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Currency Internationalization and the Hegemony of dollar

Internationalization of currency refers to the usage of a currency in countries other than the one it was initially issued in. It is determined by the demand for the currency by these other countries. This could be for various reasons, such as for international trade, holding reserves, keeping it as a safe haven investment, its domestic use within another country by currency substitution, etc. The top four currencies used for global trade are the United States' dollar (USD), the European Union's euro (EUR), Japan's yen (JPY), and the United Kingdom's Great British Pound (GBP). The US dollar is used for around 88%* of daily international trade, proving to have a clear majority. To understand how USD became the global currency, we go back to the early twentieth century.

Initially, most developed countries used gold to back their currencies and determine exchange rates. After 1914, during World War I, many countries switched from gold to paper money. However, Britain, which had the dominant currency at the time, continued using gold. It soon needed to borrow, and the US was the primary lender, not solely for Britain but also for many other countries. Later, Britain discontinued gold convertibility, leading to losses for those holding reserves in pounds.

During World War II, the US was the main supplier of weapons for the Allies and received payment in gold. In 1944, delegates from 44 countries formed the Bretton Woods Agreement. They decided to peg currencies to the US dollar instead of gold, as the US held a majority share of gold in the market. According to the Agreement, USD would be convertible to gold. However, not more than twenty years later, the US started running out of gold, and President Nixon abolished gold convertibility and the Bretton Woods system. By the 1970s, a neoliberal system was established where floating exchange rates were prevalent. However, some countries regulated them by pegging their currency to the US dollar or maintaining the rates within a certain range. However, could the dollar collapse? If it does, it could lead to contagion and impact the entire globe.

Could it be overthrown? Many researchers and economists have pondered these questions. To determine the scope of the other widely used currencies posing a potential threat to the USD, we analyze each of them. The euro has around 32%* of the foreign exchange market takeover. The European Union recently issued jointly backed debt, and if it is able to develop a large liquid market for its bonds, it may gain the trust of countries and investors. However, the currency has its challenges. Historically, European countries have often been at war with each other, which made trade difficult.

The abolition of tariffs and other barriers to trade led to the creation of the eurozone and a common currency, the euro. However, there were several issues with this. The zone had a common monetary policy but different fiscal policies. Different economies having different economic strengths were tied together with a common currency. Furthermore, the European debt crisis and lack of a central treasury reduced the euro’s appeal. The yen is used for around 17%* of daily foreign trade. Japan has been plagued with decades of stagnant economy. It has an ageing population, which leads to a decreasing working-age population and low tax revenue. At the same time, it increases the need for expenditure on healthcare and welfare activities, leaving less government revenue for productive activities. It has a high debt-to-GDP ratio and suffers from deflation. GBP or the pound sterling takes up almost 13%* of global trade transactions.

The UK also has its problems, like its high debt, lowered growth rate, and rigid banking system. The uncertainty and tension around Brexit and the threat of disunity and weakness continue to haunt the country. After the EU referendum, national income fell. With respect to the euro, the value of the pound sterling fell after the Brexit vote. Some have been speculating whether cryptocurrency could pose a threat to the dollar. Economists at the US Federal Reserve published a research paper that mentioned that the rise of cryptocurrencies, like bitcoin and ether, may negatively impact the usage of USD. However, cryptocurrency is still a novel concept for many and has its own risks, such as high volatility. Now, we analyze the US. The US has an extremely high debt-to-GDP ratio and budget deficits.

In fact, it has the highest debt in the world, at more than $30 trillion. A currency collapses when it loses stability or trust, which is often brought about by high inflation or low growth in the country that the currency belongs. However, this is not likely to happen. The US is the largest economy in the world and has maintained this position for more than a century. The US markets are open and liquid, and there is transparency in trade and transactions. The sheer size of the economy relative to its competitors and the stability of the USD allow the US to remain dominant. Moreover, many countries maintain reserves in USD and hold US treasury bills, encouraged by the strength of the currency. Countries like China and Japan have been maintaining large reserves of the dollar as the US is their greatest and second-greatest exporter, respectively.

Additionally, allies of the US like Saudi Arabia hold USD reserves as a form of support, while countries like Russia and recently China has been making attempts towards de-dollarisation. Allies of the US have large and advanced economies, which increases the strength of the dollar. These factors combined have led to the hegemony or dominance of the US dollar over the other currencies of the world. Though there may be some contenders, no country can transcend the power of the US dollar. Despite its high debt and deficit, the US maintains its dominant currency due to its strong economy, trust of other countries, geopolitics, global acceptability, and credibility.

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Currencies like the euro, yen, pound sterling and cryptocurrencies have limitations, preventing them from surpassing the US dollar. We are beyond the days of physical warfare - today's world is ridden with economic warfare. To gain the upper hand, one must have strong economic tools, one such tool being a strong and dominant currency, like that of the United States. *Note that the total percentage is taken as 200%, as international trade is a bilateral transaction involving two currencies.

Afrah Mundewadi
Undergraduate Student At SRCC


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