China has already overtaken the United States to take the top spot on the list of countries with the world’s largest economy.
According to World Bank estimates, China ranks first with an economy of $41.26 trillion based on purchasing power parity (PPP). However, statistics show that the United States has fallen to an economy of $30.77 trillion. Even so, the U.S. dollar continues to dominate international trade and the financial system. The question now arises: how much longer will this dominance of the dollar continue?
Regarding this, Barry Eichengreen, an economics professor at the University of California, has provided detailed explanations about the decline in the dollar’s dominance in his book Money Beyond Borders.
Owl Currency
Looking at the history of currencies, only one currency has dominated international trade since the end of World War II. That currency is the U.S. dollar.
The first coins used on an international scale were Athens’ “owl” coins. In 117 BC, the coins of the Roman Empire served as an international currency. In the 5th century BC, the Byzantine gold “solidus” coin was used for trade from Britain to India.
After that, Spain’s “real” coin became the first international currency. After the 18th century, Britain’s “pound sterling” earned the title of international currency. Britain was the center of international trade. Due to political stability, economic progress, and colonial dominance, Britain’s “pound sterling” gained trust.
The Rise of the Dollar and Its Reasons
After World War II, to plan the international financial system, the ‘Bretton Woods’ conference was convened in the United States in 1944. At this conference, the price of gold was fixed in US dollars, and other currencies were linked to the dollar. Through this, the dollar’s dominance was strengthened.
Today, the dollar determines the prices of 40 percent of goods in international trade. As economist Eichengreen notes, “Even after the country that issues a currency loses economic dominance, that currency will retain its status for a long time.”
Reasons for Dollar Dominance:
> The lack of strong alternative currencies that can be used in place of the dollar.
> America’s strong financial management and the trust of countries around the world.
> The political and economic ties the United States maintains with countries around the world.
> The limited international use of the euro and China’s yuan.
In global foreign exchange reserves, 57 percent and in transactions, 90 percent is still accounted for by the dollar.
Is the dollar losing its dominance?
As doubts arise over the credibility of the United States, its dominance will decline as central banks shift their reserves into other investments. BRICS countries have proposed trading among themselves in their own national currencies. Digital assets and new technologies will also fuel distrust in the dollar.
Jamie Dimon, chairman of U.S. bank JPMorgan, said that “if the United States fails to maintain its economic and military supremacy over the next 25 years, the dollar could lose its status as the ‘reserve currency’.”
Key drivers behind the dollar’s decline
During Donald Trump’s time, the United States suddenly imposing tariffs on enemy countries and creating economic sanctions reduces confidence.
The U.S. president’s attempt to interfere in the Federal Reserve’s independence also puts pressure on the currency.
The rising U.S. government debt, along with the financial burden caused by Middle East deal breakdowns and wars, has made the American economy unstable.
China has kept its exchange rate flexible. Gulf countries have also allocated funds for domestic infrastructure projects to reduce their dependence on the U.S. dollar.
The dollar, which accounted for 70 percent of the reserve assets of countries around the world in 2000, has now fallen to 55 percent. When Russia invaded Ukraine in 2022, the United States froze Moscow’s $300 billion in assets. China and Gulf countries, realizing that the dollar had turned from a shield into a sword, have become cautious.
China’s foreign exchange reserves have fallen from $4 trillion to $3.3 trillion. Countries around the world are increasing the amount of gold they hold in reserve. Conversely, they are reducing their dollar holdings. Since gold can be easily converted into cash internationally, increasing gold reserves also reduces the importance of the dollar.