Polycentricity a trend in global monetary system since 2010s – Nikita Maslennikov

In 2023, the share of US dollar-denominated global foreign exchange reserves shrank by 8%. Does this mean the dollar may lose its global currency status? If so, when can this happen? Invest Foresight discussed this possibility with Nikita Maslennikov, Director of Economics and Finance at the Institute of Modern Development.

Nikita Maslennikov, Director of Economics and Finance at the Institute of Modern Development

– So, the share of international forex reserves held in dollars is declining. Will the US financial authorities just watch or take some action? What can they do to maintain financial leadership?

– The first thing they need to do to avoid losing their financial leadership is bear in mind that this trend did not emerge yesterday or even the day before yesterday. It began in the mid-2010s. I am referring to the evolvement of a polycentric financial system. The United States is well aware that the role of the dollar today is excessive, and this is affecting the American economy.

– Affecting how, exactly?

– Many countries have their external debts denominated in dollars. And this leads to a lot of unpleasantness when the Federal Reserve ups the rate, making it more difficult to service these debts. This, in turn, puts the respective economies in a pre-default state, especially those that are considered low-income. It gives governments a royal pain in the neck when their economic problems turn into political ones.

As a matter of fact, many American economists are saying the same thing today: America needs to moderate the dollar’s share a little because it is already making life difficult for the Americans themselves.

On the other hand, the reaction of the rest of the world is also understandable. The dollar has long been playing the role of an international standard of value. Forex reserves are just reserves; they have to do with various central banks’ policies, inflation and what they do to fight it, and so on. But the turnover of goods is a completely different matter. Take bilateral trade between Russia and China for example – do they use the yuan? Or rubles? No, they use dollars!

– And it’s difficult to say what could replace the dollar.

– Parties use the US dollar in international trade, and there is no obvious replacement for it at this stage. Perhaps there will be some new currency lineup, possibly with split functionality, where certain currencies will be used for certain transactions and other currencies for other transactions. But so far, eight out of ten foreign exchange transactions on Forex, for example, involve the dollar. The share of the dollar seems to be declining in reserves, but in payments, the dollar accounts for 40%, and together with the euro, for 70%. In addition, 88% of Forex trading is also connected with the dollar in one way or another.

So burying the dollar is definitely premature at this point. However, there are other trends that can change the situation.

– What trends, for example?

– First of all, these are national digital currencies. Right now, eight central banks in the world are working on digital money projects in one form or another. But we must keep in mind that the US Federal Reserve System is also doing this. They have a special working group that deals with digital money, even though there are few reports about its activity. And this group began to work as far back as under Janet Yellen (head of the US Federal Reserve from 2014 to 2018. – Ed.).

True, it is widely believed that international digital currencies will eventually penetrate the trade and payment systems around the world, but we must also remember that the digital dollar will also be there. Hence, the question of the standard of value – what will measure digital value – remains open.

– Gold, maybe?

– Not gold, that’s for sure. Gold is a classic commodity and will never be anything more than that. True, it is used as a refuge, but it is no longer a universal equivalent as before.

– But why do we need currency polycentricity, if at all? What are its pros and cons?

– Its obvious advantage is that it reflects the real economic structure of the world. Because, let’s be honest – the excessive share of the dollar does not reflect the current structure of the global economy. Let me remind you that India and China will generate 50% of global growth this year.

Therefore, polycentricity will one way or another lock in these structural changes and the world economy regionalization trend when prototypes of trade blocs emerge. Naturally, certain maintenance is required, which is not a disadvantage. World economy hubs require their own payment systems. Those who dominate in trade or added value chains will have the right to impose, for example, their own currency.

It is inevitable, and the only question is, to what extent? So, the US dollar will, undoubtedly, remain one of the major currencies.

– What pitfalls of polycentricity do you see? 

– You know, the countries whose currencies are striving for a global status must have a highly developed financial market. They must be able to offer financial instruments to investors around the world. Even China is not able to do that although it tries. The Chinese market is a closed one. What does it mean to open to the rest of the world? It means the volatility of its currency will spike. China will have to resort to liberalizing exchange rates, accept a fluctuating rate. But yuan does not fluctuate beyond 2% both ways.

If you want the Chinese yuan, for example, to be a currency widely used for global payments, you have to create a financially different economy. The one China has right now? I’m not sure it will work.

– And who is sure?

– For example, India is certainly not ready, so it tails behind the financial systems of the so-called collective West and does not aim for a breakthrough.

– Can Russia become a global or regional currency center? What does it take? 

– I believe it is early to say. Whether we need it, I can’t answer that. It all depends on how the system of payments in Russian rubles will develop. If the ruble proves to be in demand as a payment currency on the global hydrocarbons market, it is one scenario. If not, it is another.

– Perhaps, we can solve this by creating a completely new currency? 

– If we want to use the ruble, Russia must strengthen its position in the global economy and restructure its economy. Being a commodity-based economy will not suffice.  

We need a different structure of the economy with a different added value. Yes, it is possible but it takes effort.

Inventing quasi-currencies is often nothing more than political ambition as they are not popular on the market due to transaction cost issues. Would businesses bother? Probably not, because it is often costlier. Why multiply the costs of foreign currency accounts or hedging foreign currency risks and so on when you can take a familiar path?

– How many years will it take to achieve polycentricity? 

– Ten to fifteen years. Polycentricity will come after economies’ shares in the world economy change – and in the way we expect them to change in the current circumstances. Meanwhile, the economic progress criteria will start changing fast as well. GDP is not the only indicator as other criteria are shaping for developed economies.

Interestingly, financial and currency polycentricity will also depend on how and what countries will dominate in the markets of specific technologies. A national currency is always a means of technological communication with one’s partners. It is not enough to say “I refuse to sell my product to you for anything but rubles.” It is important to be selling a unique product that nobody else offers. Currently, our unique product is partly hydrocarbons but to a large extent, the oil and gas composition is something we have to trade – for how long, nobody knows.

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