There is a new fad for ‘De-Dollarization’ across the global south. This fad has been exasperated by ‘Russia-Ukraine’ war since there is a narrative going around in the global south that US/western Europe is responsible for Ukraine crisis and Russia is a victim of western hegemony. There are also plenty of agreements signed between Russia and other countries to trade with currencies other than dollars. There is also a narrative that since China de-coupled USA to become world factory, it can also successfully do the same with dollars by overthrowing it.
But how did Dollar become the dominant currency for trading and transactions?
For that, we need to rewind to ‘19th century’ when countries were struggling in order to find the solution to settle the trade balance, this is because many economies were opened-up to the world and trade between the countries increased. Increment in international trade between countries led to the need of settling this trade balance in a better possible manner.
Each country involved in the international trading had its own currency and was involved in printing unlimited currency for the purpose of trading which made settling the trade balance in the beginning of the 19th century difficult. Hence, all the countries agreed to trade with each other using ‘Gold’ in order to settle the trade transactions and this mode of exchange continued until World War — 1.
But when ‘WW-1’ broke out, many developed countries except USA suspended the use of gold to pay for their military expenses using paper money, which led to devaluation of the currencies and convertibility of the currencies to gold came down. This led to the disappearance of gold as a common medium for exchange or trading transactions which led to the collapse of ‘global financial system’. This is one of the many reasons why the ‘Great Economic Depression’ took place in the 1930s. At the same time, ‘US dollar’ which was still tied to gold overtook ‘British Pound’ to become world’s leading reserve currency.
The rise of the ‘Third Reich’ led to starting the World War — 2, during this time US sold weapons and supplies to many of its allies and it did so by collecting the payments through ‘Gold’, After the end of WW-2 the US had almost 65% of world’s gold reserve which had a huge leverage over other countries. To resolve this issue of international trade, almost 44 countries met in Bretton woods, New Hampshire in 1944 where it was decided that gold and world currencies would be pegged to US dollars.
The arrangement would maintain fixed exchange rates between their currencies and the dollar. In turn, the United States would redeem U.S. dollars for gold on demand.
As time passes, more and more countries started trading for gold using dollars, thereby dwindling the US stockpile which led to reserve banks worry about the stability of the US dollars. It was discovered that individuals were willing to accept money rather than gold — they had confidence in the currency. That’s the reason why on 15th Aug, 1971 US terminated convertibility of Dollar into Gold. Dollar now became the standard currency.
But in the absence of ‘Bretton woods system’, there was anxiety that countries may not use dollars as standard reserve currency for international trade. It was also when oil boom happened in oil rich arab countries which also had the ability of ‘currency bargaining chip’. USA then went to ‘Saudi Arabia’ and offered to buy oil and provide military aid and equipment but in return make their international oil sales in dollars only. After long negotiations, Saudis agreed to invest billions of petrodollar earnings back into US treasury and finance america’s spending, other oil rich arab countries followed saudi’s footsteps sometime after. This sealed US dollar’s fate which made it the dominant currency for transaction.
Currently:
- US dollars has $1.6 trillion in circulation.
- US dollars involved in 90% of forex trading.
- US dollars accounts for 40% of world’s debt.
What is de-dollarization?
De-dollarization refers to the country’s efforts to become less dependent on dollars, whether by using another currency to settle cross-border trade or diversifying reserves away from the dollar by turning to gold, the Chinese yuan, or bitcoin.
Why are countries seeking to de-dollarize?
Economic, Geopolitical and strategic constraints have forced other countries to de-dollarize, some of the factors are:
- Currency war: Countries in Europe are actively pursuing de-dollarization. The main objective is to establish the dominance of their currency, the euro. If successful, it would lead to establishing euro hegemony against dollar hegemony.
- Weaponization of USD: It refers to the American government’s exploitation of the currency’s global dominance to extend the extraterritorial reach of US law and policy.
- Stability of dollars: The debt to GDP ration of USA has reached 130% as of 2023 and experts say that it will rise to 145% by 2027. Many countries are losing trust on US dollars due to its high debt to GDP ratio and high inflation.
- Russia-Ukraine war: After Feb-2022 when Russia declared war on Ukraine, multiple western countries-imposed sanctions on Russia. As a consequence, countries which were dependent on Russia for trade and commerce agreed to use different currencies for trading so as to avoid sanctions.
What are the other alternatives countries are looking for?
Countries which were dependent on Russia for trade and commerce now seek to trade with different currencies so as to avoid sanctions from US:
- The volume of trade in yuan between China and Russia spiked after the start of Ukrainian war. Russia’s economy has been badly affected by the sanctions — some Russian banks have been banned from SWIFT, If there’s one country at the forefront of using the Chinese yuan for its transactions, it’s Russia.
- Brazil and Argentina struck a deal and have discussed the creation of a common currency for the two largest economies in South America.(Brazil and Argentina to discuss common currency | Reuters)
- For the first time in 48 years, Saudi Arabia said that the oil-rich nation is open to trading in currencies besides the U.S. dollar. (https://www.bloomberg.com/news/articles/2023-01-17/saudi-arabia-open-to-talks-on-trade-in-currencies-besides-dollar)
- The UAE and India are in talks to use rupees to trade non-oil commodities in a shift away from the dollar, according to Reuters. (https://www.reuters.com/markets/commodities/davos-2023-uae-india-discussing-settling-non-oil-trade-rupees-2023-01-19/)
Despite these movements, few expect to see the end of the dollar’s global sovereign status anytime soon.
Why is it difficult to de-dollarize?
De-dollarizing process is challenging for several reasons:
1: Petro-dollar system: The existence of Petro-dollar since 1970s has played a key-role in maintaining dollar hegemony. In this system, oil-rich countries agreed to trade oil using US dollar which led to countries around the world to buy oil in US dollar to buy oil and this created a surge in demand of the currency. The petrodollar applies not only to oil but to other things like gold, diamond, iron-ore etc. Even crypto-currency is pegged w.r.t dollar.
2: Omnipotent American Military Power: The US dollar’s hegemonic presence is closely linked to the military hegemony of the USA. The presence of military bases in 90+ countries facilitate and creates an environment where dollar is the acceptable currency for international transactions.
3: SWIFT payment system: The system where transactions which are made through a transitionary bank that allows you to send & receive electronic payments worldwide. This digital system replaced the earlier analog system where ‘TELEX’ was used and the particulars of the banks was sent manually that money is transferred from one account to another. But after the advent of SWIFT system, the automated messages give the transaction information to the international banks i.e. transfer of money from one bank located in random city in one country to another bank present in another country and when SWIFT sends the message in a high secured manner only then will the money be transferred.
Almost all of the international transactions are processed through SWIFT network and the primary settlement currency in SWIFT is ‘U.S Dollar’. When Banks and Corporates conduct cross-border payments, they mostly use SWIFT system which acts as a medium for settlement and messaging of the transactions.
The omnipresence of US dollar usage in SWIFT system buttresses its position as a dominant currency. If any country tries to exit from the SWIFT system, then it would be virtually impossible for that country to do international transactions. That particular country would lose access to remittances, trade settlements, and foreign fundings. It would further lose access to global financial system arrested its ability to attract FDI and conduct business with international partners. All of these may finally lead to currency devaluation and hamper the growth of the country.
4: Dominance of American financial institutions and treasury: America has some of the world’s largest and most dominant banking institutions and liquid government bond market in the world. These banking institutions play an important role in facilitating the international trade and transactions denominated in US dollars and the government bond market markets as a benchmark for global interest rates and is a safe haven for investors during times of market uncertainty. The demand for treasury securities drives demand for US dollar and thereby magnifies its hegemony.
5: Confidence and trust in US dollar: The US has one of the largest economies (in terms of absolute GDP and GDP-PPP) in the world, the size and relative stability of the American economy contributes to its confidence. The global perception of dollar being a reliable currency and lack of similar perception on other currencies (like renminbi and ruble) makes de-dollarization process difficult.
There has been attempt to de-dollarize in the past as well, For example; In 2012, Iran had agreed to trade oil with Chinese yuan. (https://www.reuters.com/article/iran-china-oil-idINL5E8G7F2Q20120508/ (From 2012)), in order to chip away from dollar.
There were a lot of predictions that chinese yuan will beat US dollar to become the world’s most circulating currency. In fact, even way back in 2004 there were predictions of disappearing dollars. (https://www.economist.com/leaders/2004/12/02/the-disappearing-dollar)
The clip below is from 1975:
But many years on, dollar still plays a important role in international market.
Here is the graph which shows the different currencies used for international payments in 2013 & 2014:
Source: https://www.wsj.com/articles/yuan-is-worlds-fifth-payments-currency-1422431603
Here is the graph which shows the different currencies used for international payments in 2023:
Source: https://coinchapter.com/chinese-yuan-beats-euro-in-swift-global-payments-share/
From observing both the graph we find that:
- USD share of global payment increased from 44.6% to 48.03%.
- Chinese yuan share of global payment increased from 2.2% to 3.4%.
USD’s share of global payment increased much more than Chinese yuan did.
Here is the overall figure of U.S Dollar share in global economy from 2012 to 2022/23:
Source: U.S. Dollar Defends Role As Global Currency [Infographic] (forbes.com)
Except in official FX reserves, the U.S dollar’s share has increased in all other 2 international transactions. So the speculations that US dollar would lose out was false.
As for the question that whether chinese yuan would beat U.S dollar in global payment currency and world’s reserve currency then the chances for that is less as well as explained by the economists themselves:
China doesn’t want to liberalize its currency and allow money to move freely in and out of its economy: Even though China appears keen to upset the global dominance of the US, it only wants to do so on Beijing’s terms, says Rory Green, the chief China economist. The People’s Bank of China has moved cautiously over the past decade to promote greater use of yuan without disrupting financial security and it’s unlikely to upset that dynamic now. This stability is maintained through the use of capital controls — a grip on how much foreign money can move in and out of China’s economy, which in turn influences the foreign currency exchange rate. Because of these controls, “Beijing can never fully liberalize its current account, but it can still pursue RMB internationalization,” Green added, referring to the yuan by its official name, the renminbi.
China doesn’t want to and cannot afford to run a persistent deficit like the US does: The US dollar’s position and clout as a reserve currency comes at a cost — a current account deficit for America. That’s because there’s more global demand for US dollars than American demand for imports, which are also being paid for in the greenback. So, the US will need to contend with ever larger amounts of deficit in order to maintain its reserve currency position. In 2009, the US has been running larger budget and current account deficits than most other countries simply because it’s the issuer of the world’s principal reserve currency. While China is the world’s second-largest economy right now, it just cannot afford to run a persistent deficit like the US, said Green. “China is politically unwilling and economically unable — barring significant structural reform — to run a sustained current account deficit and to provide sufficient supplies of RMB assets globally,” wrote Green.
Beijing faces many geopolitical risks, so China needs alternative assets: One key challenge for any currency taking on the US dollar as the world’s dominant reserve currency is the greenback’s dominance. Right now, even the euro’s role is larger than the yuan. This means there’s a lack of wide-ranging choices when it comes to reserve assets — which is a problem for the Chinese central bank, wrote TS Lombard’s Green. Given these issues, it’s unlikely for the yuan to overtake the greenback, said Green.
Owing to all these reasons, it would be difficult for yuan or any other currency (except euro) to beat U.S dollar and become the global currency.
References:
https://www.stordahlcap.com/insights/de-dollarization-5-reasons-why-it-wont-happen-anytime-soon
BRICS Raging Against the Dollar Is an Exercise in Futility — Bloomberg
Dollar bears bide their time as US economic strength persists | Reuters
Analysis: China’s yuan may slip further to aid economic recovery — analysts | Reuters
Bangladesh struggling to pay for fuel due to dollar shortage, letters show | Reuters
Why the dollar keeps winning in the global economy | Reuters
Threats to the dollar’s dominance are overblown | Financial Times (ft.com)
https://www.livemint.com/market/dedollarisation-the-eroding-dominance-of-the-us-dollar-11689403313340.html
https://watcher.guru/news/brics-plans-to-dethrone-u-s-dollar-fizzles-out
https://www.cnbctv18.com/views/bottomline-should-indian-equity-investors-be-cheering-the-fall-in-the-dollar-17233841.htm
https://www.livemint.com/opinion/online-views/long-live-the-slowly-dying-and-unlamented-us-dollar-11689605017905.html
