Currency Usage for Cross-Border Payments
Cross-border payments are at the heart of the international monetary system (IMS). They enable the exchange of goods and services between nations, the settlement of financial contracts between corporations across borders and the channeling of international aid. By facilitating cross-border transactions, the IMS is the backbone of globalization in trade and finance.
The currency configuration for cross-border payments is dominated by the U.S. dollar and the euro. While there are more than 150 currencies in the world that are deemed legal tender, cross-border payments mainly concentrate in a small number of currencies. As of end 2021, the U.S. dollar accounted for about 40 percent of cross-border Swift flows, followed closely by the euro. A few other currencies, the British pound, the Japanese yen, the Australian dollar, the Hong Kong dollar, and the Canadian dollar, also have a share of more than 1 percent. The Chinese renminbi (RMB), the only reserve currency issued by an emerging market,1 has also gained traction in recent years with its share rising to about 2.5 percent.
The payment landscape is closely interrelated with other facets of the IMS. Money performs three distinct functions, as a medium of exchange, a unit of account, and a store of value. The U.S. dollar usually plays a vehicle currency role in trade invoicing, pricing of financial assets, and central bank reserves.
This is because a currency’s role as a unit of account for invoicing decisions is complementary to its use as a safe store of value, and this complementarity can lead to the emergence of a single dominant currency in trade invoicing and global banking (Gopinath and Stein, 2021). The dominant currency paradigm has recently come to the forefront of policy debate, raising questions on the benefits of exchange rate flexibility for external adjustment (Gopinath et al, 2020; Adler et al, 2020).
Historically the IMS has undergone profound but slow transformations. In the past two hundred years, the IMS has transitioned from the sterling dominance under the gold standard in the pre-war period, to the coequal
status of the sterling and the U.S. dollar in the inter-war years, to the full dominance of the U.S. dollar, which was institutionalized under the Bretton Woods system and remained deeply entrenched after the Bretton Woods system broke down in 1973 (Eichengreen, 2008). More recently, the advent of the euro and the rise of China has spurred discussions on a potential multipolar system, where the U.S. dollar, euro, and the RMB would share the role of international currencies (Eichengreen, 2011, 2017; Subramanian, 2011; Prasad and Ye, 2012).
Recent technological and geopolitical changes may bring faster changes to the IMS. Historically the high degree of inertia of the IMS largely reflects the strong network effects and switching costs (Eichengreen, 2008).
These two factors could be significantly altered by the digital revolution and recent geo-political tensions. Digitalization could substantially reduce switching costs, increase currency competition, and promote the
internationalization of new currencies (Brunnermeier et al, 2019). Similarly, geo-political tensions may break down existing payment networks into separate blocs, weaken the incumbent advantage, and facilitate system
changes.