[Insight & Opinion] Why the Era of the Dollar Is Bound to Continue

Key Currency Must Endure Current Account Deficits
Yuan and Others Unable to Shoulder the Burden
Even Bitcoin Transactions Are Settled in Dollars

President-elect Donald Trump of the United States showed a sensitive reaction to challenges against the dollar's hegemony. He stated that if BRICs countries attempt to create a new currency to replace the dollar, the U.S. would impose a 100% tariff and block access to the American market. The BRICs, an alliance of emerging economies, originally consisted of five countries: Brazil, Russia, India, China, and South Africa, but now includes Iran, Egypt, Ethiopia, and the UAE (United Arab Emirates), totaling nine countries. After the summit held this year in Kazan, the member states issued a statement indicating their intention to seek an escape from dollar hegemony.

The United States became the world's largest economy in the 1870s, but the dollar became the key currency only after World War II. Since then, challenges to dollar hegemony have persisted. Fundamental crises are often self-inflicted by the U.S., such as the abandonment of the gold standard in 1971 and the financial crisis of 2008, as well as the annual fiscal deficit reaching $2 trillion and national debt close to 100% of GDP.

The U.S. share of the global economy is also different from before. The U.S. accounted for over 30% of the world's GDP in 2000, but that share has decreased to about 26% today. A report by the International Monetary Fund (IMF) titled “The Stealth Erosion of Dollar Dominance” shows that the share of the dollar in central banks' foreign exchange reserves dropped from 71% in 1999 to 59% in 2021. Probably, Trump's protectionist and tariff policies, along with the resulting inflation, will not help the dollar's hegemony either.

However, the era of the dollar is still far from over. After abandoning the gold standard, the U.S., concerned about maintaining dollar hegemony, chose oil and in 1974 signed the so-called Petro Dollar agreement with Saudi Arabia, stipulating that all oil transactions be settled only in dollars. In June, Saudi Arabia officially announced the end of this agreement. Yet, what the Saudi central bank has been actively purchasing recently is U.S. Treasury bonds. Their holdings of U.S. Treasury bonds have reached $143.9 billion, the largest amount in four years.

The reason the dollar is the key currency is not because we like the dollar. There is no other reason for the dollar's power. It is because there is no alternative. Candidates for key currencies other than the dollar include the Chinese yuan, the European euro, the British pound, and the Japanese yen. However, the UK and Japan cannot compete with the U.S. in scale, and Europe is not in an economic condition to discuss key currency status.

What remains is the yuan of China, the world's largest trading nation, accounting for 11% of global trade. China is also striving to make the yuan an alternative to the dollar. However, it is still difficult to replace the dollar. Currency generally serves as a measure of value, a store of value, and a medium of exchange. Especially, a key currency used in international settlements must have a network effect that lowers transaction costs by being widely used, and for this, both liquidity and reliability are necessary.

However, there is no currency other than the dollar that possesses all these elements. Even Bitcoin transactions are based on the dollar. Of course, the international financial system will not operate forever as it does now, and the era of the dollar will eventually end. But at least for the time being, there will be no change in the dollar's dominance as the key currency. The key currency is said to inevitably face the so-called “Triffin’s dilemma,” which means that while supplying the international currency needed by the global economy, the country must endure a current account deficit. China cannot bear this. The yuan's share in international trade settlements has yet to exceed 3%.

Sangcheol Kim, Economic Commentator