Is dominance of US dollar in global economy about to decline?

Recently, the BRICS summit was held in Kazan, Russia. Initially, BRICS was formed by four countries: Brazil, Russia, India, and China. Later, South Africa joined, giving it its current name, BRICS. Last year, five more countries were admitted, raising the membership to ten, although the group retained its original name. In this recent summit in Kazan, in addition to the 10 full BRICS members, 25 countries joined as observers, many of which may soon gain full membership. BRICS is fundamentally an economic cooperation bloc, whose member states represent 57% of the world's population and account for 47% of global GDP.

The ultimate aim of BRICS is to establish a multipolar economic system that can reduce the dominance of the United States in the global economy. BRICS is not a military alliance, as its members have bilateral issues with each other that prevent it from forming a unified military bloc. Instead, BRICS seeks to emerge as a strong economic alliance that can compete with the United States and its allies in various international arenas.

In the global sphere, the US dollar plays a crucial role in the economic dominance of the United States. After World War II, the International Monetary Fund (IMF) was established to reconstruct the war-torn global economy. While the IMF has made significant contributions to the world economy, it has often served the interests of capitalist nations, especially the United States. Since its inception, the IMF has rarely taken any decision that opposed US interests. Prior to 1947, the British pound held a similar dominance, with most countries conducting international trade, investment, and reserves in pounds. The IMF then promoted the US dollar as the global reserve currency, replacing the pound by lending in dollars and requiring loan repayments in dollars.

Even countries that initially used the British pound for international transactions, like Bangladesh after its independence, quickly switched to the dollar. Today, almost every country accepts the dollar, and while there is no official global currency, the dollar’s broad acceptance has effectively given it international status. The US dollar is the world’s most stable currency, with approximately 60% of global reserves held in dollars. The dollar’s dominance is a pillar of the capitalist system, as many nations peg their currency's value to it. When the dollar strengthens, competing nations' currencies typically depreciate. However, after the onset of the Russia-Ukraine war, an unusual event occurred: while severe economic sanctions were imposed on Russia, the ruble did not depreciate as expected.

To counteract these sanctions, Russia halted oil exports to sanctioning countries, requiring ruble payments for oil imports from willing nations. Meanwhile, the Federal Reserve raised interest rates multiple times to curb inflation, making investments in US bonds more attractive. This led Americans with investments abroad to repatriate funds, strengthening the dollar further. Surprisingly, the Russian ruble also strengthened at the same time, an occurrence rarely seen. A strong currency holds significant influence over the global economy, and economists believe the US dollar’s strength has been key to the United States' strong economic position.

This dominance of the US dollar has become a source of envy worldwide, as previous efforts to establish other currencies on the global stage have had limited success. For instance, when the Euro was launched by the EU in 2000, the aim was to hold at least 15% of global reserves in Euros within a decade, a goal that remains unfulfilled. Although the Euro’s exchange rate against the dollar is often higher, a currency’s value is not determined solely by its exchange rate. Since the start of the Ukraine war, some countries have attempted bilateral trade using their own currencies, with little success. Weakening the dollar’s dominance organically is a challenging task.

Most countries peg their currency to the dollar, so when its supply increases, demand drops, and local currency strengthens. Conversely, when the dollar's supply diminishes, demand increases, and its exchange rate rises. There are several methods to determine the exchange rate of local currencies to the dollar, the most common being the fixed, crawling peg, and market-based systems.

In a fixed rate system, central banks set the dollar's exchange rate, while in a crawling peg, banks are allowed to set rates within a spread defined by the central bank. For example, Bangladesh recently set a crawling peg rate of BDT 117 per dollar, allowing banks to trade within a range of 117 to 120 BDT per dollar. The crawling peg resembles a freer market approach. The most accepted method worldwide is the market-based exchange rate, where banks set rates based on demand and supply without intervention from the central bank, providing an accurate reflection of the currency’s value.

Bangladesh Bank used to indirectly influence the exchange rate by releasing dollars from reserves in times of shortage or purchasing dollars when supply increased. However, artificial control over currency markets can create issues, as fixed rates may reduce earnings from remittances and exports. Under the crawling peg system, remittances and export earnings saw a significant drop as the set rates did not align with market demand.

At the latest BRICS summit, members reached a consensus to introduce a unified BRICS currency in the future. Although a decision on this was expected earlier, it was deferred. Now, BRICS leaders are committed to creating a common currency for intra-bloc trade and financial transactions. This decision is significant for the international currency market, leading some to believe that the dollar’s dominance could soon wane. However, it’s essential to recognize that the dollar’s current position did not materialize overnight, nor will it be easily dethroned.

Population size or economic power alone does not determine a currency's strength; otherwise, the dollar would have been replaced by the Euro long ago. A unified BRICS currency will facilitate trade and financial transactions within member states, but it is unlikely to diminish the dollar’s dominance globally, as nations outside the bloc will still rely on the dollar for transactions. Therefore, concerns about the dollar’s future seem premature.

Author: M A Khalek, former General Manager, Bangladesh Development Bank PLC, and an economics writer.