no close competitors.

References:

  1. https://www.imf.org/external/np/exr/center/mm/eng/mm_dr_01.htm
  2. https://www.federalreserve.gov/faqs/currency_12773.htm
  3. https://www.federalreserve.gov/faqs/currency_12773.htm
  4. https://uk.reuters.com/article/emerging-markets/emerging-markets-emerging-market-stocks-surge-over-5-as-feds-dollar-stream-lifts-sentiment-idUKL4N2BD1V3
  5. https://www.economist.com/content/global_debt_clock
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