The challenges have been increasing as support for the US dollar has been declining with the rise of China as a stronger economic power. This article focuses on globalization in a new context and takes a closer look at the reshaping of the global financial system.
Globalization has basically reshaped the activities of economic powerhouses, such as the European Union and the United States of America. As a result, the financial systems of developed economies have changed with the current global financial flow. Emerging and developing economies are increasingly contributing to changes in global economic growth. This clearly indicates that these growing economies have a larger share now in global economic trade activities.
International trade expansion has been accompanied by an increase in foreign assets. It indicates that the interest of major economies has grown in promoting of global trade in order to increase the money supply (Fig 1). Therefore, an increase in international trade and investments has resulted in a focus on certain currencies. The US dollar still plays a pivotal role, with the Euro in second place.
This is the main reason why the US and several other Western countries have been using this power platform to impose trade sanctions on some countries. The rate of sanctions via this currency payment system has been increasing, which has led to several other countries around the world to establish other own payment systems to evade such economic sanctions. Some countries having bilateral payment networks have begun to accept their partner currencies or have even set up alternate payment systems to replace the global SWIFT payment system. China's Cross-Border Interbank Payment System (CIPS) is one such example.
Weakening US dollar
The world is currently experiencing several rapid changes, including a weaker lead role in globalization by advanced economies, the rise of China as a superpower, and the increasing intensity of sanctions in the current monetary system. One may wonder whether the confidence of countries participating in global trade and investment activities will ever decline in the current US dollar-based monetary system.
Monetary systems used by countries participating in international trade should be considered based on two aspects, market size and thickness. As the monetary system has become weaponized because of the Russia-Ukraine conflict, China and Saudi Arabia are becoming more wary of participating in the SWIFT payment system. Zhou Xiaochuan, former Governor of the People's Bank of China, has spoken of the risks for China and called for an increased use of the yuan globally through the CIPS system, but the transaction value is only 1% compared with the SWIFT system.
A currency system chosen for international payments must satisfy the high funding needs of international financial institutions during a financial crisis. The US Federal Reserve (FED) has launched two programs in response to the shortage of payment currencies, the 2008 global recession and the Covid-19 pandemic in March 2020. The value of these transactions is huge, and worth USD 585 bn during the 2008 crisis and USD 450 bn during the Covid-19 pandemic. The Euro is also widely used in international payments but is not as widely used for currency exchange as the US dollar. For this reason, the US dollar is used as a means of payment rather than a currency for direct payments between countries, as China has asked for.
Gita Gopinath and Jeremy Stein described another feedback loop related to pricing. Lots of commodities are priced in US dollars, causing US dollar assets to have relatively predictable purchasing power. This underpins demand for these assets, thereby making it somewhat less costly to take loans in US dollars than loans in other currencies. Cheaper loans in US dollars will give businesses an incentive to limit risk in debts through product pricing in US dollars.
An important issue when choosing a currency for international payments is how developed the debt market is for that currency. When the Euro came into existence, it paved the way for the development of a debt market in competition with the US dollar, but after the debt crisis, big concerns about default caused Euro bonds issued by the European Union to become divergent. This is to say that there is no longer a Euro bond market to compete with the US bond market.