The United States Dollar has been the de facto global currency for the better part of the past century. While rhetoric questioning its longevity in this role has been around for decades, the past year has seen more leaders of rapidly emerging economies beginning to question why it still needs to be this way.
Brazil’s president Luiz Inácio Lula da Silva, for example, is among many leaders now calling on the BRICS countries (Brazil, Russia, India, China, and South Africa) to replace the US dollar with a common currency of their own.
This transition may already be in its early stages.
Data from SWIFT, indicates that the share of China’s Renminbi used for trade finance has more than doubled to 4.5% since Russia invaded Ukraine in late February 2022.
As the ensuing Western sanctions left Russia largely excluded from US dollar transactions, the warring nation turned to its more lenient neighbour for many of its international trade needs – leading to a rise in Yuan-denominated shipments.
As the prospect of the USA becoming dethroned as the world’s largest economy becomes increasingly talked about, it pays to consider how a change in the predominant global currency would materialise.
How would a change in the dominant currency impact the world?
Most of the world’s population has only ever experienced a world dominated by the US dollar, making the implications of such a shift difficult to grasp.
If the renminbi overtakes the dollar as the major global currency, there would likely be several differences that the average person would notice when travelling or conducting business overseas.
Exchange rates between it and other currencies would shift, potentially drastically, resulting in changes to the prices of goods and services.
Furthermore, investment opportunities globally would start to be priced in yuan, making it imperative for firms to hold increasingly larger balances of the currency if they want to transact beyond their own borders – including for transactions that do not even involve China.
This will lead to significant shifts in global economic power, with the global economy becoming more dependent on the renminbi and, by extension, China. The geopolitical implications would be immense and likely change the balance of power on the world stage.
It would also create a greater need for individuals worldwide to learn Mandarin – the official language of China – to conduct business effectively. It is not by happenstance that today’s Lingua Franca – English – is the language of the nation whose currency the world relies on.
To understand more about these implications, it can help to look back in time and understand how and why the US dollar was able to gain prominence in the first place.
History of US dollar domination
The US dollar became the world’s reserve currency in 1944.
At the time, the United States was the dominant economic and military power in the world, being the only major power to escape the brunt of devastation from the second world war that was still raging across Europe and the Pacific.
This sense of relative stability made the US dollar a promising prospect as a basis for the new global fixed exchange rate system that was being negotiated by delegates from 44 countries at the secluded Mount Washington Hotel in Bretton Woods, New Hampshire
Among other notable accomplishments, the Bretton Woods Agreement – as the result of this conference has come to be known – established a fixed exchange rate system, where countries would peg their currencies to the US dollar, which was, in turn, tied to the value of gold, with a set price of $35 per ounce.
As a result of this agreement, countries had to monitor and maintain their currency pegs within a 1% margin, a feat primarily accomplished by buying and selling US dollars with their own currencies.
This system helped to create a stable international monetary system and made it easier for countries to conduct international trade.
Over time, particularly as the United States became a major lender to other countries as they rebuilt their economies from the rubble of war, the US dollar’s status as the world’s reserve currency solidified.
While the basis of this system – the dollar’s tie to the value of gold – was eliminated when President Nixon took the country off the gold standard in the 1970s, the greenback’s entrenchment into the global financial system has remained, bringing with it some key geopolitical advantages.
The geopolitics of money
As a nation, having a key global currency can provide several geopolitical and economic advantages.
Since the US dollar is so widely used, it effectively forces other nations to hold a sizable amount of the currency as reserves, which gives the USA more control over the global financial system.
This can also lead to cheaper borrowing costs, higher borrowing limits, and more confidence in the American debt – all of which provide stark economic advantages to USA-based firms.
From a political standpoint, nations that use another country’s currency are generally considered to be in that country’s sphere of interest and must, to some degree, be willing to bend to that country’s will and demands or risk having their assets frozen or face other economic sanctions.
This power bestowed on the USA is amplified by the fact that – due to its longstanding entrenchment following Bretton Woods – there really aren’t yet any suitable alternative currencies.
This means that countries wanting to participate in the global financial system must currently accept the dollar as a means of exchange, strengthening the USA’s position in the global economy.
Despite the benefits, being a global currency provider is no simple task.
It requires a stable economy, sound monetary policies, and the ability to maintain the confidence of the global financial community.
On top of this, it comes with an onus to act as a responsible global actor, both economically and politically. This means maintaining good relationships with other countries, being a reliable trade partner, and promoting international cooperation.
All of this means that countries must want to play this role, and often whether they do or not depends on their own economic and political goals.
It may be telling that Brazil’s president is calling on the BRICS nations as a whole to shoulder the burden rather than offering up the Brazilian real as a sole candidate for the role.
While it is an interesting thought experiment to imagine a world without the US Dollar as the dominant global currency, it more than likely will remain just a thought experiment. There is a possibility that other currencies increasingly gain influence, as we enter a new era of splintered allegiances, the US Dollar is still significantly stronger than any other alternative.
However, recent bank failures, macroeconomic uncertainty and geopolitical instability have shown that we have to stay nimble. Could the next black swan event be the reshuffling of global currency domination?