Context: 

Attempts to de-­dollarize have picked up pace in the aftermath of Russia’s invasion of Ukraine last year.

Key Terms:

• De­-dollarisation: It refers to the replacement of the U.S. dollar by other currencies as the global reserve currency.
• Reserve currency: 

1. 1. A reserve currency refers to any currency that is widely used in cross border transactions and is commonly held as reserves by central banks.
   2. A reserve currency reduces exchange rate risk since there’s no need for a country to exchange its currency for the reserve currency to do trade.

How the U.S. Dollar Became the World’s Reserve Currency?

• Post world war, the U.S. emerged as the dominant economic power which had enormous implications for the global economy. 
• At one time, U.S. Gross Domestic Product (GDP), which is a measure of the total output of a country, represented 50% of the world’s economic output.
• As a result, it made sense that the U.S dollar would become the global currency reserve. 
• In 1944, following the Bretton Woods Agreement, delegates from 44 nations formally agreed to adopt the U.S. dollar as an official reserve currency. 
• Since then, other countries pegged their exchange rates to the dollar, which was convertible to gold at the time.

Background of De-dollarisation: 

• Countries have tried to dethrone the dollar as the global reserve currency for many decades now for various reasons. 
  • But of late, attempts to de-­dollarize have picked up pace in the aftermath of Russia’s invasion of Ukraine last year. 
• The U.S. imposed several sanctions that restricted the use of the U.S. dollar to purchase oil and other goods from Russia, and this has been seen by many countries as an attempt to weaponise the dollar. 
• Since international transactions carried out in the U.S. dollar are cleared by American banks, this gives the U.S. government significant power to oversee and control these transactions. 
• Currently, the Chinese yuan is seen as the primary alternative to the U.S. dollar owing to China’s rising economic power.

The Reserve Currency Advantage:

• Lower borrowing costs: As the world reserve currency, the US dollar benefits from high demand, which allows the US government to borrow money at lower interest rates than other countries. This reduces the cost of servicing the national debt and allows for greater spending flexibility.
• Increased economic power and influence: As the reserve currency, the US dollar gives the US a powerful economic tool, allowing the US government to exert influence over other countries through economic policies and trade agreements. This can also translate into political influence on the global stage.

• Increased demand for US goods and services: The US dollar’s status as the world’s reserve currency means that it is widely used in international trade, which can increase the demand for US goods and services.
• Increased financial stability: The reserve currency status of the US dollar contributes to the stability of global financial markets, making it a safe haven for investors during times of economic uncertainty or instability.
• Reduced exchange rate risk: The reserve currency status of the US dollar means that other countries hold significant reserves of the currency, reducing exchange rate risk for the US and increasing the stability of the currency’s value.

The Popularity of the U.S. Dollar 

• Many economists argue that the U.S. dollar is not forced on anyone to be accepted as a medium of exchange for cross-border transactions. 
• The U.S. dollar is widely used in international transactions because people actually prefer to use the American currency over others for various economic reasons. 
• Trust in Financial markets of USA: 

• • The US dollar is the cheapest means of access to acquire nominally risk-free US Treasury instruments.
  • The U.S. has been running a persistent trade deficit for decades now. The excess dollars that the rest of the world accumulates due to the U.S. ‘s trade deficit has been invested in U.S. assets such as in debt securities issued by the US government. 
  • The high level of trust that global investors have in the U.S. financial markets, perhaps owing to the ‘rule of law’ in the U.S., is considered to be a major reason why investors prefer to invest in U.S. assets. 

• Unpopularity of other currencies :

• • Rupee-Rouble Trade: A recent attempt by India and Russia to carry out trade between the two countries in Indian rupees rather than in U.S. dollars has hit a roadblock because the value of India’s imports from Russia far outweighs its exports to the country. 
  • This left Russia with excess rupees in hand which it was unwilling to spend on Indian goods or assets, and led to Russian demands for the settlement of bilateral trade in U.S. dollars.

                                                                                                                     News Source: The Hindu