"We are the reserve currency, I see no option for any other currency to be the reserve currency," Warren Buffett, the famed investor and Berkshire Hathaway CEO, said during his company's annual meeting on Saturday.
Before agreeing or disagreeing with Buffett, let's take a look at why the dollar's status is even being discussed lately. The search for an alternative to the dollar as the world's reserve currency got a fillip in the past year for a few reasons:
1.
Emerging markets see the US as having mismanaged its economy during the pandemic by printing way too many dollars to post cheques to its citizens, resulting in an inflation of at least 10 percent in 2022. The Federal Reserve then went into overdrive, raising rates by 500 basis points in a year, leading to capital outflows from emerging markets. Countries like Sri Lanka and Pakistan, already reeling under their domestic problems, were hit even harder by the capital flight.
2. The second big reason for anger with the dollar was triggered by the US and Europe derecognising Russia's reserves after it invaded Ukraine. Every counrty — not belonging to the NATO — was worried that it too would be in danger of losing its reserves if it invited the wrath of the US. The hunt for a non-dollar reserve currency got hotter.
3. Also, the US and most European countries imposed sanctions on trading with Russian banks. This led to a sharp rise in fuel, wheat, and edible oil prices —products which are largely exported out of Russia and Ukraine.
These triggered a desire for non-dollar modes of payment on the part of both the seller (Russia) and the buyers, which were many small Asian and African nations which had seen a flight of dollars as the US Fed started raising rates and bond yields started giving higher returns.
4. Finally, the rise of digital payments and central bank digital currencies has triggered hopes that countries can settle bilateral transactions at least partly through their payment systems without using dollars and going through the European and US banking systems.
India has been spearheading efforts to link its UPI (Unified Payment Interface) to Singapore’s PayU so that small retail payments can be made without recourse to the dollar. Similar talks are afoot with some Gulf countries too.
Separately, India has also negotiated with Russia to pay for its oil in rupees, thus ducking the worst of crude price hikes in the aftermath of the Ukraine war.
However, last month, Russian foreign minister Sergey Lavrov had said that Russians have billions of rupees accumulated in (vostro) accounts of Indian banks and that for Russia to use them, they need to be transferred to other currencies.
The Russian minister’s statement clearly expresses the problems that will be faced in the absence of a single international reserve currency. After the Ukraine war broke out, India’s trade deficit with Russia has soared to nearly $40 billion versus around $4 billion year ago. Now Russia can’t find much to buy from India, but needs a lot from China, which means it would perhaps like India to convert its rupees into yuan. But India runs a larger deficit with China and can’t generate excess yuan, even if trade with China was done in rupees and yuan, which means India will have to buy yuan from the market to pay Russia. Also in the event of India-China trade being done in rupee versus yuan, China too would be saddled with rupees, which it clearly has no use for.
In short, even countries most uncomfortable with the US will want cross-border transactions in the dollar because of its sheer acceptance across countries.
Warren Buffett got it damn right: in matters of reserve currency, the incumbent has a huge advantage — 60 percent of the world's reserves are held in dollars and most countries wouldn't want to see their reserves erode.
But the more important reason is the TINA factor — there is no alternative. The second largest economy in the world is China, making the yuan the best alternative to the dollar. But the yuan has several disadvantages. Not just countries in the Western Bloc, but even "non-aligned" countries like India are uncomfortable with China's political might.
Despite dissatisfaction with US’s hegemonic behaviour and its mismanagement of its economy with consequences for all countries, it is still preferred over Chinese hegemony partly because of civil liberties and free media in America. The western rule of law and judicial system is widely preferred over the opaque Chinese legal system.
Economists who push the case for non-dollar settlement of trades ask why China's internal rule of law — or a lack thereof — should matter while settling trades in yuan. They may have a point. Yet, it is difficult — even impossible — to see countries like India opting for the yuan as a global reserve currency over the dollar.
The US dollar, thus, isn't at risk of losing its status as the world's reserve currency, as Buffet said. But the latter part of his sentence is equally important: the American government's aggressive spending could have devastating consequences, Buffet warned. If the US doesn’t control its inflation to 2 percent, chances are higher of the global reserves shifting to gold and the yuan. But it will take a lot to dislodge the dollar. It is almost like the English language. England may be a non-entity in global power, but every financial, legal, medical, scientific document of any importance has to be written in — or at any rate translated into — English. That’s the power of the incumbency-plus-network effect.
First Published: May 10, 2023 4:23 PM IST
