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Who Can Dethrone The US Dollar?

By Ajay Shah
July 24, 2023 19:24 IST
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Policymakers should aspire to restore the pre-Independence environment where the rupee was trusted and used all over South Asia, in Southeast Asia, in West Asia, and in East Africa, suggests Ajay Shah.

Illustration: Dominic Xavier/

The United States was at the upper edge in per capita gross domestic product among the nations of the world by 1820.

By 1920 it had the biggest GDP of the world. Prior to Nazi rule in Germany, there were no capital controls anywhere, so the size of the US financial system attracted investing and fund-raising activities from across the world.

There is a lot of hand-wringing about the domination of the dollar and attempts to 'dethrone' it, but any big decline in the role of the currency is unlikely.

This shapes how we think about the place for the rupee and the place for India in the global economy.

A currency is sometimes viewed as 'international' in the context of international trade (currencies used in invoicing for trade transactions) or the official reserves portfolio (currencies held on the balance sheet of central banks).

The bulk of what happens on the currency market, however, is international finance.

Most of the activity on the currency market consists of capital account transactions.


The dollar is the most important vehicle of this international finance. It is useful to envision this at the level of one private decision maker and then at the level of a macroeconomy.

A private person has the money to invest: What would she do? New York and London are the greatest collections of institutional capacity to find global investment opportunities. Or, a private person wishes to raise capital.

New York and London are the greatest pools for fund-raising. The bulk of this fund-raising or investing is denominated in dollars.

A network effect is at work: Suppliers of capital operate in dollars because the users of capital operate in dollars, and vice versa.

This is undergirded by the dollar bond-currency-derivatives nexus, which has the best liquidity in the world.

This is also undergirded by institutional quality in the US: A non-resident holding assets in New York does not worry about inflation, taxation, capital controls, or demonetisation.

These are the factors that created dollar domination, after the First World War.

This arrangement is convenient for persons who keep score in dollars because their currency risk is reduced.

For everyone else, international activities take place in dollars but there is currency risk when expressing back into home currency.

State actors at the receiving end of Western sanctions (such as Iran, Russia, or North Korea) and State actors envisioning such conflicts in the future (such as China) resent the possibilities for economic statecraft that flow from the economic domination of the advanced democracies.

They have sought pathways to do business without routing through the West. These possibilities are, however, limited.

In a macroeconomic perspective, the gains from capital account openness are the ability to have savings diverge from investment.

In some years, there is optimism about India, domestic investment is on fire, and investment exceeds savings.

At such times, we run a current account deficit -- we import capital from the global financial system.

Conversely, when there is pessimism in India, and investment lags savings, we export capital into the global financial system.

The term 'global financial system' here refers to the advanced democracies, all of which have open capital accounts.

The institutions and policy arrangements of these countries are giving India the privilege of this balancing service -- to absorb or supply capital based on the state of optimism in India.

The bulk of this activity takes place through dollar-denominated financial contracts.

In the 1990s there was one big State-led campaign to dethrone the dollar, by the Japanese State.

Japan had many points of strength in this: It was the second-largest economy in the world, it had good institutions, and it commanded confidence from the world on inflation, taxation, and capital controls.

They tried a big 'industrial policy' push to establish the Japanese yen as a major international currency. This attempt failed.

Then came the rise of the euro, which is now an important currency, and in some respects the European Union rivals the US as an economic powerhouse.

The euro has made gains as an international currency and it is likely that it will become more important in the future with more countries adopting it.

However, the euro remains a small player when compared with the importance of the dollar.

The Chinese government has launched a big programme of trying to push the renminbi as an important currency on a global scale.

However, China has an even weaker hand of cards than Japan did in the 1990s.

China has an Indian-style administrative system of capital controls.

The Chinese central bank pegs the renminbi primarily to the dollar, so it is not even a true independent exchange rate in its own right.

China's institutional quality on questions of inflation or taxation does not inspire confidence.

Unlike Tokyo, it does not have an attractive financial system where non-resident investors or fund-raisers might like to partake. Hence, this ambition of the Chinese State is likely to go unfulfilled.

For India, there are two distinct aspects at work.

India can and should become a powerhouse of internationalised financial services production.

The pathway to this lies in the Percy Mistry report titled Mumbai As An International Financial Centre (2007), and in Justice B N Srikrishna's Financial Sector Legislative Reforms Commission (2011-2014).

This work programme does not require the rise of the rupee as an international currency: It primarily involves interoperating with the existing global economic system.

A distinct issue is the role of the rupee.

Policymakers should aspire to restore the pre-Independence environment where the rupee was trusted and used all over South Asia, in Southeast Asia, in West Asia, and in East Africa.

This requires a 50-year run with good institutions on display on questions of inflation, taxation, capital controls, and demonetisation.

On inflation, an institutional commitment of 4 per cent was made in February 2015.

Now we need to achieve a 50-year block where inflation has 4 per cent average and low volatility.

Ajay Shah is a researcher at XKDR Forum.
Disclaimer: These are Ajay Shah's personal views.

Feature Presentation: Rajesh Alva/

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