Dollar : Rise, Hegemony and Fall

India found a way of coming out of dollar payment and paying Iran in rupees for the oil it bought when sanctions were enforced on Iran prior to the signing of the Joint Comprehensive Plan of Action, known commonly as the Iran nuclear deal or Iran deal, signed between Iran and the P5+1 countries in Vienna on July 14, 2015.

As the sanctions hit Iran once again from November 4, 2018, this time only at the behest of the US, India may once again pay Iran in rupees for the oil it buys from its third largest supplier. This time round it is not just India that will be opting out of using dollar as the preferred mode of payment, but many countries have started settling trade transactions in local currencies so as to reduce their dependence on the US dollar. Germany and France are setting up a Euro-based trading system to continue trading with Iran in the wake of the US call to punish countries having any trade relation with Iran while Turkey, Russia and China too have started looking at a future without the dollar and BRICS countries are talking of using their respective currencies for trading between each other.

Pursuing the same line and with a view to decrease their dependence on the dollar, India and Japan agreed to raise the value of currency swap from the $50 billion (agreed in 2013) to $75 billion during Prime Minister Narendra Modi’s recent visit to Japan. This means India can now readily borrow up to $75 billion from Japan in exchange for rupees, signaling even lesser dependence on dollar. More and more countries are slowly realizing that they will have to move away from their dependence on dollar. Such a scenario couldn’t have been expected till the beginning of this decade!

If we look at the dollar’s rise, hegemony and downslide, we find it has taken only a little over a 100 years to go through all this. Dollar’s birth goes back to 1914 when the first of the currency note was printed upon the creation of the Federal Reserve Bank. Within next five to six decades, particularly due to two back-to-back wars that Europe underwent, the dollar gradually rose to officially become the world’s reserve currency. Another five to six decades later, countries across the world have begun to look for avenues to come out of their dependence on the dollar.

When the Federal Reserve Bank was created in 1913, it was Britain that was the centre of world commerce with much of the transactions taking place in British pound. In order to create stability in currency exchanges, most countries then pegged their currencies to gold. But with World War I breaking out in 1914, many European countries were forced to abandon the gold standard to move to paper money. This step greatly devalued their currencies resulting in the US dollar gaining world centre-stage. As a result, the US became the chief lender for many countries that were left with no choice but to buy dollar-denominated US bonds. Slowly but surely, the dollar replaced the pound as the world’s leading reserve after Britain was forced to abandon the gold standard in 1931, leading to a sharp devaluation in sterling. Though this helped the UK recover from the great financial crisis of 1931, this step contributed immensely to the dollar’s ascent to greater heights.

The US was again at an advantageous position when World War II started. The Allies had nowhere else to look to but towards the US to meet their requirements of weapons, supplies and other goods. The US collected its payments in gold and by the time the war ended, it owned the vast majority of the world’s gold.

Dollar’s ascendancy reached its peak when, in 1944, delegates from 44 Allied countries met in Bretton Wood, New Hampshire, and concluded that the world’s currencies couldn’t be linked to gold as most countries had exhausted their gold reserves to the US’s advantage. They agreed on linking their currencies to the US dollar, which was to remain linked to gold. Known as the Bretton Woods Agreement, the participating countries agreed that the central banks would maintain fixed exchange rates between their currencies and the dollar and, in return, the US would redeem dollars for gold on demand. Thus the US dollar became the world’s reserve currency, signaling the final ascent of dollar to its peak.

Instead of gold reserves, other countries started accumulating reserves of US dollars. And to store their dollars at a safe place, they started buying the US Treasury securities.  But this trend was short-lived! As the US began to flood the market with paper money, several countries including France got concerned and began to convert dollar reserves into gold.As this trend caught up, President Nixon of the US had to intervene and delink the dollar from gold – an action that led to the new trend of floating exchange rates, as it exists today.

During the periods of its hegemony and continuing till today, the US Treasury securities remained the safest store of money because of the trust and confidence that the world had in the ability of the US to pay its debts. This confidence remained despite unbridled printing of paper money by the US, its large deficit spending and huge foreign debt.

Dollar’s ascent was complete when the US was able to persuade the oil producing countries in the Middle East to trade oil and gas only in the US dollar. The US Dollars surge was now complete!

With time, various commodities became so much dependent on the US dollar that there emerged an inverse relation between the value of the US dollar and the commodity prices. Even in case of oil, a stronger dollar makes oil more expensive to the world and oil prices tend to fall as the dollar rises. The Federal Bank’s actions began affecting the economy of all the countries of the world. If the Bank increased the interest rate, dollars flew back to the US and if it lowered rates, dollars moved to other countries making them richer. The trillions of dollars that the banks loaned to the corporate houses made them richer and richer and eventually made the people poorer. This remains the scenario even to this day!

Complete dominance often results in arrogance and this became visible in the actions of the US. The US walking out of the Paris Treaty, it unilaterally ending of the P5+1 agreement where it was the signatory and its total neglect of WTO terms are just a few examples. Other countries began realizing that the dependence on dollar was to their disadvantage so much so that the emerging powers like China started drifting away from the status quo, thereby reducing their reliance on the US dollar.

The emerging scenario saw an increasingly greater number of countries beginning to talk of the dollar stranglehold. While some just spoke, few others took the first step to move out of dollar dependence and started trading in their own currencies. But it is easier said than done! The dollar may be down but it is far from being out. The Federal Bank still is and will continue to remain the world’s central bank, at least for a few more decades. This is despite nations, including India, trying their best to decrease their reliance on the US dollar.