dollar decline

Written by Liza Wasique 11:51 am Opinion, Published Content

Are Digital Currencies & China’s Yuan Causing the US Dollar to Decline?

Since the Bretton Woods system was first introduced, the US dollar has established itself as the world’s largest reserve currency. However, with the increasing popularity of non-traditional currencies, questions have arisen about the possible decline of the dollar’s dominance. Liza Wasique attempts to answer these questions while acknowledging the declining trust in the US currency, and the competition between the dollar and China’s yuan.
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About the Author(s)
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Liza Wasique is an undergraduate student of international relations at Quaid-e-Azam University, Islamabad.

Dollar Dominance

America’s dollar has been the largest reserve currency in the international system since the formation of the Bretton Woods system. International exchange, cross-border transactions, and trade systems are influenced by US dollars. Its dominance is a part of US dominance and hegemony and has helped to increase the fiscal capacity of the superpower. It enables the American military power and geo-political strength to be exercised around the world.

The world has been forced to adjust according to the supply of the dollar, and the interest rate the United States’ charges, and thus, the US has been less sensitive to global economic fluctuations. But as the world is shifting from a unipolar to a multipolar world there arose a question, will America’s dollar be able to sustain its dominance or decline?

It was assumed in the late nineties, that the dollar’s dominance would end with the fall of the Bretton Woods system. But the dollar emerged even stronger after the fall and has remained unchallenged in the international monetary system since then. So, is there any threat to the dollar’s dominance in this changing world?

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The Rise of Non-traditional Reserve Currencies

In the twenty-first century, the tendency to sustain the international monetary system on non-traditional reserves – like China’s yuan, euro, Australian and Canadian dollars, Swedish krona, and even cryptocurrency – is increasing. Of course, it is happening at a very slow pace, people in the economic crisis during Covid-19 still bought US dollars as a reserve more than any other currency considering it safe.

A decline in dollar dominance is still not in sight for the coming years, but economists are claiming that the dollar will ultimately lose its position as a foreign reserve currency and if it does, there are serious consequences for America. The United States of America will lose its ability to gain foreign policy goals through the financial system.

Over several years, the countries like China, Russia, Iran and Venezuela, and others have started to substitute international trade settlements other than US dollars. Due to the Ukraine-Russia war, sanctions were imposed on Russia, and these restrictions have further threatened the dollar’s dominance in the long term because this will encourage fragmentation in the system. Russia started to convert its reserves into yuan and gold after America froze its dollar reserves.

Declining Trust in America’s Dollar

One of the major reasons for the decline of the dollar is the US’ growing current account deficit. The value of exported goods is less than imported goods and services which means more outflow of dollars from the country, which has an impact on the GDP. The contribution of American GDP to the world’s economic output has decreased by 50% over time. With the increase of a 3.6 percent account deficit in 2021, America’s contribution to the world’s economy decreased to 22 percent.

The US has been borrowing dollars from abroad to finance the deficit and this, in turn, has expanded the international balance of payments. The dollar share in the global foreign exchange reserves has decreased to 58.8%, the lowest in the last twenty-five years. Two decades ago, the dollar made about 70% of the total foreign exchange reserves in the central banks. This is an alarming situation for the United States in that the dollar is losing its reliability due to a lack of confidence in America’s foreign economic policy. 

China’s Yuan vs America’s Dollar

With the emergence of China as a global power, the role of the dollar as a payment currency is in threat. China is developing a cross-border interbank payment system based on the yuan that will link up with the payment systems of other developing countries. With the passage of time, this will reduce the chokehold of the dollar in the swift messaging system.

China and Japan, and likewise South Korea and India, have signed trade deals in which they will be using their own currencies as a medium of payment. China’s policymakers are working to internationalize the yuan and even are developing a digital yuan system. Whereas, America is hesitant to introduce the digital dollar. China’s long-term developmental goal is to change the proportions of currencies in its favor in the international system. Although at this point, China’s economy is dependent on America’s dollar, it is slowly trying to reduce the influence of the dollar in its economy.

Will the Dollar be Replaced?

The US dollar’s dominance is threatened by the factors like the rise of the Chinese economy and currency, technological advancements, an increase in the efforts to sustain the international system on non-traditional reserves, and a lack of confidence of investors in US treasuries. But the threat and falling of shares in the system are not big enough to shake the roots of the US economy and cause the decline of America’s dollar.

At the start of this century, economists were claiming that the euro can replace the dollar, but it has been seen that the European Union has failed to internationalize the euro at the speed at which it was expected to. Moreover, becoming the most dominant currency in the world has some disadvantages, like having higher exchange rates, and Europe is not ready to take that risk.

China’s yuan is also not very appealing to foreign investors, however, in the long run, Chinese policies can bring a lot of change to the international system. Therefore, a currency other than the dollar is in a position to be held as a reserve. The competition is for the second largest reserve currency not for the largest reserve currency. The dollar is still considered the safest asset and in times of crisis, it ensures stability.  

The diversity of currencies in the world reserves, on one hand, provides stability and a better monetary system, but on the other hand, with two dominant currencies facing each other there will be more insecurity at the time of crisis. Right now, the US dollar provides certainty in the system to some extent. So, it is confirmed that the dollar is here to dominate the world’s monetary system as a reserve and payment currency for at least another half-century.

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The views and opinions expressed in this article/paper are the author’s own and do not necessarily reflect the editorial position of Paradigm Shift.

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