The United States Dollar (USD) is the most important currency in the global economy. The US Dollar is widely used by central banks all over the world as a major reserve currency. In addition, USD is the primary currency when it comes to international trade and financial transactions. But is there a chance for de-dollarization?
- The US Dollar is the world’s reserve currency, accounting for over 60% of global foreign exchange reserves. Which means that central banks hold large amounts of USD to support their local currencies and provide stability to local economies. The main purpose of central banks is to help businesses by controlling inflation. Inflation is necessary for growth of any economy, however, when it gets out of hand, meaning gets higher than target inflation, it can crash even the strongest economies. High inflation makes it difficult for businesses to operate. It becomes impossible to plan for the future or even calculate frequently changing prices. Central banks are very limited in this regard. They typically have two options at hand, interest rates and reserves in foreign currency.
- The USD is the dominant currency when it comes to international trade. Around 80% trade transactions are made in USD.
- The US Dollar is commonly used as a currency for making international investments. In addition, it is a benchmark currency for global financial markets. Most commodities, derivatives and Contracts for Difference (CFDs) are paired with USD in financial markets.
Some countries are actively trying to limit their reliance on the US Dollar. For example, China has been seeking to increase the use of the Yuan as a reserve currency to challenge the dominance of the USD. This would give China more influence in the global economic affairs and reduce its dependence on the US and other countries for financial support.
One more reason why many countries such as Russia, China, India, the United Arab Emirates, and others try to limit their dependence on USD is that their economies can become less impacted by the fluctuations in US Dollar price.
In order to reach their goal, countries that try to de-dollarize need to replace the currency in global trade and this will also affect global reserves.
How did the US Dollar become the world’s major currency?
The US Dollar has come a long way to become the world’s main currency. Initially countries started to use USD as a reserve currency due to the fact that it was backed by the world’s biggest gold reserves thanks to the Bretton Woods Agreement. This agreement allowed other nations to peg their local currencies to US Dollar and the US government made a promise to exchange dollars for gold at a fixed rate of 35 USD per ounce.
One more factor that made the Dollar so commonly used is that the US economy became the largest economy after World War II, and held the largest physical gold reserves.
Furthermore, the US was also a dominant military power globally, with well-developed financial and political systems. The United States of America was viewed as a stable economy and as a result, countries started to trade using USD.
Plans and actions countries take for de-dollarization
In recent years, some nations have made efforts to “de-dollarize” their economies to lessen their reliance on the US Dollar. Major ways countries are trying to achieve this are following:
- Diversification of currency reserves. Countries are diversifying their foreign currency reserves by holding more non-USD currencies such as Yen, Yuan, and Euro. For example, Russia has been reducing its reserves in USD and increasing holdings in Euro, Yuan, and gold. Gold is historically viewed as a hedge against inflation, as when there’s high inflation, investors seek to increase their physical gold holdings, which in turn increases the commodity price.
- Trading in local currencies. Countries that have strong trading ties try to use USD less and less. For example, Brazil, Russia, India, China, and South Africa have created a New Development Bank, that allows them to lend to each other in their own currencies.
- Some countries such as Venezuela are trying to increase use of alternative currencies, such as Bitcoin.
How can you benefit from economic turmoil?
While it’s true that some countries are doing their best to de-crown US Dollar from global financial markets, the USD remains the most commonly used currency in the world.
Keep in mind that every challenge can become an opportunity. And even if the US Dollar becomes much weaker, you can benefit from the process.
The best way to take the advantage of currency fluctuations is to trade Forex markets. Forex is also known as foreign exchange or FX, and it’s the largest market by volume. The FX market is the most liquid and offers 24/5 active trading opportunities.
Forex trading can be done through a variety of platforms such as: MetaTrader 4, MetaTrader 5, cTrader, and others. cTrader offers a very modern and user-friendly interface. The platform has advanced charts, multiple timeframes and supports automated trading through using trading robots. You can read more about cTrader here to get the ins and outs of the platform.
The most popular trading platforms are MetaTrader 4 (MT4) and MetaTrader 5 (MT5). Both platforms are built by a Russian software company MetaQuotes. MT4 was released in 2005 and MT5 in 2010. Both platforms became instantly popular and they are still offered by the vast majority of brokers today.
MetaTrader platforms are highly reliable and they support automated trading using Expert Advisors (EAs). EAs are MetaTrader trading algorithms that help build or access custom-built trading robots, backtesting algorithms and indicators. cTrader also uses its trading robots called cBots. You can learn more about how cTrader compares to MT4 and MT5 here.
When trading currencies on the Forex market, you receive various benefits that make it easier to profit from changing economic conditions. The main benefits include:
- Leverage: Forex trading enables you to speculate on currency prices using leverage. Traders use leverage to increase their purchasing power drastically. It’s common for brokers to offer 500:1 or even 1000:1 leverage. This means that by choosing 500:1 leverage, you get to control 500 times more money than what’s on your trading balance. However, it should be noted that while high leverage does a great job increasing potential rewards, it can also increase your losses. And therefore, professional traders always use risk management when trading with leverage.
- Ability to go short or long: currency pairs consist of base and quote currencies and this gives traders the opportunity to go long or go short easily.
- High liquidity and tight spreads: Forex markets are the most liquid in the world, which means that there are lots of buyers and sellers that make transactions easier. Difference between buying and selling price is minimal and trading currencies is much less expensive than low liquidity markets.
- 24-Hour market: currency trading is available 24 hours a day from Monday to Friday. The FX market is decentralized, which makes it possible to buy a certain currency pair during one trading session, and sell during the other.
- Low barriers to entry: currency trading is not tightly regulated and it’s possible to register, open a live trading account and start trading within a day. Most brokers do not have any minimum initial deposit requirements. During registration, most brokers ask for proof of your identity and proof of your residence documents that can be uploaded digitally, and that’s it, you can download a platform and start trading.
- Information on currency pairs is widely accessible on the internet. There are lots of books, webinars, seminars, video guides and mentorship classes you can take to become a professional in currency trading.
What impact can de-dollarization have on the US economy?
The US economy is very strong. The country has advanced agriculture and manufacturing. The USA is one of the biggest producers in the world. However, it should be mentioned that the country is also the biggest consumer.
Partly, consumption is powered by debt. As of April 2023, the US national debt is over 31 trillion dollars, according to the US Treasury Department. The US national debt is the total amount of money owned by the federal government to its creditors, including individuals, corporations, and foreign governments. Most producer countries such as Japan, Germany, and China buy US government bonds as keeping cash is a terrible way to keep money. Stored cash is eaten by inflation.
But, if the US Dollar becomes less important currency, and countries start using it less and less in trade, less governments and individuals will purchase US government bonds and the whole financial system will collapse. The American government will have no other choice but to cut spending on most government programmes.
Collapse of the US Dollar as the world’s main currency will damage the US economy instantly. However, the US is still one of the main producer countries in the world with vast natural and human resources. The current financial system is highly imperfect. The US government takes new loans every year to cover for the interest of previous loans. As a result, debt is increasing every year. More money gets printed and inflation increases.
To stop the inflation, central banks limit money supply by increasing interest rates, which in turn slows down the economy.
The Covid-19 has urged governments globally to take more loans to fight the pandemic. And the US government was not an exception. In a scenario where the US Dollar is no longer a global currency, taking cheap loans is impossible for the Amercans.
On the other hand, collapse of the US Dollar in the global arena can urge the US economy to become more productive and help reduce negative trade balance with other countries. However, it will take time, and in the short term, de-dollarization will hurt the American economy.
Key takeaways
To sum everything up, there are three major ways that USD is exercising its dominance on the global economy:
- It’s the world’s major reserve currency with more than 60% held in reserves
- The USD is main trading currency with 80% global trade transactions made in USD
- It’s the main investment currency in the world of finance
Some major currencies, such as Brazil, Russia, India, China, and South Africa are actively trying to replace USD or limit their dependence on the currency by de-dollarization.
De-Dollarization can have negative short term effects on the US economy. Particularly, it will make it highly difficult for the US Government to take cheap loans and increase debt. Instead, the government will be forced to cut spending on most government programs and this might create a healthier economy long term for the Americans. The best way to profit from the economic turmoil is to speculate on the currency market. Forex trading offers various benefits, such as ability to use leverage, enjoy high liquidity, etc.