The US dollars status as the leading global currency is often scrutinized, with any slight decline seen as evidence of its impending downfall.However, the foundation of its dominance lies in global trade, making it challenging to shift the tide away from the dollar, writes Daniel Gros, Professor of Practice and Director of the Institute for European Policymaking at Bocconi University, in a recent article.Modern trade involves complex supply chains that span multiple borders and rely on intermediate inputs from various countries.Using the same currency for invoicing and financing these transactions simplifies trade and reduces costs.The resilience of the US Dollar: a closer look at its global dominance.
(Photo Internet reproduction)Consequently, if most trade is conducted in one currency, even entities outside the US have the incentive to denominate and settle transactions in that currency.This established practice is challenging to change since no single organization in the supply chain would benefit from switching currencies if others do not follow suit.As a result, the US dollar remains widely used in third-country transactions, even when the US is not involved, earning it the title of a vehicle currency.In contrast, the euro is primarily used in Europe, while the US dollar dominates international trade among Asian countries, says Gros.The convenience of the US dollars usage extends beyond its home country due to the openness and size of US financial markets, which account for 36% of the global total.Many countries banking systems rely on the dollar to provide short-term credit, similar to using a credit card for purchases.Consequently, these banks invest in US financial markets to refinance themselves in dollars, enabling them to offer dollar-based short-term loans to their clients.The US dollars position as the premier global currency is not solely the result of US efforts to promote its international use.The dollar will continue to dominate as long as private organizations engaged in international trade and finance find it the most convenient currency.While some governments, like China, may attempt to provide alternatives to the US dollar, their chances of success are slim.Government-to-government transactions in currencies other than the dollar face challenges in finding productive uses for those currencies.Moreover, limited opportunities exist for substantial investments outside the US, with the euro area bond market valued at less than one-third of its US counterpart.In times of crisis, major OECD economies, including Europe and Japan, are more likely to align with the US than China, given their reliance on US dollars for trade, says Gros.Democracies, which uphold trust and a well-established rule of law, dominate global trade and financial markets.Non-democratic regimes lack the foundations for establishing the rule of law, leaving investors subject to the rulers whims.In conclusion, the US dollars dominant position is sustained by a self-reinforcing network of transactions in global trade and the size of US financial markets.It remains a position for the US to lose rather than for others to gain, concludes Professor Gros.