Dollar has the power to fight off digital challengers

Analysts generally trace the hegemony of the US currency to its widespread use in international commerce. A decade after China eclipsed the US as the world’s largest goods-trading nation, that dominance doesn’t seem to be waning. The much-anticipated Petroyuan has been a myth so far.

An even bigger moat could be the greenback’s role in fundraising. It will take a long time for the People’s Republic to match the depth, liquidity and openness of the dollar-denominated capital market, in which companies and banks borrow and hedge their risks. A proposed common currency for the so-called BRICS grouping of Brazil, Russia, India, China and South Africa may falter for this reason.

That still leaves the de-dollarization camp with low-hanging fruit, which they can reap with digital technologies. When it comes to moving value in illicit currency corridors, the dollar is a strong mule. This is a big part of the reason that around 90% of forex trades end up on one side of the trade. The funds are first converted into US currency, and then reconverted into whatever the payee’s bank will accept: Euros, Yen, Swiss Francs or something else. This preferred vehicle-currency status accounts for 40% of the dollar’s $6.6 trillion-per-day turnover.

It’s what keeps Brazilian President Luiz Inacio Lula da Silva awake at night. Bypassing the need for the dollar as a middleman is also the approach underlined by the Southeast Asian countries in Bali last year. They want payments made in Thailand to be directly exchanged between the rupee and the baht using an Indonesian app. Five central banks in the region—Indonesia, Malaysia, the Philippines, Singapore and Thailand—are seeking to achieve this by syncing their domestic, smartphone-based, instant-payment systems under a protocol called Nexus. This will solve some of the existing issues related to slow transfers. Heavy fees charged by banks for cross border transactions will also come down.

However, the problem of foreign exchange will remain. This is because the Singapore dollar is the only Southeast Asian currency for settlement by CLS Group Holdings AG. Jointly owned by several of the world’s largest banks, CLS arranges payments so that neither party to a trade is left with a claim after discharging its obligations.

Settlement risk forces banks to set aside capital to cover it. It has a charge. Therefore, for an illiquid bilateral payment corridor in Southeast Asia, both the Singapore dollar and the US dollar will still end up as vehicles as they help cut costs. Nexus won’t change it. No matter how hard BRICS pushes its rival IOU, the greenback is not going away.

One way to remedy this would be to use blockchain technology to eliminate settlement risk. If countries all put their central bank digital currencies, or CBDCs, on a common platform, it would be easier to ensure “atomicity:” transfers across borders would either succeed in their entirety, or fail entirely. Money will not get stuck anywhere. Long chain of banks between the sender and the receiver. In a payment journey where the dollar is just a vehicle, it can be ditched. Tokenization will provide protection to intermediaries.

A multi-currency CBDC network could eliminate a whopping $120 billion in transaction costs per year. However, the enormous coordination and trust that would be required to create such a global public good, and then agree on its ownership and governance, makes the idea a non-starter. Especially when the same blockchain technology can more feasibly be employed to maintain the exceptionalism of the dollar.

In a recent experiment with Singapore’s central bank, the New York Federal Reserve showed it could keep the dollar in play even in a blockchain world. One vehicle currency managed to deliver 47 payments in one second in an illiquid corridor of two other national units. Distributed ledgers that did not share a common technology were able to participate without the need for a central party. What’s more, the Fed doesn’t need retail digital dollars to do so. A wholesale token, available only to banks, was sufficient.

It may take time for the Fed to decide whether to issue a retail CBDC, but it is not wasting its time. e-CNY, now available to 1 billion retail users through the popular WeChat Pay and Alipay wallets, is gaining acceptance in stores in China. Sooner or later, the online yuan will become global. But why would any of these options get a second look from intermediaries if a bulk token of US currency is available to offload payments in the illiquid corridor? Dollar is a mule with very strong legs. ©Bloomberg

Updated: May 31, 2023, 11:16 PM IST