The United States has been the leading economy for a long time and the US dollar has been the Global Reserve Currency for a long time. Other developed economies around the globe have expressed their concerns regarding a single fiat currency dominating the entire global economy. This is mainly because of the significant debt that the American economy is in.
The status of the USD as the world’s reserve currency gives the US a lot of economic power. It also means that the USD is more likely to be stable in value than other currencies. However, there are also some risks associated with being the world’s reserve currency. For example, if the US economy were to experience a major crisis, it could have a negative impact on the global economy.
As a result, many crypto enthusiasts have called for governments around the world to develop stablecoins backed by their own fiat currencies to introduce new use cases for their currencies and challenge the dominance of the US dollar. However, the question remains at large–can an official USD-backed stablecoin preserve the fiat currency’s status as the Global Reserve Currency.
How did USD Become the Global Reserve Currency?
The United States dollar (USD) became the global reserve currency primarily as a result of the economic and geopolitical developments that took place after World War II:
Bretton Woods Conference (1944): In July 1944, representatives from 44 Allied nations gathered in Bretton Woods, New Hampshire, to design a new international monetary system. The conference established the International Monetary Fund (IMF) and the World Bank to promote monetary cooperation and facilitate reconstruction and development after the war. The delegates agreed to peg their currencies to the USD, and the USD, in turn, was pegged to gold at a fixed exchange rate.
Post-World War II economic dominance: After World War II, the United States emerged as the world’s leading economic power. Its industrial infrastructure remained relatively unscathed by the war, unlike many other major economies. The US also had a large and productive workforce, abundant natural resources, and significant technological advancements.
Marshall Plan and economic aid: The United States implemented the Marshall Plan in 1948, which provided financial assistance to European countries devastated by the war. This initiative helped rebuild the war-torn economies and cemented the US’ role as a global economic leader.
The gold standard and stability: Under the Bretton Woods system, major currencies were pegged to USD, providing a sense of stability and confidence in the USD’s value. Central banks and international investors viewed the USD as a reliable store of value due to its convertibility into gold at a fixed rate.
Trade and investment: The United States was a major exporter and importer of goods and services, and the USD was widely used in international trade transactions. This further strengthened its position as a global reserve currency, as countries needed USD to facilitate cross-border transactions.
Stability and liquidity of financial markets: The US financial markets, particularly the New York Stock Exchange and the US Treasury market, were some of the most stable and liquid in the world. This made the USD an attractive currency for central banks and investors to hold as part of their foreign exchange reserves.
To this day, many countries and institutions still hold significant amounts of USD in their foreign exchange reserves due to its widespread use in international trade, financial markets, and the relative stability of the US economy.
However, following the collapse of leading banking institutions in the United States like the First Republic Bank, the Silicon Valley Bank, and the Signature Bank, the trust in the US economy has been shattered. The regulators were unable to prevent the collapse of these banks and the government had to pay the investors out of their own pockets.
Pros And Cons Of USD Being Global Reserve Currency
The United States dollar (USD) being the global reserve currency has both advantages and disadvantages:
Pros
Liquidity and Stability: The USD is one of the most liquid and stable currencies globally. It is widely accepted and traded in financial markets, making it easy for countries to hold and exchange for various purposes.
Facilitates International Trade: As the global reserve currency, the USD simplifies international trade and finance. Many commodities, such as oil and gold, are priced and traded in USD, making it a preferred currency for conducting cross-border transactions.
Lower Transaction Costs: Since the USD is widely used, international transactions settled in USD can often result in lower foreign exchange costs, reducing currency conversion expenses.
Safe Haven Asset: During times of economic uncertainty or geopolitical tensions, the USD is often considered a safe haven asset. Investors and countries seek to hold USD assets for stability and risk mitigation.
Access to USD-denominated Markets: Countries holding USD reserves can access the deep and liquid US financial markets, which offer a wide range of investment opportunities.
Global Financial System Dominance: The USD’s status as the global reserve currency enhances the United States’ influence over the international financial system and economic policies.
Cons
Vulnerability to US Economic Policies: Countries heavily reliant on the USD as a reserve asset are exposed to the impact of US economic policies, such as interest rate changes or sanctions.
Exchange Rate Volatility: The value of the USD can fluctuate, causing exchange rate risks for countries holding significant USD reserves.
US Trade Deficit Pressure: As the global reserve currency, there is a continuous demand for USD in international transactions, which may put pressure on the US to maintain a trade deficit to supply sufficient USD liquidity to the rest of the world.
Dependence on US Monetary Policy: Countries using the USD as a reserve currency may face challenges in conducting independent monetary policies, as they need to consider the actions of the US Federal Reserve.
Potential for Financial Instability: The USD’s dominant role may encourage excessive borrowing in USD, leading to financial instability in some countries if they struggle to service USD-denominated debt during economic downturns.
Challenges for Developing Economies: Smaller or developing economies may face difficulties in accumulating and maintaining USD reserves, which can affect their ability to stabilize their own currencies and manage their economies effectively.
Currencies that Might Challenge USD’s Position As the Global Reserve Currency
Some of the key competitors of the US dollar are:
Euro (EUR)
The euro, used by 19 European Union member countries, is the second most widely held reserve currency after the USD. The eurozone has a substantial share in global trade and a large and stable financial market. If the eurozone strengthens its economic and fiscal integration further, it could enhance the euro’s appeal as an alternative to the USD.
Recently, the EU passed the Markets in Crypto-Assets regulation (MiCA) and the legislation covers a range of cryptocurrencies, digital assets, utility tokens and stablecoins. This could boost the usage of euros around the globe.
Chinese Yuan (CNY/RMB)
As China’s economy has grown rapidly over the past few decades, there has been increasing internationalization of the Chinese yuan. China’s efforts to promote the yuan’s use in international trade and investment, along with the Belt and Road Initiative, have elevated the currency’s profile. However, the yuan’s global reserve currency status is also contingent on further financial market reforms and concerns about China’s strict capital controls.
It is crucial to note that China has been experimenting with the digital yuan for a very long time and has promoted the usage of the CBDC in the retail sector. Additionally, the country has become optimistic on blockchain technology unlike the US.
Japanese Yen (JPY)
Japan has one of the largest and most stable economies in the world. The yen is actively traded in the foreign exchange market and held as a reserve currency by several central banks. However, Japan’s demographic challenges and persistent deflation have impacted the yen’s growth as a global reserve currency.
Recently, the government decided to reduce the taxation on digital assets and uplift the ban on the usage of stablecoins in the region. There are also plans of a CBDC to promote the usage of JPY.
British Pound Sterling (GBP)
Historically, the British pound was a dominant global reserve currency. While its influence has waned compared to the USD and euro, the GBP is still an important international currency due to the UK’s strong financial services sector and historical ties to global trade.
Canadian Dollar (CAD) and Australian Dollar (AUD)
These currencies are significant in the commodity markets, particularly for oil, gas, minerals, and agricultural products. Countries with large commodity reserves may prefer to hold their assets in currencies linked to those commodities, potentially increasing demand for the Canadian and Australian dollars.
Swiss Franc (CHF)
Switzerland’s stable economy, strong financial sector, and reputation for political neutrality have made the Swiss franc an attractive currency for investors seeking a safe haven during times of geopolitical uncertainty.
BRICS Moving to Reduce Dollar Dominance
It is important to note that the BRICS nations of India, China, Russia, Brazil, and South Africa have decided to challenge the dominance of the US dollar. While China and Russia have led the de-dollarisation initiatives because of their rivalry with the US, India, Brazil, and South Africa are contributing out of their own interests.
Recently, Russian President Vladimir Putin confirmed that the minilateral member states were working on developing a new global reserve currency to challenge the position of the US dollar as the Global Reserve Currency. Russia has been the victim of sanctions imposed by the US and EU after it initiated a war in Ukraine.
India is working on promoting its own currency and despite being a strong ally to the US, the leading economy aims to combat China’s plan to internationalize the renminbi. India aims to reduce its reliance on the US dollar but is not quite supportive of China’s plan to dethrone USD as the two do not have very good relations.
Russia to Debut a Stablecoin
Recently, it was confirmed that the Central Bank of Iran and Russia’s central bank will work together to create a gold-backed stablecoin. The plan is to develop a “token of the Persian Gulf region” to be used as payment in global trade. The proposed stablecoin will operate in an Astrakhan special economic zone, where Russia began to accept Iranian cargo shipments.
In addition, Russia is planning to debut a national digital currency, the digital ruble, in 2023. The digital ruble will be a central bank digital currency (CBDC), which is a digital version of a fiat currency that is issued and regulated by a central bank.
The digital ruble is being developed as part of Russia’s efforts to modernize its financial system and reduce its reliance on the US dollar. The digital ruble will be used for both domestic and international payments.
Are Cryptocurrencies Threatening US-dollar’s Dominance?
Cryptocurrencies have the potential to impact the position of the USD as the global reserve currency, but the extent of their influence depends on various factors and their adoption rate in the global economy:
Competition for Global Payments: Cryptocurrencies offer a decentralized and borderless payment system that can bypass traditional financial intermediaries. If cryptocurrencies gain widespread adoption and prove to be efficient, cost-effective, and secure for international transactions, they could compete with traditional payment systems, including those denominated in USD. This could potentially reduce the demand for USD in cross-border transactions.
Currency Substitution: In countries experiencing high inflation, economic instability, or currency controls, cryptocurrencies might be seen as an alternative store of value and medium of exchange. If cryptocurrencies become widely accepted and used as a substitute for local currencies, it could reduce the reliance on the USD in those regions.
Decentralized Finance (DeFi): The growth of decentralized finance platforms and applications built on blockchain technology could provide an alternative financial ecosystem. If DeFi becomes more accessible and functional, it could offer new financial services that compete with traditional banking and investment options, potentially impacting the demand for USD-denominated assets.
Central Bank Digital Currencies (CBDCs): Some countries are exploring the development of their own CBDCs, digital currencies issued and regulated by central banks. If CBDCs gain traction and are used for international trade and transactions, they could challenge the USD’s role as the primary global reserve currency.
Impact on Financial Stability: Cryptocurrencies’ volatility and speculative nature may raise concerns about financial stability. Large fluctuations in cryptocurrency prices could lead to disruptions in financial markets and reduce confidence in digital assets as reserve assets.
Regulatory and Legal Uncertainty: The lack of unified global regulations and legal frameworks for cryptocurrencies can create uncertainty for businesses and investors. Regulatory developments could impact the adoption and usage of cryptocurrencies, which in turn might influence the USD’s position as the global reserve currency.
It’s essential to note that cryptocurrencies, especially Bitcoin and other decentralized cryptocurrencies, were originally designed to operate outside the traditional financial system and without government control. As a result, they present unique challenges and opportunities for the global financial system. The USD’s status as the global reserve currency is deeply rooted and supported by the strength of the U.S. economy, geopolitical factors, and the USD’s widespread use in international trade and financial markets.
While cryptocurrencies have gained significant attention and adoption, their impact on the USD’s global reserve currency status is uncertain and highly dependent on how the regulatory landscape evolves, technological advancements, and the overall confidence in digital assets as a store of value and medium of exchange.
USD-backed Stablecoins to Preserve USD’s Dominance?
The emergence and adoption of US dollar-backed stablecoins could potentially have both positive and negative implications for the USD’s status as the global reserve currency. Stablecoins are digital assets designed to maintain a stable value by pegging their price to a reserve asset, such as a fiat currency like the US dollar. Tether (USDT) and USD Coin (USDC) are examples of stablecoins pegged to the USD.
Here are some ways US dollar-backed stablecoins could impact the USD’s global reserve currency status:
Positive Impacts
Enhanced Accessibility and Efficiency: US dollar-backed stablecoins, being digital assets, can facilitate faster and more efficient cross-border transactions compared to traditional banking systems. This could make it easier for countries and institutions to conduct international trade and finance using stablecoins, potentially increasing the demand for USD-backed stablecoins.
Reduced Exchange Rate Risk: For countries with volatile domestic currencies, using USD-backed stablecoins in international transactions could reduce exchange rate risk. This could promote the use of these stablecoins for trade settlement and reserve holdings, indirectly benefiting the USD.
Financial Inclusion: Stablecoins can improve financial inclusion, especially in regions with limited access to traditional banking services. Increased usage of USD-backed stablecoins may introduce more people to the USD and foster familiarity with the currency.
Negative Impacts
Regulatory Concerns: The widespread adoption of USD-backed stablecoins may raise regulatory challenges for governments and central banks. Regulators could be concerned about the potential impact on monetary policy, financial stability, and consumer protection.
Risks of Concentration: The dominance of a few USD-backed stablecoin providers (e.g., Tether and USD Coin) may lead to concentration risks. Any issues or loss of confidence in these stablecoin operators could have adverse effects on the broader ecosystem, potentially affecting trust in the USD-backed stablecoin model.
Competition with Central Bank Digital Currencies (CBDCs): Some central banks are exploring the development of CBDCs, which are digital currencies issued and regulated by central authorities. If CBDCs gain traction, they could vie with private stablecoins, potentially influencing the demand for USD-backed stablecoins.
Financial Stability Concerns: Rapid and widespread adoption of USD-backed stablecoins without proper risk management and regulation could pose financial stability risks. If stablecoin issuers do not hold adequate reserves or face liquidity challenges, it could lead to disruptions in the market and potentially impact confidence in USD-backed assets.
Conclusion
While US dollar-backed stablecoins may offer benefits for cross-border transactions and financial inclusion, it’s essential to recognize that their widespread use as global reserve assets would require addressing regulatory and stability concerns. Additionally, the USD’s status as the global reserve currency is influenced by various complex factors beyond stablecoin adoption, such as the US economy’s overall strength, geopolitical dynamics, and the depth and liquidity of US financial markets.
In summary, while US dollar-backed stablecoins may play a role in facilitating international transactions, their potential to preserve the USD’s global reserve currency status would depend on how well they address regulatory, financial, and geopolitical challenges. The USD’s position as the primary global reserve currency remains deeply rooted and is unlikely to be significantly impacted solely by the rise of stablecoins in the near term.
