The Dollar is to currencies what English is to languages

Professor Hélène Rey delivers Exim Bank’s 35th Commencement Day Annual Lecture in Mumbai

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For decades, economists, emerging market commentators and politicians have been in caught up in a long-standing discussion and debate about the emergence, and now leading importance, of Asian economies.

With Asia increasingly becoming the economic centre of the world and with US influence on global trade shrinking, combined with the emergence of digital currencies, the end of dollar hegemony on international finance may be nearer than anticipated.

This is the view of London Business School’s Hélène Rey, Lord Bagri Professor of Economics who recently delivered the 35th commencement day lecture of the Exim Bank in Mumbai. Professor Rey observed that since the Second World War, the greenback has been the hegemonic currency for global finance and trade, and US Federal Reserve's monetary policy has been setting the tone for the global financial cycle.

There are however difficulties for the US to remain a world banker or insurer since the Bretton Woods Institutions came into being in 1945. This fact is placed, noted professor Rey, in sharp relief by the fact that China is now a bigger economy in terms of purchasing power parity than the US, accounting for 19 per cent of world output.

Given China’s huge importance to the global economy, the ripple effect of the coronavirus could be significant, perhaps a catalyst for further and faster change to the power and influence of the US dollar. In addition, in the long view, the dollar is becoming more unstable over time as the relative size of the US within the world economy has shrunk, while the stock of dollar liabilities in the rest of the world is consistently growing.

Outside the waning influence of the US dollar, and the present economic reverberations of the coronavirus, professor Rey warned that the emergence of private, or public digital currencies could introduce instabilities to exchange rates and upset the overall money supply. A further concern relates to Brexit, which continues to create significant uncertainty for the banking and financial services industry.

Although the dollar's demise remains a staple of financial market commentary, Professor Rey acknowledged there is as yet no effective alternative to the greenback, back by the unequalled size, depth and liquidity of US capital markets. Though the euro may be the closest substitute to the dollar, the incomplete architecture of the euro area and the absence of a euro area-wide safe asset inhibits the internationalisation of that currency.

With regard to the Chinese renminbi, Rey noted that while the use of yuan for trade invoicing and cross-border financial transactions has increased, its adoption in international markets is deterred by the capital controls imposed by China, as also the underdeveloped financial system in the world's second largest economy.

In sum, the renminbi is barely taken up in international markets, while the euro is a distant second to the dollar.

Professor Rey characterised the dollar’s significance to currencies what English is to languages, adding that India is among the most dollarised countries as far as trade invoicing is concerned. Rey warned that the asymmetry inherent in a hegemonic system may also create financial fragilities that can ultimately lead to its demise, creating a scenario of what she called a "new Triffin dilemma", under which countries may compete using increasingly sophisticated cross-border payment technologies to expand the network of countries under their monetary and financial influence, creating a new type of geopolitical game.

Within this environment, the dollar’s dominance of the global financial system increased the risks of a liquidity trap of ultra-low interest rates and weak growth. Professor Rey said that irrespective of a remorseless reordering of the world economy, the US dollar remained important dominant international currency with nearly 62.2 per cent of international debt, 56.3 per cent of international loans, and 62.7 per cent of forex reserves denominated in the greenback.