After the end of second World War, the dollar has assumed the role of the foremost reserve currency at a global extent, and it remains the currency of choice for international trade. Its universal demand helps advantageous borrowing rates for the United States and strengthens the effectiveness of its sanctions. Surpassing other currencies such as the euro and the Chinese. Many central banks and financial institutions worldwide seek to own American dollars and dollar-backed securities like US Treasury bonds, creating a strong demand. This demand allows the United States to borrow money at lower interest rates than it otherwise could. Since the Cold War's conclusion, the dollar's dominance has encountered hurdles, particularly as emerging economic powers aim to reduce dependence on its hegemony. The emergence of cryptocurrencies further complicates the dollar's hold on global finance.
The history of the dollar's domination
(1) The history of the dollar's dominance spans several pivotal moments, but one of the most significant milestones was its ascent to the status of the primary reserve currency, a position it arguably achieved in the mid-1920s, displacing the British pound. But the 1944 Bretton Woods Conference cemented its standing on the international scene. This historic meeting, which was attended by 730 representatives from 44 ally powers during World War II, established a system of fixed exchange rates. Every nation consented to fix the value of its money at a fixed rate of $35 per ounce of gold, with the dollar serving as the benchmark. The purpose of this arrangement was to maintain stability and stop nations from enacting trade and economic policies that would endanger their trading partners or neighbors. The Bretton Woods Agreement established the groundwork for the dollar's hegemony in international finance and its long-term position as the cornerstone of the world economy.
(2) However, by the 1960s, the US did not have enough gold to support the dollars in circulation outside the US, thus the US stopped the dollar's convertibility to gold in 1971, effectively ending the Bretton Woods exchange rate regime. Later, the Smithsonian Agreement, announced in December 1971, established a new dollar standard (raising the price of gold to 38 dollars), under which a number of industrialized countries' currencies were tied to the US dollar. These currencies were allowed to move against the dollar by 2.25%. The gold-free market continued to put pressure on the US$ official rate following the Smithsonian Agreement, and soon after a 10% devaluation was announced in February 1973, Japan and the OEEC/OECD countries opted to let their currencies float. As a result, all developed countries did the same, resulting in the demise of the Smithsonian Agreement and bolstering the free market economic system in which prices of products and services are maintained on the basis of supply and demand.
Pegging effect
Currency exchange rates can be either fixed or variable. The fixed exchange rate is regulated by a particular country, but the floating rate is decided by market demand and supply dynamics. Because the US dollar and other major currencies are floating currencies, their values fluctuate in response to demand and supply dynamics. Pegging to the US dollar is used to stabilize exchange rates between trading partners and maintain the value of its currency low. With a lower-value currency, the country's exports can be priced relatively competitively. Countries that engage in international trade must ensure that the value of their currency remains steady. Pegging is one method for countries to accomplish this. When a currency is pegged or fixed, it is linked to the currency of another country. Countries choose currency pegs to protect the competitiveness of their exported goods and services. A weakened currency benefits both exports and tourists by making things cheaper to buy. The broader the currency volatility, the more damaging it can be to international trade. However, many countries have chosen to keep a fixed policy, and there are still a considerable number of currencies linked to the US dollar today. Countries peg to ensure that their goods and services stay competitive rather than being negatively harmed by the frequent fluctuation of the exchange rate of a floating currency
Using the dollar as one‘s official currency
More than 50 nations have pegged their individual currencies to the US dollar, promising to exchange the same amount of their currency for each unit of the fixed currency. The U.S. dollar was approved as the official currency of 11 nations.
Reserve Currency and worldwide trade
The U.S. dollar is the world's dominant reserve currency amongst eight major reserve currencies acknowledged by the International Monetary Fund (IMF), the organization in charge of overseeing the global monetary system. In addition to making up the majority of the world's reserves, the dollar is the preferred currency for trade on a worldwide scale. The main currency used for buying and selling major commodities like oil is the US dollar. Saudi Arabia is one of the nations whose currencies are still tied to the dollar. The constant value of the dollar, the size of the American economy, and the strength of the US geopolitical position are all factors that contribute to the dollar's dominance. Furthermore, no other nation has a market for its debt that is comparable to that of the United States. Without a market comparable to the Treasury market, it is difficult to compete with the dollar.
Challenges to dollar dominance
Harry Robertson, a market writer, cautioned that the US dollar faces a lot of threats and could depreciate to the level of the British pound in an essay that appeared in "Markets Insider" on April 1, 2022. Several geopolitical and economic variables are currently working together to undermine the US dollar's supremacy. The dollar's scenario was already a ticking alarm clock due to growing participation. China is currently emerging as the next major economic force. A global economic downturn and Russia's absence from the dollar-driven SWIFT system (which facilitates international financial transactions including money transfers) are posing challenges to the US dollar's hegemony. We anticipate these factors to continue, especially in light of how the West has responded to the conflict in Ukraine. The collapse of the dollar's dominance looks to have already begun.
Cryptocurrency impact on dollar dominance
The belief that the world will start moving away from the US dollar as a reserve currency is one of the hottest themes in today's society discussing that "gold or bitcoin are the front-runners to substitute the US dollar as the global reserve currency." Once a limited group of people was familiar with cryptocurrency prior to it suddenly becoming a common phrase. Since 2011, cryptocurrencies have been more popular, attracting attention from investors and decision-makers for a variety of reasons. With a digital character that effectively enables direct payments without the help of any banking institutions, cryptocurrencies represent another type of coin. There are numerous aspects to consider when it comes to cryptocurrency as a challenge to dollar dominance. Some of them can be discussed in the following paragraphs:
(i) Although cryptocurrency is a relatively young technology and has yet to have a long-term impact, it has the potential to bring about significant changes in the financial sector. Its decentralized nature, borderless
transactions, and potential for financial inclusion can reshape how we perceive
and engage with money. However, challenges like regulatory concerns and
scalability issues need to be addressed for widespread adoption and long-term
impact.
(ii) Because they are not backed by governments but rather an algorithm, cryptocurrencies have benefits over traditional currencies. In addition, compared to other currencies, they offer enormous flexibility and quickness in international transfers. Due to the anonymity of their users, cryptocurrencies do not impose transfer restrictions based on watch lists or embargoed nations. Additionally, it has been noted that cryptocurrencies appear to act as money and foster a different corporate climate. This is because cryptocurrencies increase transaction security and may lower transaction fees and exchange rate risks, which would enable them to replace traditional currencies.
(iii) The main concerns of cryptocurrency trading are cybersecurity and price volatility. The world of cryptocurrencies is complex and difficult for the common person to understand, therefore understanding them takes time and effort. The crypto sector must demonstrate its worth as a long-term investment. Cryptocurrency has significant scaling problems, and its newcomers are exposed to security threats. The lengthy processing time needed to complete a Bitcoin transaction makes it unsuitable as a means of payment for regular transactions.
(iv) Perhaps as they emerge, digital assets will resemble conventional reserves in terms of safety and liquidity while being free from geopolitical interference. Although none of the stable coins or crypto-assets built on blockchain that are currently accessible completely meet those standards, nevertheless further developments may bring in a more dependable replacement. The bulk of digital assets is believed to have been created and designed in a way that will strengthen rather than decrease the dollar's control. The dollar is undeniably the absolute monarch of global foreign exchange trade, but cryptocurrency has a far smaller market than forex, which is dominated by the US dollar.