As we sit here in March of 2023, the US dollar is still wearing the crown as the king of all currencies. It’s the currency that everyone wants to hold onto and use in their international dealings.
Now, you might be wondering, “Why is the US dollar so popular?” Well, it’s all thanks to the Bretton Woods system established back in 1944. The dollar was chosen as the anchor currency, and most other currencies were pegged to it. Since then, it’s been the most frequently used currency in the world, and it’s stayed on top because of its worldwide acceptability and stability.
But that’s not all! The US dollar is also the most traded currency in the forex market, making up over 85% of the trading volume. And get this – it’s the most popular reserve currency in the world, accounting for a whopping 64% of all known central bank foreign exchange reserves. That’s a lot of faith in the dollar!
Why is the US dollar so widely favoured? There are a few reasons. The US has one of the largest and most influential economies globally, making the dollar highly attractive to investors and traders. Additionally, the US plays a significant role in international trade, with many global transactions being conducted in dollars. These factors contribute to the widespread use and appeal of the US dollar in global markets.
One significant factor contributing to the US dollar’s global dominance is the petrodollar system. In 1974, Saudi Arabia agreed to sell its crude oil in US dollars and invest its oil revenue in US Treasury securities, in return for US government protection. This system helped undergird the status of the US dollar as the global reserve currency, particularly after US President Richard Nixon ended the convertibility of the dollar to gold in 1971.
Now, some people have been speculating that the US dollar might lose its top spot as the global currency. But most experts believe that it’s going to stay on top for the foreseeable future. No other currency can match its acceptability, stability, and strategic importance.
But there are some challenges. Other currencies like the euro and the Chinese yuan are starting to give the dollar a run for its money. Plus, US-led sanctions on countries like Russia have led to some oil trades being denominated in other currencies. So, the dollar’s dominance in global trade is definitely a complex issue.
All in all, it really does seem like the US dollar is the boss of global finance. And with a strong economy, a huge financial market, and a lot of historical clouts, it’s easy to see why. So, hold onto your dollars, betting against the US might not be a great idea yet!
Impact of US Inflation on the Indian Debt Market
The US dollar’s dominance in global trade and finance
The US dollar is currently the dominant currency in global trade, accounting for approximately 85% of all foreign exchange trades. There are several reasons for this, including:
1. Strength and Stability of the US Economy
Despite trillions of dollars in foreign debt and continuous large deficit spending, the United States still holds global trust and confidence in its ability to pay its obligations. As the US economy has weathered all economic storms that have come its way while also being the largest and most highly stable economy in the world, it provides a sense of security and instills trust among investors globally.
2. Role of the US in International Trade
The US is one of the largest importers and exporters in the world. As a result, many international transactions are denominated in US dollars. This usage has made the US dollar the go-to currency for many countries that engage in global trade.
3. Historical Dominance of the US Dollar
Since the end of World War II, the USD has been the dominant currency in global trade. Many countries have established their currencies’ exchange rates with the US dollar, which further cements its position as the leading currency in global trade.
4. Size of the US Financial Markets
The US financial markets, including the stock and bond markets, are among the largest and most liquid in the world. This makes the US dollar an attractive currency for investment. When investors want to buy or sell stocks or bonds, they need US dollars. Thus, the size of the US financial markets has contributed to the US dollar’s dominance in global trade.
‘World’ Economy on the Greenback!
What’s ‘greenback’ you might be pondering?
Greenback’s dominance started in 1914 when the Federal Reserve Bank was created, and the US printed its first paper currency aka ‘Greenback’. It gave the US a major stake in the global financial system. Since then, the US dollar has become the world’s most widely held reserve currency, accounting for over 64% of all foreign exchange reserves held by central banks worldwide.
But lately, things have been changing. The dollar’s share of global foreign exchange reserves has been declining in recent years, despite it remaining the dominant global reserve currency. This is perplexing to analysts and investors alike.
The US dollar became so dominant due to the positioning of the US economy right at the top – its stability, openness to trade, and capital flows. It has also had strong property rights and the rule of law. This allowed the US to borrow money more easily and impose painful financial sanctions on other countries.
This dominance imposes its fair share of challenges on the US economy. When foreign central banks stockpile dollars, they effectively push up the purchasing power of American consumers. This can make it harder for US companies to compete in international markets.
The US dollar exchange rate has also become increasingly politicized, with calls for a weaker exchange rate to boost employment and exports. This is adding to the perplexity of experts who are trying to understand the implications of these changes.
Global banks hold a significant amount of US dollar-denominated liabilities, which have been steadily increasing since the Global Financial Crisis. The only other currency with a notable amount is the euro, with over $9 trillion of foreign-denominated bank liabilities.
Recent trends show a decline in the US Dollar Index, which measures the performance of the greenback against a basket of other currencies, including the euro, Japanese yen, British pound, Canadian dollar, Swiss franc, and Swedish krona.
The US dollar’s role in the world economy remains complex and multifaceted, with ongoing debates about its future trajectory and potential challenges it may face in the years ahead. Every finance literate needs to stay informed about these trends and their potential implications for our future. Who knows what kind of exciting developments we may see in the coming years?
Geopolitical issues and it’s impact on the Debt Market
The pros and cons of the US dollar’s global dominance
One of the primary benefits of the dollar’s dominance is that it is widely accepted in global trade, giving the US a significant advantage in international commerce. The dollar’s status as the world’s reserve currency also allows the US to borrow at low-interest rates. It stimulates economic growth and provides flexibility in responding to financial crises. Some economists go on to argue that the US dollar’s dominance has helped to maintain stability in the global economy.
The dollar’s global dominance also has its downsides. The global economy is highly susceptible to swings in US monetary policy, as the Federal Reserve’s decisions affect the monetary policies of countries that link their currency to the dollar. The dominance of the US dollar has also led to concerns about the potential negative effects of the country’s large trade deficits and debt levels on the global economy.
In this decade, some have even suggested that the US dollar’s dominance may be challenged by the rise of digital currencies, particularly as more countries explore their own central bank digital currencies (CBDCs). There’s a growing recognition that the global economy could benefit from a more diverse range of reserve currencies, which would help reduce the risks associated with any one currency’s dominance.
Fluctuating Fate of the Dollar and Rupee
As of March 9, 2023, the exchange rate between the Indian rupee and the US dollar was 0.0121, which means one US dollar was equivalent to 82.49 Indian rupees. The reason for the fluctuation is that, as per the laws of demand and supply, the value of the rupee increases against the dollar when the demand for the dollar is high.
A fall in the rupee against the dollar can have an impact on an investor’s US stock portfolio. A lot of forexes analysts are currently attributing the depreciation of the rupee to the recent hike in US interest rates. Although, that is just the short-term outlook and will not continue for long as India remains the fastest-growing economy.
The Indian government also has started paying for most Russian oil in non-dollar currencies, denting the decades-old dollar dominance. This follows a move by a coalition opposed to the war to impose an oil price cap on Russia.
The depreciation of the Indian Rupee against the US dollar can lead to an increase in the prices of essential goods and services, as India needs to pay more for the same items. The strength and weakness of the dollar can impact the profitability of Indian companies, which either earn a large chunk of their revenues in dollars or import key raw materials.
Foreign fund flow into Indian equities is dictated by the currently accepted investor sentiment which is generally dictated by the trend of appreciation or depreciation of the INR/USD duo.
Despite the challenges posed by the fluctuations of the US dollar, Indian Finance Minister Nirmala Sitharaman remains optimistic about the resilience of the Indian rupee. She has noted that the currency has performed better than many other emerging market currencies and even a 10% slide in its value may not be a cause for concern.
Recently the Indian currency plunged against the US, although the Indian economy can show a significant growth projection in its GDP in the near future. That may happen if the Government essentially enhances the financial sector. The changes can be possibly made to strengthen the debt market (Bond) for larger firms and the banks can lend money to the SMEs in order for them to emerge. The report from the Centre for Economic and Business Research, predicts that the Indian economy can overtake Germany by 2031 to become the World’s third-largest economy.
The Dark Side of Dollar Dominance: Unintended Consequences for the US Economy
Firstly, it has been noted that the decline in the dollar’s share of international reserves since the turn of the century is not solely due to changes in exchange rates and interest rates or reserve accumulation by a small handful of central banks. Rather, it reflects active portfolio diversification by central bank reserve managers. This trend toward diversification may continue and could lead to a further decline in the dollar’s share of international reserves.
Secondly, there are concerns about the impact of dollar dominance on the US government’s ability to run large budget deficits with impunity. The dollar’s status as the world’s reserve currency has allowed the US to borrow at lower costs and run larger budget deficits.
The US government has recorded a budget deficit of $421 billion for the first quarter of the fiscal year 2023, which covers the period from October 1, 2022, to December 31, 2022. In January 2023, the federal government recorded a budget deficit of $39 billion, compared to a surplus of $119 billion in January 2022. The total deficit for the 2022 calendar year was $1.42 trillion.
President Joe Biden’s upcoming budget proposal aims to cut deficits by nearly $3 trillion over the next decade, indicating that the US government is still dealing with budget deficits in the future.
A decline in the dollar’s dominance may lead to higher borrowing costs and reduced ability to run large deficits, potentially constraining the government’s spending.
Thirdly, there are concerns about the impact of digital currencies on the dollar’s dominance. The rise of digital currencies, such as Bitcoin and other cryptocurrencies, has the potential to disrupt the dominance of the US dollar. If the use of digital currencies continues to grow, it may reduce the demand for the US dollar and weaken its position as the world’s reserve currency. It is clear that cryptocurrencies continue to be a topic of interest and speculation among investors and financial experts although, it remains to be seen how cryptocurrencies will impact the US dollar in the future
Finally, it has been suggested that the dominance of the US dollar gives the US government unprecedented insight into the functioning of the international economy. The potential loss of this insight could have unintended consequences for US economic policymaking.
While the unintended consequences of dollar dominance on the US economy are complex and multifaceted, it is clear that there are potential risks associated with the decline of the dollar’s dominance.
