The hegemony of the US dollar is diminishing

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De-dollarization trend set to accelerate due to Fed’s massive use of quantitative easing policies

Different countries have adopted various measures to mitigate the negative economic effects of Covid-19. The United States, Canada and many European countries have announced massive fiscal stimulus packages in an attempt to ease the suffering of people and businesses affected by the extended lockdowns. The aim of the bailouts is to get the economy back on track for recovery and growth.

Many countries have made extensive use of expansive monetary policies. Central banks in many countries have reduced key interest rates to close to zero, and in some countries benchmark interest rates have moved into the negative zone. The implications of these easy money policies go far beyond the immediate effects on the path to economic recovery.

The unprecedented liberal use of monetary expansion calls into question the integrity and soundness of fiat money in many Western capitalist countries. An excessive increase in the money supply can lead to inflationary results if the growth of the real economy remains very slow. This can quickly erode the value of money.

Loss of faith

The US government launched a stimulus package worth $ 1.9 trillion in March 2021, bringing its total spending (in 2020 and 2021) on the pandemic to $ 5 trillion. The Federal Reserve has taken its quantitative easing policies to new heights. It has taken unprecedented steps to support the economy.

The Fed promises to buy any amount of treasury bills issued by the US government in order to fund its stimulus packages. It is the de facto monetization of the budget deficit. This method, guided by the knowledge of modern monetary theory and called “money printing”, is now used on a large scale.

The Federal Reserve has expanded its bond buying business well beyond treasury bills and mortgage-backed securities, which have been its traditional areas of business. The Fed has shown a willingness to buy corporate bonds, including junk bonds.

Is there a limit to printing money? What is the significance of the strength and integrity of money in the functioning of the modern capitalist system? It is very likely that at some point people will lose faith in fiat money if the growth of the money supply loses the link with the rate of growth of the real economy. This is a phenomenon that occurs quite often in developing countries.

The advanced capitalist countries with hard currencies have so far been able to avoid this fate in the post-war period. But in the aftermath of the recession caused by Covid-19, even advanced capitalist economies cannot be immune from the dangers of stagnation and high inflation.

The loss of confidence in fiat currencies in advanced capitalist countries will have serious international repercussions.

Damage to status

It is a matter of debate now that the current US monetary policy stance of excessive quantitative easing could cause serious damage to the dollar’s status as the world’s reserve currency.

For 75 years since the end of World War II, the status of the US dollar as the world’s primary reserve currency has remained virtually unchallenged. About 60% of the world’s currency reserves are in dollars and the vast majority of world trade and investment is done in dollars. By comparison, around 20% of the world’s foreign exchange reserves are in euros.

The United States has recorded trade and current account deficits with the rest of the world over the past four decades. The dollar’s global reserve currency status allows the United States to borrow large sums of money from the rest of the world. The United States has the largest foreign debt in the world. As of September 2020, foreigners held $ 21.3 trillion in US debt.

The Federal Reserve’s excessive printing of currency in response to the Covid-19 crisis is likely to sow fear among U.S. foreign lenders. Indeed, an excessive increase in the money supply could lead to high inflation, leading to a sharp fall in the value of the dollar. The US government’s trillion-dollar stimulus package is largely funded by borrowing from the Federal Reserve.

Changing foreign perceptions

Due to the Federal Reserve’s policy of keeping the interest rate near zero, there has been very little involvement by foreign lenders in providing funds to the US government. This is an indication of changes in foreign perceptions of the strength of the United States, which over time will erode the hegemonic status of the dollar. A recent IMF report shows that central banks around the world are reducing the share of US dollar assets in their total reserves.

In recent years America has been very aggressive in using the power of its currency to impose sanctions on countries with which it has disagreements or disputes. The United States has used the dollar as a foreign policy tool against some strategic rivals such as Iran, North Korea, China, and Russia.

It is true that the replacement of the dollar by another currency as the world reserve currency does not seem likely in the near future. The TINA argument is not without merit. But there are other ways in which the dominance of the dollar is called into question.

In recent years, many countries, including China and Russia, have attempted to de-dollarize their economies. These countries diversify their foreign exchange reserves and conduct commercial transactions in other reserve currencies (such as the euro) or in their own national currency. This trend of de-dollarization which has been underway for many years now is likely to accelerate due to the large-scale use of quantitative easing policies by the Federal Reserve in response to the Covid-19 crisis. .

There is a noticeable trend towards diversification from US Treasuries into gold by central banks in several countries. The 60% increase in the price of gold between 2018 and mid-2020 reflects this development. Compared to the United States, the post-Covid economic recovery in China is likely to be much stronger, leading to a significant reduction in the GDP gap between the two countries. The shift in balance in favor of China should accelerate the process of de-dollarization.

(The author is SK Dey Chair Professor, Institute of Social Sciences, New Delhi)


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