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1 The US Dollar: Role in today’s monetary system and its future prospects
The US Dollar: Role in today’s monetary system and its future prospects
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Student’s University Name
2 The US Dollar: Role in today’s monetary system and its future prospects
Table of Contents
1 Introduction 3
2 Research Question and Hypothesis 5
3 Literature Review 6
4 Research and Data Collection Methodology 9
5 Data Analysis and Interpretation 11
5.1 Role of US Dollar as Medium of Exchange, Store of Value
and Anchor Cu
ency
12
5.1.1 Role of US dollar as Store of Value 14
5.1.2 Role of US dollar as International Medium of Exchange 18
5.1.3 Role of US dollar as Anchor Cu
ency in Exchange Rate
Regime
22
5.1.4 Role of US dollar in Invoicing Exports 28
5.2 Validation of US Dollar as Primary Capital Market and
Transaction Cu
ency
32
5.3 Future Prospects of US Dollar 35
5.4 Other Feasible Alternatives to the US Dollar 38
6 Conclusion 40
3 The US Dollar: Role in today’s monetary system and its future prospects
1. Introduction
US dollar has proved its importance in global economy in terms of a standard cu
ency, which
has stronger role in international finance and trade, as medium of exchange and store of value. In
order to justify the efficient role of international cu
ency, it is in general expectation that
cu
ency will ca
y the characteristic of a unit of exchange and store of value; and justify its
prudence in roles of a medium of exchange, anchor cu
ency in exchange rate regimes, foreign
exchange reserve’s primary cu
ency, transaction cu
ency to international capital market and
foreign exchange, international trade invoicing and settlement cu
ency. US dollar is at
significant position in all that standard global financial roles and thus efficiently managed to
control the most of economic and financial activities around world economies.
Considering such crucial role, most of the world economies have adopted the exchange
ate regime to evaluate the value of their home cu
ency with that of US dollars. This fact has
strengthened the position of cu
ency in international market where US dollar exerts extensive
dominance in key global financial functions. This cu
ent role of US dollar as dominant
international cu
ency has been challenged by the emergence of other competent cu
encies like
Euro, Swiss Franc, Pound Sterling and Japanese Yen. Considering the recent turmoil in US
economy and significant fluctuation in its international value, several other cu
encies have
shown their prudence and ability to qualify as international cu
ency and take position of US
dollar.
In a specific research, Chinn and Frankel (2008) have uncovered their research finding
egarding the evolving roles of the cu
encies. It has been projected by them that cu
ent status of
the US dollar is based on different region’s growth trajectories, and in next few decades Euro
4 The US Dollar: Role in today’s monetary system and its future prospects
may establish itself as biggest rival or may even surpass the legacy of US dollar. In similar
manner Eichengreen (2011) has strongly supported his research finding that global economy is
moving under situation where evolution of multi-cu
ency regime is an obvious event to occur
and that also beyond the continuing dominance of US dollar.
Significant decline in the international cu
ency status of US dollar has been noticed after
the cu
ent economic slowdown and recessionary situation in United States and European
economies. This recession has not only degraded the intrinsic trust and hidden value of the
cu
ency (US dollar), but also affected the upcoming potential of emerging alternatives like Euro
and others. Due to such recessionary effect Euro has lost its significance in its nascent stage and
compelled global community to think on development of portfolio of cu
encies, bearing
characteristic of potential international cu
ency. A portfolio of stronger and capable cu
encies
will give birth to multi-cu
ency regime, which bears the uncertain economic shocks and prevent
economies to lose in value of their secured reserves; degradation in value of a portfolio of
cu
ency is less likely to happen in comparison of the single cu
ency.
In this paper discussion objective comprises the evaluation of the cu
ent position of US
dollar in national and international monetary and financial system, with reference to the past
events of economic slowdown and recessionary influences. An extended approach of studying
the future prospects of US dollar and other emerging economy’s cu
encies will help in getting
significant information about the cu
ent and future potential of US dollar as an international
cu
ency. With evaluation of present and future potential of US dollar as a competent
international cu
ency, an estimation of future potential of other cu
encies will enhance the
effectiveness of the study. Thus the overall paper will be comprised of the exclusive evaluation
5 The US Dollar: Role in today’s monetary system and its future prospects
of US dollar as competent international cu
ency and its future prospects in scenario of other
strengthened cu
encies.
2. Research Question and Hypothesis
In order to accomplish the desired evaluation and derive expected research outcome, it is
necessary that specific research plan should be followed. This research plan initiates with the
formulation of research question and hypothesis, on basis of which overall study will be made
and final conclusion will be derived. These research questions and specific hypothesizes will
help in getting appropriate information to understand and examine the role of US Dollar as an
international cu
ency and to determine its future role. In order to make exclusive study of US
dollar’s cu
ent and future role, following research questions can be proved as valuable inputs.
Such research questions and hypothesis can be mentioned as:
To discuss the role of US Dollar as an international medium of exchange, as a store of
value, an anchor cu
ency in exchange rate regimes and its use for Invoicing of Exports a
To validate the use of US Dollar as a primary cu
ency in official foreign exchange
eserves and a transaction cu
ency in Capital and Foreign Exchange Markets (How is it
going to be validated?)
To discuss the future prospects of US Dollar (How)
To explore other feasible alternatives to the US Dollar as an International Cu
ency
An exploration of the above mentioned research questions will provide the valuable insight on
the US dollars role as the international cu
ency facilitating benefits of store of value,
international medium of exchange and fulfillment of anchoring cu
ency requirement of
exchange rate regime. Focus on specific research question will help in confinement of study and
6 The US Dollar: Role in today’s monetary system and its future prospects
facilitation of much exclusive details on specific subject topic like US dollar’s cu
ent position in
economic or international monetary system and financial system, and analysis outcome of future
prospects of US dollar and other feasible alternatives.
3. Literature Review
In order to ascertain the desired outcome of study, it is necessary to have an initial review of the
past researches and studies, which can provide meaningful insight about the research topic and
facilitate necessary guideline to make the research work much exclusive and focused. It has been
experienced in several past decades that US dollar has maintained its legacy of being prime
cu
ency of international trade and exchange and willingly accepted by the international
community as the anchor cu
ency for the exchange rate regime. Even though US dollar has
served international economy, in terms of an effective and strong international cu
ency, from
decades, but in consideration to the recent changes in global economic situations, the financial
institutions across the world are concerned about the role of dollar as the main reserve cu
ency.
Recent economic turmoil and recessionary instances has induced the feeling of insecurity within
the global economies and respective financial institutions.
Even on that, the Government’s steps of providing fiscal stimulus and keeping low levels
of interest rates led to weakening of the economy and rise in the level of national debt. This
further increased the levels of unemployment and led to fall in tax revenues. In the long run, this
may lead to risks of inflation and hyperinflation. The present study is being conducted to assess
the role of US Dollar today and its future as an international cu
ency. In order to accomplish the
same certain viewpoints of other researchers has also been considered.
7 The US Dollar: Role in today’s monetary system and its future prospects
Paul Krugman, the Nobel Prize winner states that “a country whose fundamentals are
persistently and predictably deteriorating will necessarily have a [cu
ency] crisis at some point.”
(Paul Krugman, 1997 Cu
ency Crisis, International Capital Flows, Martin S. Feldstein)
Jorg Bibow (2010) investigates the role of U.S. dollar as the international cu
ency which
was a contributing force in the international developments which led to the crisis in 2007-09. The
paper also lays emphasis on the role of dollar in future as the repercussions of the crisis are
educing. Bibow is of the view that the dollar will retain its hegemonic status for a considerable
number of decades but the public spending in US would be a facilitator of global growth rather
than private debt.
Paul Krugman (1984) lays emphasis on the six roles of dollar in the international
scenario. He discusses each aspect of dollar in detail and also assesses what are the consequences
if the role of dollar declines rapidly. The fall of dollar would lead to increase in exposure of the
financial intermediaries to the exchange risk. In the long run, all cu
encies namely euro, dollar
and pound will gain the role of international cu
ency. This would lead to an increase in
transaction costs in the inter market. The fall of dollar would also result in difficulties as there
will be no single unit of account.
Richard Cooper (2009) in his research has found that the US dollar is bound to stay as an
international cu
ency over the next decade and maybe longer. No cu
ency will be able to take
over the dollar because of its wide acceptance. The use of Euro internationally is expected to
grow but may not replace dollar because of its limitations in financial markets. To replace the
dollar an international decision needs to be taken and a number of practical difficulties. The
8 The US Dollar: Role in today’s monetary system and its future prospects
government’s across the world need to adopt policies with respect to exchange rates to promote
the adoption of a new international cu
ency.
Jörn Griesse & Christian Kellermann (2008) analyze that the future of dollar is bleak.
There may be a shift in the present monetary system. There may be strengthening of Euro as an
international cu
ency or a shift towards monetary regionalization. Monetary regionalization
leads to high levels of liquidity and long term benefits. Other regions like Asia may follow the
steps of Europe and adopt monetary integration. For Euro to emerge as an international cu
ency
there needs to be a degree of openness maintained by the Euro zone. Protectionist policies should
not be adopted and Europe should formulate a multilateral framework for the new monetary
system. At present the euro needs to co-exist with the dollar as reserve cu
encies. This will help
in managing excessive fluctuations in the exchange rates of these two cu
encies. Thus, this
would lead to a new era of multilateralism and combating the cu
ent financial crisis.
Linda Goldberg (2011) presents that the US dollar is still the dominant cu
ency. If the
ole of dollar changes, the consequences will be seen in terms of seignorage returns, U.S.
insulation from foreign shocks, U.S. funding costs, the dollar’s value and U.S. global influence.
The author also stress on the consequences, which will be felt on the international
macroeconomic policy and transmission of shocks.
Linda Goldberg (2010) questions the pre-eminence of US dollar as an international
cu
ency. The author analyses that the emergence of euro has changed the value of dollar and the
ongoing crisis has posed a challenge to the cu
ency’s position. On analyzing empirically it has
een found that the dollar has retained its position in the area of international trade and finance.
Various factors like inertia in cu
ency use, the dollar pricing of oil and other commodities, and
9 The US Dollar: Role in today’s monetary system and its future prospects
the large size and stability of the U.S. economy will help the dollar in maintaining its dominant
ole as a medium of international transactions.
4. Research and Data Collection Methodology
The Methodology adopted will be on the lines of assessing historic data and comparing the
situation today with the 1980s and 1990s when the US dollar exercised great powers across the
world. To see the status of US Dollar on several aspects as listed in the research question data
will be collected from various financial institutions and reports. The research will be based on
Secondary sources of data. This data is primarily collected by other researchers and institution
for their specific research objective and due to similarity of research subject this will help in
developing valuable insight.
To assess the role of dollar today as an international cu
ency, we need to analyze its role
as an international medium of exchange, as a store of value and as an anchor cu
ency in
exchange rate regimes. Data for these aspects for the years 1990 to 2010 will be taken from the
Federal Reserve Bank, IMF and US Treasury Department. This will help in notifying the
characteristic and technical aspects of US dollar’s primacy in international cu
ency role.
To assess the role of dollar as international cu
ency, data for share of U.S. Banknotes
Held outside the United States, can be taken from the Federal bank. This data will be analyzed in
terms of percentage of bank notes held starting from the year 1990 to 2010. The data in terms of
denomination of bank notes held can also be charted and analyzed for. The denomination of
notes refers to the number of notes of different values.
To further understand the role of Dollar in Exchange Rate A
angements and foreign
exchange Reserves, Foreign Cu
ency Reserve Holdings from International Monetary Fund,
10 The US Dollar: Role in today’s monetary system and its future prospects
Cu
ency Composition of Official Foreign Exchange Reserves (COFER) data will be used from
1990 to 2010. This data can also be supplemented by share of U.S. Dollar Assets in Foreign
Cu
ency Reserves from International Monetary Fund, Cu
ency Composition of Official
Foreign Exchange Reserves (COFER) data; Board of Governors of the Federal Reserve System
staff estimates. This data will also range from the year 1990 to 2010. The foreign cu
ency
eserve holdings will further be
oken down into those held with developing and industrialized
countries. The same can be incorporated for the data of Dollar Assets in Foreign Cu
ency
Reserves.
To examine the role of dollar in foreign exchange market sand as an invoicing cu
ency
data for Turnover in Traditional Foreign Exchange Markets can be extracted from the site of
Bank for International Settlements. This data for the years 1990 to 2010 will be analyzed in
terms of dollars, euro, yen and other major cu
encies of the world. This can be further assisted
y use of dollar in the invoicing of exports from Goldberg and Tille (2008). The data for
invoicing exports to certain countries like UK, France, Germany, Japan, Thailand and Malaysia
can be used.
To further strengthen the role of dollar as an international cu
ency and its use in
International Financial transactions, U.S. Dollar Share of Debt Securities Outstanding from
European Central Bank will be used. This data will be used to assess international and all debt
securities of US. This data for the period 1990 to 2010 will be further assisted by Cross-Border
Foreign Cu
ency Liabilities of Non-U.S. Banks from the year 1990 and U.S. Dollar Share of
Cross-Border Foreign Cu
ency Liabilities of Non-U.S. Banks from the year 1990 to 2010. The
data will be extracted from Bank for International Settlements will be incorporated to reach a
11 The US Dollar: Role in today’s monetary system and its future prospects
valid conclusion. Both the factors will be assessed for in terms of banks and Non-Banks as well
as the Total share in non US Banks.
The next part of the research which is to analyze the future prospects of US Dollar and
explore other feasible alternatives to the US Dollar as an International Cu
ency the study will
use data on US debt and US debt to GDP ratio from the IMF. This data for the period 1990 to
2010 will be compared to that of other countries whose cu
encies are competing to make their
cu
ency an international one. Some of these countries are China, Germany, US, UK and Japan.
To further predict the role of dollar in coming years, data of US exchange rates from
Federal Reserve and share of US Dollar in global reserves from the IMF will be used. The period
from the year 2000 will be considered. The reserves will be seen in terms of US dollar, Euro and
other major cu
encies, which are competing with the dollar to become an international cu
ency.
A comparative analysis of US Dollar v/s the major cu
encies of the world in terms of
foreign exchange transactions will be ca
ied out based on data from Bank for International
Settlements to predict the status of dollar in future. This comparative analysis will ca
y out on
the basis of the foreign exchange transactions, which have taken place with reference to other
major competing cu
encies like Euro, Yen, and Yuan etc. The pattern of transaction that will
finally emerge will provide a sound basis for understanding the position of dollar in the world.
5. Data Analysis and Interpretation
A significant and crucial part of the study starts with the analysis and interpretation of the data
esources, being retrieved from various sources like: journals, articles and previous research
papers related to the subject of study. Comprehensive analysis of the data resources and
evaluation of the provided information helps in developing insight about the study objective. It
12 The US Dollar: Role in today’s monetary system and its future prospects
further affirms the appropriate approach to extract out exclusive research outcome, which
answers the predetermined research questions and validates or rejects the initial hypothesis.
These interpretations provide aspired details about the US dollar’s status in international
monetary system, as per the specific role of international medium of exchange, store of value and
anchor cu
ency. Specific details related to the role of US dollar as primary and transaction
cu
ency will be of great help in validation of its specific role in global system as primary
cu
ency in official foreign exchange reserves and a transaction cu
ency in Capital and Foreign
Exchange Markets. An extended and intense analysis will facilitate the valuable insight about the
future prospect of US dollar as international cu
ency and its other potential substitutes.
5.1 Role of US Dollar as Medium of Exchange, Store of Value and Anchor Cu
ency
As per the economist view the prime function of any cu
ency is considered to be the ability of
cu
ency to store certain value and being widely accepted as the medium of exchange for routine
and business transactions. This specific characteristic has greater significance in global scenarios
where such cu
ency has to play the role of international cu
ency. In order to attain the position
of international cu
ency it is necessary that cu
ency should possess the definite and sufficient
value and should be considered by the global economies as universal medium of exchange. As
much is the global acceptance higher would be the status of cu
ency as international cu
ency.
Store of value preposition of cu
ency depends upon the associated value and liquidity of
the intrinsic or underlying assets, which helps in determining the overall value of the cu
ency in
economy and international system. It depicts that higher the value of the underlying assets higher
will be the value of the cu
ency and vice-versa. Global acceptance of cu
ency, as international
cu
ency, is dependent on the specific value of the cu
ency and its stability prospects in varied
13 The US Dollar: Role in today’s monetary system and its future prospects
economic and monetary conditions. Stored value of the cu
ency is dependent of certain other
factors like safety and liquidity of the central assets, ample availability of it to meet out the
international liquidity demand and ability to deliver appropriate return in long run. (Jeanne,
2012)
Table.1 Top Foreign Holders of US Treasury Securities till 2009
Source: Treasury Department
Another important aspect under consideration is the role of cu
ency as the anchor cu
ency in
exchange rate regimes and its specific use for invoicing of Exports and Imports. As per exchange...