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Context

As per IMF’s first deputy managing director Gita Gopinath, financial sanctions imposed on Russia threaten to gradually dilute the dominance of the U.S. dollar and could result in a more fragmented international monetary system.

To understand more on this and related risks to the dominance of the dollar in view of the prevailing global situation and what it means for the international financial market.

Russia- Ukraine War and USD

The Russia-Ukraine conflict conveys no signal of coming to an end or any tendency towards a peaceful settlement.
This has disrupted the global supply chain and has caused a major blow to the global economy.
The World Bank has reduced its annual global growth forecast for 2022 by nearly a full percentage point, from 4.1% down to 3.2%.
The financial sanctions imposed on Russia by the major Western powers have prompted changes in the international financial order driven by USD.
The United States has to some extent weaponized the dollar against Russia.
Countries are concerned that the money it holds in dollars would be worthless if dollar inflation set in.

How US Dollar became the global currency?

The U.S. dollar has been the world’s dominant currency since the end of World War II.
Roughly half of international trade, international loans, and global debt securities are denominated in USD.
The USD became the official reserve currency of the world in 1944. The decision was made by a delegation from 44 Allied countries called the Bretton Woods Agreement.
Despite the challenges faced by the US economy due to fiscal and external deficits of the 1980s, the dollar’s share of global reserves remained steady and reserves even grew as time progressed.
The dominance of the dollar is backed by strong and highly credible institutions, deep markets and the fact that it is freely convertible.
Almost 40% of the world’s debt is issued in dollars. As a result, foreign banks need a lot of dollars to conduct business. This became evident during the 2008 financial crisis.

Implications of USD led inflation

The dollar’s role as the world’s “reserve currency” is a cornerstone of the global economy and global finance as well as geopolitics.
Most of the transactions are dollar-dominated, currency depreciation is rather unlikely to increase exports.
A depreciation in the currency relative to the dollar leads to an increase in the price of imported goods which means high pressures on inflation.

Challenges to USD

In the 1990s the dollar’s role started diminishing and the US became a net debtor to the world.
With the emerging global value chains, China’s integration into the world economy has been an impediment to the economic growth of the US.
A considerable decline in the dollar’s share can be attributed to the greater use of the Chinese renminbi.
It was notified by the IMF official that the dollar’s share of international reserves had fallen from 70% to 60% over a period of time with the growing trading currencies led by the Australian dollar.

Calls for a one world currency

In March 2009, China and Russia called for a new global currency.
China is a huge player in world trade, which you might think would make people want to hold a lot of yuan assets.
They wanted the world to create a reserve currency that is disconnected from individual nations and is able to remain stable in the long run.
They thus want to remove the inherent deficiencies caused by using credit-based national currencies.
In the fourth quarter of 2016, the Chinese renminbi became another one of the world’s reserve currencies.
China wants its currency to be fully traded on the global foreign exchange markets. It would like the Yuan to replace the dollar as the global currency.

What lies ahead?

For many years, undermining the dollar’s dominance has been the dream of governments that have looked uneasily at US global primacy, and formed coalitions.
Some experts also advocate that either China’s or Russia’s threat to the dollar hegemony will remain a fantasy.
It is predicted that the sanctions against Russia will not foreshadow the decline of the dollar as the reserve currency.
The Russia-Ukraine Conflict will definitely slow down the global economy but will not cause a global recession.