Context:

As China, India, and Russia dabble in trade using partner currencies for payment instead of the U.S. dollar, various media are rife with speculation about the demise of the dollar as world reserve currency. 

Rise of the Dollar:

• The U.S. dollar’s status as a preferred currency and reserve currency was not a result of any purposeful policy or international agreement.
• The dollar’s dominance aligns with the rise of the U.S. economy and stable government.
• The dollar has faced challenges from other currencies, but its dominance continues.
• The dollar’s share of foreign exchange reserves has fallen from 80% in the 1970s to 60% in 2022, with the euro making up 20% of the remaining 40%.

China, India, and Russia as potential challengers:

• China runs a closed capital account, so it is not a prominent choice for foreign exchange reserves.
• China and Russia accumulate each other’s currency as foreign exchange reserves, making a trading arrangement between them more viable.
• India’s biggest trading partner is still the U.S., despite Russia being its biggest supplier of oil.
• Geopolitical compulsions push India closer to the U.S., casting doubt on the long-term viability of a common currency or reciprocal trading arrangement between China, India, and Russia.

Demand for dollar-denominated assets:

• Demand for dollar-denominated assets worldwide, including U.S. government debt, is a key reason for the dollar’s importance in the international financial system.
• The U.S. dollar is also used as a quality collateral in international transactions.
• Many currencies are pegged to the U.S. dollar, and some countries use the dollar as their own currency.

The advantages of being a supplier of international reserve currency:

• Being a supplier of international reserve currency confers a distinct advantage on the issuing government – the ability to borrow at a low interest rate.
• The U.S. government debt is in high demand worldwide and gets issued at the lowest interest rate, relaxing the fiscal constraint substantially.

Conclusion:

• The run of the U.S. dollar as an international reserve currency is far from over, with the euro as its closest competitor.
• Any currency competing for the position of the U.S. dollar as an international reserve currency will have to provide the additional services that the dollar currently offers.
• The current system is not optimal, but a common currency between China, India, and Russia or any such reciprocal trading arrangement is unlikely to be a serious contender.

News Source: The Hindu