C.R.L. Narasimhan

Perils of being a hegemon

Hegemony is defined as political, economic or cultural dominance or authority over others. When applied to the current global economy, hegemony refers to the primacy of the American dollar in relation to other currencies. Many commentators have argued that the U.S. has acquired that status because the dollar has remained the world’s foremost reserve currency, leaving behind by a large distance other contenders such as the yuan and the euro.

Whether justified or not, the primacy of the dollar over a long period of 70 years has brought about a degree of stability to the global financial system and by extension to the global economy. The dollar has remained the superpower of the financial and monetary system. As a means of payment, a store of value and as a reserve currency the dollar has reigned supreme over all other currencies.

Statistics are revealing. There are seven major reserve currencies. Apart from the dollar, the reserve currencies are the euro, British pound, Japanese yen, Swiss franc, Canadian and Australian dollars. About 62 per cent of international currency assets are held in U.S. dollars, 23 per cent in euros and four per cent in yen and sterling. Almost two thirds of India’s forex reserves are said to be in dollars.

A layman’s interpretation would be that the dollar is the most sought after currency by individuals and governments alike. A substantial portion of global trade including to and from India is invoiced in dollars.

To qualify as a reserve currency, the country must run a large current account deficit which will be easily financed by other countries desiring to park their reserves in that currency. For most parts, the dollar has been the first choice of central banks to invest their reserves.

Doubts persist

Yet and not for the first time doubts have been raised as to the stability of the system presided over by the dollar. This is because the dollar’s supremacy rested on a strong U.S. economy. More and more observers are pointing out that the foundations on which the dollar rests are becoming weak. As the Economist in a recent special issue (October 3 to 9) points out a ‘fault line’ has opened between America’s economic clout and financial muscle. The U.S.’s share of global GDP is 23 per cent and its share of global merchandise trade is 12 per cent. Those are impressive numbers but not sufficient to reinforce its number one position when one considers that 60 per cent of the global output lies within a de facto dollar zone (currencies are either pegged to the dollar or move in tandem with it).

The U.S.’s share of global corporate investment has been declining. However, it is Wall Street that has an overreaching influence over stock markets everywhere. In short, the gap between America’s economic might and financial power is widening .This creates problems for everyone, in the dollar zone and beyond.

As the Economist puts it succinctly the costs of dollar dominance are starting to outweigh the benefits,

As seen in India too, currencies and stock markets suffer wild gyrations. A miniscule rise in the American interest rate or even a talk about it is enough to cause huge reverse flows of dollars invested elsewhere. Share prices go downhill very fast.

Second, there are limits beyond which the U.S. can make up for liquidity shortage in the global financial system which has grown enormously.

Three, America’s political system is seen to be dysfunctional. The question needs to be asked for how long countries will tie their financial systems to the vagaries of U.S. politics.

Finally, the U.S. is not averse to using its financial clout to achieve political objectives. Take Iran for instance.

The default option

There is no denying the benefits the U.S. has had from this arrangement, cheaper borrowing for instance. The dollar being the reserve currency brings unmatched benefits. But there are costs such as in providing liquidity.

The case for one or more currencies sharing the burden with the dollar looks strong. However, over the years no other currency, not the euro not even the much touted yuan can occupy that place.

The yuan particularly has a strong backing in India and other emerging market countries. Sooner rather than later the yuan will acquire reserve currency status. However the recent slowing down of its economy as well as the series of currency devaluations have lent some opacity to China’s macro management. The yuan has some distance to go before it qualifies as a global currency. A very recent report from China talks of accelerated financial reforms which will inter alia allow the currency to trade freely by 2020.


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Printable version | Sep 28, 2022 2:29:34 am | https://www.thehindu.com/opinion/columns/C_R_L__Narasimhan/perils-of-being-a-hegemon/article7858482.ece