Exchange rates:

The future of the currency system

First, let's delve into the history of the currency system development.

Initially, the British pound sterling served as the reserve currency, playing a dominant role in international settlements at the time. However, at the end of World War II, the global community began to reorganize the old financial system.

The Bretton Woods Conference of 1944 played a key role in this update, where the decision was made to use the US dollar alongside the pound sterling as an international payment and reserve currency. As we already know from history, soon the US dollar took on a dominant position in international settlements.

In addition to the obvious preferences for the US currency, within the United Nations (UN), structures such as the World Bank and the International Monetary Fund (IMF) were created, which are currently the largest financial organizations in the world.

The World Bank is a shareholder-owned corporation with 188 member countries. The bank provides loans only to poor countries, while the IMF can provide loans to any of its member countries.

According to the original concept, the value of gold was strictly fixed, the US dollar was backed by gold, and other world currencies were backed by the dollar.

However, on August 15, 1971, US President Richard Nixon unilaterally announced the decision to abandon the Bretton Woods agreements, specifically the cancellation of the free convertibility of the dollar into gold. Thus, the US abandoned the gold standard that had been in existence for two centuries (1717-1944).

After the decision to adopt a de facto floating exchange rate for gold, fluctuations in exchange rates inevitably arose among other currencies. At some point, this gave rise to a new sphere of activity for that time - currency trading, and since then the exchange rate has depended on market demand and supply.

And what about today?

The modern international currency system was adopted shortly after the US unilaterally abandoned the gold standard, in Jamaica on January 8, 1976. Today, currency exchange rates are determined not by states but by the open market.

The foreign exchange market (also known as Forex, from Foreign Exchange) is a system of stable economic and organizational relations for conducting transactions involving the purchase or sale of foreign currency and foreign payment documents.

The Jamaican financial system was formed in 1976-1978 as a result of the reorganization of the Bretton Woods currency system.

Its main features and principles are:

  • The gold standard and gold parities were officially abolished.
  • The demonetization of gold was established: gold can be purchased as an ordinary commodity at market prices.
  • The Special Drawing Rights (SDR) system was introduced, with the IMF issuing these special rights.
  • In addition to SDR, the US dollar, British pound sterling, Swiss franc, Japanese yen, German mark, and French franc (the latter two transformed into the euro) were officially recognized as reserve currencies.
  • A regime of freely floating exchange rates was established, with their quotations formed on the foreign exchange market based on supply and demand.
  • States can independently determine the regime for forming exchange rates: freely floating or rigidly pegged to any reserve currency.

A reserve currency is a globally recognized national currency that is accumulated by central banks of other countries in their currency reserves. It serves as an investment asset and serves as a means of determining currency parity.

Currently, the reserve currencies are considered to be the US dollar, the euro, the Japanese yen, and the British pound sterling. Sometimes the list is expanded to include the Swiss franc, the Canadian dollar, the Chinese yuan, and the Australian dollar.

As already mentioned, there are currently two main types of currencies in the world. The first type is rigidly tied to the value of another currency (or a basket of currencies), while the second type freely trades on exchanges. The second type of currency predominates in the world.

Interestingly, with this change, central banks have acquired a function in addition to the initial management of a country's reserves, namely ensuring exchange rate stability. To achieve these objectives, both direct currency interventions and indirect influence can be employed, such as regulating the refinancing rate or reserve requirements.

In most cases, interventions involve mass purchases or sales of currency in the futures market.

What comes next?

Amidst the crisis caused by the COVID-19 pandemic, which has affected the global economy, economists have once again raised the question of the active need for the emergence of alternative reserve currencies. Additionally, due to the recession in the United States, there has been a renewed global movement towards de-dollarization. Experts from many countries want to replace the US dollar in international settlements.

There is also a natural shift away from the dollar in favor of national currencies. For example, Russia and India have agreed to conduct trade operations in rupees and yuan, and cross-border trade with China also takes place in yuan and rubles. According to the Bank for International Settlements data, over the past 20 years, the share of the US currency in global reserves has decreased from 70% to 60%.

However, despite all of this, the dollar continues to maintain its dominant position as the global currency. In the coming years, or even decades, it will be challenging to replace the US currency with something else. The American currency is used in settlements for practically all export goods, and therefore, it also has the status of a technical unit for international settlements. Consequently, one of the first stages of currency system renewal should be the abandonment of the dollar in international assessments.

What alternatives are there?

For any currency to compete with the dollar for the title of a global currency, the economy of that country must approach the American economy in terms of diversification and competitiveness in the global market. Currently, only the euro meets these criteria among existing currencies.

But in the autumn of 2022, the BRICS countries announced plans to create their own currency for international trade instead of the dollar. And on January 18 representatives of South Africa confirmed the BRICS' desire to replace the dollar in international settlements:

"We have always been concerned about the dominance of the dollar, and we need to seek an alternative to it. This is one of the reasons why we created the New Development Bank of BRICS," said South African Minister of Foreign Affairs Naledi Pandor.

It is expected that the new currency will be based on a basket of currencies from all BRICS member countries, either in proportion to GDP or export volumes. It will also be a supranational currency, meaning it will not replace national currencies as it happened in the European Union, but will coexist alongside the national currencies of the participating countries.

Interesting fact: all the currencies of the BRICS countries start with the letter "R": the Brazilian real, the Russian ruble, the Indian rupee, the South African rand, and the Chinese yuan, also known as "renminbi."

Today, the BRICS countries represent almost half of the world's population and a quarter of the global GDP. Therefore, if this project is realized, the new currency will have significant chances to challenge the hegemony of the US dollar. Initially, such a currency could be used as a reserve currency, and then countries would transition to direct trade using it.

In addition to the mentioned currencies, cryptocurrencies are worth noting in this context.

Their emergence was planned as a "revolution in the financial system." After all, they mostly do not depend directly on central banks or specific companies. Modern cryptocurrencies have become similar to traditional money in many ways. However, for bitcoin, for example, to become a reliable benchmark of value, it still needs to go through a long process of stabilizing its exchange rate and gaining acceptance from global financial institutions.

Interestingly, some projects are already actively used as an international means of transferring value. For example, the Ripple platform (partially a cryptocurrency project) is actively used by banks in Asian and Oceanic countries for cross-border transfers.

Many projects are also in the development stage. For instance, experts from RACIB recently announced plans to create a "Persian Region Token" for settlements between Russia and Iran. It is expected to be backed by gold and thus become a reliable instrument for digital transactions.

However, despite all this, global financial authorities believe that decentralized payment systems are not yet ready to replace cash and traditional national currencies due to potential financial and economic instability in the absence of regulators and censors for illicit transactions.

In any case, any similar projects always contribute to economic development, regardless of actual results. Therefore, it is important for new ideas to emerge, new organizations to be born, and economists from all countries to continue improving the current financial system. What this will lead to, we will certainly find out soon.

© – , updated 06/27/2023
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