Domination of the Dollar: Are There Any Alternatives?

18 december 2014

Discussions about Reserve Currencies and Their Outcome

Sergei Afontsev is Head of the Economic Theory Department at the Institute of World Economy and International Relations (IMEMO), Russian Academy of Sciences; Co-Director of the Research and Education Center on World Economy, IMEMO and Moscow State University; professor at the Moscow State Institute of International Relations. He holds a Doctorate in Economics.

Resume: The possibilities of club monetary interaction mechanisms are very modest as they do not replace but supplement global mechanisms. Nevertheless, they deserve attention and support. Equally important is the fact that such mechanisms may have side effects, namely, general shifts in the structure of global economic governance.

The idea that the global economy is overly dependent on the U.S. dollar as an international means of payment and the leading reserve currency and that this dependence should be reduced has been heatedly discussed by politicians and experts for decades. As is always the case when economic arguments are closely intertwined with political interests, debaters often mistake the wish for reality and portray the undesirable as unviable. An objective analysis of the problem requires decomposing it into two parts – firstly, what role do global currencies play in the global economy today? And secondly, why is it that the dollar is the leading global currency? It is only when we have answers to these questions will we be able to draw conclusions about prospects for the international monetary system and the place of national currencies, including the dollar, in it.


Let us start with the first question. From the point of view of global economic governance, the presence in the world economy of global currencies which are used in international transactions and provide possibilities for accumulating international reserves is the central element of the world monetary and financial system’s stability. Due to this, it would be fair to view the functioning of global currencies in the context of the policy of creating global public goods. In economics, the term “public good” is used to describe a good that meets the following two conditions: first, it is non-rivalrous, that is, its use by one individual does not reduce its availability to others; and second, it is non-excludable in that its producer cannot exclude individuals not paying for it from using it.

National defense is a classic example of a public good at the national level: the defense of one citizen from an attack by a potential enemy does not weaken in any way the defense of other citizens (non-rivalry), and at the same time, citizens who have not contributed to the creation of the national defense system (for example, evaded paying taxes) cannot be “excluded” from among those protected by this system (non-excludability).

Global public goods are non-rivalrous and non-excludable goods available worldwide. They are divided into final global public goods which meet the needs of the global community (maintenance of peace, stability of the international trading system and international finance, preservation of the environment, etc.) and intermediate global public goods which are used as inputs in the production of final goods.

Global currencies are one of these intermediate global public goods. They perform important functions in the international system and help to develop international trade and maintain global financial stability. Their use greatly reduces transaction costs in trade and investment operations. This means not only (and not so much) eliminating the costs related to national currency conversion (this function can be performed by regional currencies, such as the euro) but also establishing a universal system of international payments using universally recognized legal tenders. They provide liquidity in international financial markets and ensure global mobility of capital flows, creating conditions for the development of international investment cooperation. Finally, global currencies enable countries to accumulate international reserves not related to particular types of commodity assets (for example, gold), which gives the national governments and central banks much more flexibility in managing the balance of payments. Therefore, they are an important tool for alleviating international imbalances. Countries with a steady trade surplus can accumulate international reserves as assets denominated in global currencies, without needing to restrain export growth, thus maintaining favorable prospects for long-term development of the national economy.

The main problem of world reserve currencies is that, while performing the functions of global public goods, de facto they remain under the control of the national monetary authorities, whose policies focus primarily on the needs of national economies and/or subjects operating within it. This explains the criticism of the Federal Reserve whose policy, dictated by national priorities, can have a significant negative impact on the economies of countries thousands of miles away from the American continent. But the outward transmission of impulses produced by national monetary and credit policies is a common property of global currencies. Whatever currency replaces the dollar, this property will remain unchanged. In this sense, the only difference is the policy of what country (the United Kingdom, the United States or, for example, China) will have an impact on the economies of other countries that use its currency in international payments. Countries that issue global currencies may change but the content of criticism leveled at them will always be the same.


Currencies that serve as global currencies (or candidates for this status) must comply with certain very stringent requirements. Firstly, there must be high demand for them on international markets, in other words, among economic entities in various countries. Secondly, the supply of a global currency must be sufficient to meet the demand for it. Thirdly, it must be highly reliable: the value of assets denominated in it, and its quotations against other currencies must be based on market principles and, at the same time, be free from the risks of sharp and unpredictable fluctuations that may be caused by the currency issuer’s policy.

The situation is complicated by the fact that the global currency status has two grades. The first grade – currency for international payments – implies its active use in international trade and investment transactions. The second grade – international reserve currency – implies the willingness of the central banks in various countries to include assets denominated in this currency in their international reserves. In the latter case, requirements for the currency’s reliability and supply (market availability of assets denominated in it) are much more stringent than in the former one.

What currencies in the contemporary world meet the requirements listed above? Obviously, this best applies to the U.S. dollar, and partially to the euro, the British pound and the Japanese yen. They steadily hold top positions in terms of “global demand.” According to the Bank for International Settlements, in 2013 the dollar served 87.0% of foreign exchange transactions, the euro served 33.4%, the yen 23.0%, and the pound 11.8% (as each transaction involves two currencies, the sum of the percentages in the global foreign exchange turnover equals 200%). A large amount of assets denominated in these currencies circulate on the world market, their quotations are regulated by market factors and are not subject to sharp speculative fluctuations. Suffice it to say that the credibility of euro-denominated assets remained steadily high even at the height of the Eurozone crisis, while the dollar continues to play the role of safe haven where investors park their money at the first hint of deterioration in the world economy.

Finding candidates for the global status beyond the Big Four global currencies is highly problematic. If we take currencies of developed countries, the main problem with them is not so much the low demand for them (the Australian dollar, for example, accounted for 8.6% of all foreign exchange transactions in 2013) as the shortage of assets denominated in them on the international market. This problem became graphically evident in 2010-2011 when investors sought to find alternatives to assets denominated in dollars and euros. However, they were faced with a shortage of assets denominated in other currencies (primarily the Swiss franc, the Australian dollar and the Norwegian krone). Moreover, their efforts caused big problems for the stability of these currencies and even forced Switzerland to peg its franc to the euro in September 2011. In other words, the above currencies can successfully serve international payments and even be included by central banks in the pool of international reserves, but they are unable to challenge the positions of the Big Four today or in the foreseeable future.

Among the currencies of developing countries, the Chinese yuan (renminbi) is now (and in the coming decades) the only serious candidate for the status of a global currency. It relies on the booming Chinese economy, the political will of Chinese leaders,  stock market enthusiasts, and a large community of critics of the dollar’s “domination in the global economy.” However, objective facts indicate that one should not delude oneself about the renminbi’s international prospects, at least, in the medium term.

First, despite China’s rapid rise as a leading world exporter, the role of the renminbi in global foreign exchange markets is still limited. In 2013, it accounted for only 2.2 percent of the global foreign exchange market turnover. The much publicized policy of increasing the renminbi’s market share through bilateral swap agreements (25 agreements were concluded with partner countries, including Russia, as well as with the EU and Hong Kong from December 2008 to July 2014) produced very modest results. Very indicative in this sense is the story of the swap agreement with South Korea, the first agreement of this kind signed on December 12, 2008, which provided for 360 billion renminbi (64 billion Korean won) worth of transactions. The first transaction under this agreement was concluded only six years later. In May 2014, Korea’s Hyundai signed a contract for the supply of cars to China, with the loan amount standing at a mere 124.74 million renminbi (about $20 million). Obviously, Beijing had expected more than that. On the whole, the share of the renminbi in serving currency swaps (in actual transactions) in 2013 stood at 0.9 percent, as compared with 93.0 percent held by the U.S. dollar.

Second, even if the renminbi strengthens its positions as a currency for international payments, its transition to the status of a world reserve currency will meet with obstacles as there is no sufficient amount of reliable assets denominated in the renminbi on the global market. The unique position of the dollar in the international monetary system is secured largely by the saturation of markets with liquid dollar assets, which is a direct consequence of constantly large budget deficits financed by the U.S. government by way of U.S. debt obligations. At present, there are no renminbi assets of a similar amount and quality. Theoretically, China’s government debt instruments could serve as such assets. They are issued to finance the large budget deficit which ranged from 0.8 trillion to 1.1 trillion renminbi between 2009 and 2013. In 2013, it reached its peak of 1.06 trillion renminbi ($174 billion) over a five-year period. This amount exceeds the minimum pre-crisis U.S. federal budget deficit ($161 billion in 2007), and is only one-fourth of the 2013 level ($680 billion). So, there is a theoretical possibility for China to issue government debt instruments en masse. The question is whether these assets will be of adequate quality and whether they will be in demand on international financial markets. A positive answer to this question is quite possible, but it is not clear yet what factors can help Beijing  translate this possibility into reality.

Third, the renminbi remains a currency with a tightly controlled exchange rate. Although the Chinese authorities have eased their exchange regulation policy (for example, in March 2014 the renminbi currency band was widened from one to two percent), there is still a very long way to go before the renminbi becomes a free floating currency. The dilemma is how to find a balance between the needs of the export sector, which needs a low exchange rate, and the financial sector which is interested in strengthening the renminbi. This strengthening, inevitable if exchange control is liberalized, bears high risks for export, which are unacceptable amid the economic slowdown in China. In turn, the status of a reserve currency requires the renminbi to become a free floating currency – no country would want to have a large amount of assets with a value dependent on Beijing’s political decisions.


What alternatives are there to global currencies issued by individual countries now that the costs of the U.S. monetary policy for the rest of the world have become very burdensome, and prospects for replacing the dollar in its global function with national currencies of other countries are vague? As regards the concept of global public goods, the most effective alternative to the current situation would be the creation of a truly international currency that will not depend on decisions of the monetary authorities of any one country and that will be controlled by a supranational body recognized by all. However, the creation of such an artificial currency is doomed to failure due to the aforesaid conditions which help the dollar to retain its current position.

The main point is that parties to economic transactions do not need any artificial currency (unless it, like the euro, replaces other currencies actively used in trade and investment transactions). The story of the Special Drawing Rights issued by the IMF vividly illustrates this thesis. Diplomatic talk aside, the significance of these assets in the present world economy gravitates to zero.

Club currencies offer a more interesting range of possibilities. They can be used either by countries united into regional integration associations or by a group of countries that are close economic partners. Club currencies are either created artificially or the stronger currencies of individual member countries can be used as such. Artificial club currencies have the same weaknesses as artificial global currencies. To date, the only successful example of an artificial club currency is the euro which has replaced European national currencies, some of which (especially the Deutsche Mark, the French franc, and the Italian lira) played significant roles in international trade and finance. Previous projects to create artificial club currencies on the basis of weaker national currencies (for example, in ASEAN) invariably failed. In this context, one can only welcome the fact that the Eurasian Economic Union Treaty, signed on May 29, 2014, makes no mention of a supranational currency. There have been too many ambitious but unfulfilled plans of this kind in the post-Soviet space and it is good that another one has not been added to the list.

The last decade has been marked by a new trend in currency cooperation, whereby partner countries use their national currencies in mutual trade. These projects can be realized within regional integration associations (for example, Mercosur) and in interstate clubs, whose members are not formally united into regional integration associations. Such mechanisms are now widespread in the Asia-Pacific region. Another club that has recently announced currency cooperation plans is the BRICS. As there is not even a hypothetical chance of the Russian ruble becoming a global currency, the possibility of increasing its international role through BRICS mechanisms may be of direct practical interest.


The recent BRICS summit in Brazil’s Fortaleza in July 2014 produced important political statements and a final declaration which formulated two major monetary initiatives. The first one announced plans to establish a New Development Bank (NDB) to finance infrastructure and other projects in the BRICS member countries. The second one authorized the creation of a reserve currency pool to jointly counter monetary risks.

For the NDB to be able to fulfill its mission of supporting sustainable development in the BRICS countries (and, possibly, in other developing countries that may join it), its resources should be sufficient to finance a set of “model” projects that can have a systemic effect on the BRICS economies and attract private investors. Given the Bank’s authorized capital of U.S. $100 billion, this task seems to be quite realistic.

The key issue, however, concerns the amount and timing of contributions to the authorized capital. Under the NDB agreement, the Bank will have an initial capital of U.S. $50 billion (later it can be doubled). Of this amount, $10 billion will be paid by the BRICS members in equal shares over seven years – a really small amount, considering the payment schedule. (Just to compare, the modernization of the Zarubino port alone in Russia’s Far East requires U.S. $3 billion in investment, to say nothing of building a gas pipeline from Russia to China, which will cost no less than U.S. $55 billion, according to very modest estimates.) In view of this, investment guarantees (the remaining $40 billion) will be of paramount importance. Therefore, the development of mechanisms for providing these guarantees (which is expected to be done in the national currencies of the BRICS countries) is a fundamental condition for the NDB to gain momentum after it becomes operational in 2016.

Although the NDB was founded by the BRICS countries, it is open to other countries, as well. Their participation can increase the NDB capital (although the share of the BRICS countries in it cannot be lower than 55 percent). Member countries of the Shanghai Cooperation Organization (SCO) are the most obvious candidates for admission. Among them only Kazakhstan can make a tangible contribution to the Bank’s capital. Nevertheless, the involvement of other countries in the Bank’s activities through major investment projects may be an attractive prospect for both Russia and China. The same applies to countries that have “dialogue partner” status in the SCO. Belarus as a member of the Eurasian Economic Union, to begin functioning next year, Sri Lanka as a close ally of India, and Turkey as a fast-developing economy and an active member of the G-20 can be welcome candidates for admission to the NDB. Things are more difficult with observer countries. Given the turbulent political situation in Afghanistan, problems associated with the international position of Iran, and tensions between India and Pakistan, Mongolia seems to be the only indisputable candidate among them. If the Bank’s enlargement proves successful, the national currencies of the BRICS countries (primarily the Chinese renminbi and, possibly, the Russian ruble) will strengthen their positions in the world economy.

While the NDB can be considered a “club analog” of the World Bank as regards its functions, the currency pool of the BRICS countries can assume part of the IMF’s functions. When this pool reaches U.S. $100 billion, the BRICS will feel more confident during monetary and financial crises. Although the pool’s resources are unlikely to play a significant role for Russia and China, which have significant international reserves (about $478 billion and more than $4 trillion, respectively), they may be useful for other BRICS members in situations of monetary instability. The good news is that an applicant country can receive 30 percent of its quota without having to seek the IMF’s approval for its anti-crisis program. And in any case, the very existence of such a mechanism can serve as a kind of “safety cushion” and thus lend more credibility to BRICS currencies among market players.

However, there is a reasonable question to ask: How useful will the national currency reserves created by the BRICS countries be if one of them comes under pressure? As mentioned above, the share of the renminbi in foreign exchange transactions on international markets in 2013 was 2.2 percent. Currencies of other BRICS countries played an even lesser role (about 1 percent for the Brazilian real and the Indian rupee, and well under 1 percent for the Russian ruble and the South African rand). Limited use of a currency in the global economy means limited demand for it among external agents. In other words, a “club” currency pool is important primarily for relations among the pool member countries. It expands the range of possibilities open to these countries, but it does not exclude the need for them to use “real” global currencies.

As we can see, the possibilities of club monetary interaction mechanisms are very modest as they do not replace but supplement global mechanisms. Nevertheless, they deserve attention and support. Equally important is the fact that such mechanisms may have side effects, namely, general shifts in the structure of global economic governance. Now that global functions are still performed by a limited set of currencies of economically developed countries and  the reform of international financial institutions is actually blocked, club  interaction formats can provide an alternative strategy for enhancing the role of the leading emerging economies in global economic processes.

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