End of dollar hegemony fast nearing: Economist Helene Rey

With Asia increasingly becoming the economic centre of the world and the US' influence on global trade shrinking, coupled with the emergence of digital currencies, the end of dollar hegemony on international finance may be nearer than anticipated, London Business School economist Helene Rey said on Friday.

Since World War II, the greenback has been the hegemonic currency for global finance and trade, and the US Federal Reserve's monetary policy has been setting the tone for the global financial cycle.

Delivering the 35th commencement day lecture of the Exim Bank here, Rey, the Lord Bagri professor of economics at LBS, also noted that there are difficulties for the US to remain a world banker or insurer, which it has been since the Bretton Woods institutions came into being in 1945.

 

It can be noted that from a being a poor developing country till about the mid-1990s, China has come a long way and is today a USD 14-trillion giant controlling 16 percent of world trade.

Its sway on global economy has been underlined well in the bloodbath on global equity markets since the outbreak of the deadly coronavirus since last month and the resultant gloomy outlook on global economy, given the supply chain disruption the epidemic has created.

The equilibrium in which the dollar is the dominant international currency is becoming more unstable over time as the relative size of the US in the world economy is shrinking, while the stock of dollar liabilities in the rest of the world is consistently growing, Rey said.

"As the economic centre of the world is moving towards Asia, and China is emerging as a geopolitical force, the days of the dollar hegemony may be counted," Rey said.

She also warned "the emergence of private or public digital currencies can also have a catalytic role and upset the payment systems in ways which are unusual historically."

But despite all these, both emerging markets and advanced economies are increasingly holding large amounts of assets cross-border -- mostly denominated in US dollars -- even though the 2008 crisis moderated the trend and Brexit may jeopardise some international financial links in Europe, she said.

However, she also admitted that dollar's demise as the most powerful global currency is not that easy as there is no effective alternative to the greenback.

Though the euro may be the closest substitute to the dollar, the incomplete architecture of the Euro area and the absence of a Euro area-wide safe asset inhibits the internationalisation of that currency, she said.

And when it comes to the Chinese renminbi, Rey observed that while the use of yuan for trade invoicing and cross-border financial transactions has increased, its adoption in international markets is deterred by the capital controls imposed by China, as also the underdeveloped financial system in the world's second largest economy.

"The renminbi is barely taken up in international markets, while the euro is a distant second," she averred.

But a more potential threat to the dollar, she said, is from digital currencies which may disrupt the international monetary system that is today heavily dependent on the dollar, and profoundly transform geopolitics.

Reeling out numbers to underline the dollar hegemony, Rey said the US unit is the dominant international currency with nearly 62.2 per cent of international debt, 56.3 per cent of international loans, and 62.7 per cent of forex reserves denominated in the greenback.

Also, the sum of cross-border financial claims and liabilities scaled by annual GDP has risen from about 70 per cent in 1980 to 440 per cent at the eve of the financial crisis in 2007 for advanced economies, and from about 35 per cent to 70 per cent for emerging markets.

For India in 2018, the corresponding number is 61.3 per cent, of which 20.5 per cent is gross external assets, and 40.8 percent is gross external liabilities of annual output, she said.

"The dollar is to currencies what English is to languages," she said, adding India is among the most dollarized countries as far as trade invoicing is concerned.

Rey also warned that the asymmetry inherent in a hegemonic system may also create financial fragilities that can ultimately lead to its demise, creating a scenario of what she called a "new Triffin dilemma", under which countries may compete using increasingly sophisticated cross-border payment technologies to expand the network of countries under their monetary and financial influence, creating a new type of geopolitical game.