Is the World Economy Actually De-dollarizing?
Dollar dominance refers to the disproportionate use of American dollars in the world economy, a condition which has prevailed since it overtook the British pound at the end of World War II. This means it is the most used currency for international trade and is used as a reserve currency by most nations, with central banks or treasuries holding dollars as part of their country’s formal foreign exchange reserves. Countries hold these reserves to weather economic shocks, pay for imports, service debts, and moderate the value of their own currencies. As of the end of 2022, the USD accounted for 58.36% (down slightly since the start of the century) of official foreign exchange reserves, followed by the Euro.
Yet, we are seeing a growing number of press articles and pundits ranting about the end of the U.S. dollar’s dominance, especially with the rise of Chinese and Russian bilateral agreements to trade in their own currencies — most recently with oil and gas. Therefore, is the USD dominance set to decline?
The short answer is yes, it is declining slightly — but no, its dominance will remain for the foreseeable future. The dollar’s role in international payments has never been stronger, according to the latest transaction data compiled by global financial messaging service Swift, which shows that 46% of all Swift FX transactions involved the dollar. This is up from roughly 33% a decade ago. The Euro’s share however has fallen to an all-time low, but still comes in second place. Meanwhile, the Yuan has exceeded 3% and is rising, but still far from being a globally dominant currency. Then there are other factors to consider, such as (I) common accounting practices using the USD which maintains stability when measuring the value of goods and services, (II) geopolitical risks associated with other currencies (e.g. Russia-Ukraine with a tumbling Rouble, China-Taiwan posing a long-term threat to Yuan trade), fuelling the low likelihood of private and public sectors in the West to take on foreign exchange at scale and (III) the U.S. economy and military remain amongst the largest and most influential, with a long enough track record of trust in the ability of the United States to pay its debts, to maintain the dollar as the most redeemable currency.
Also let us not forget the power of U.S. financial sanctions. The majority of international trade is conducted in U.S. dollars. Even trade among other countries can be subject to U.S. sanctions, because they are handled by correspondent banks with accounts at the Federal Reserve. By cutting off the ability to transact in dollars, the United States can make it difficult for those it blacklists to do business. A cornerstone of U.S. foreign policy, whether explicit or implicit, is to maintain the U.S. dollar’s dominance, and therefore they can weaponise USD sanctions on threats abroad, be it individuals, companies or central banks. For example, in the wake of the Russia’s invasion of Ukraine last year, U.S. sanctions cut Russia off from the dollar, freezing $300 billion in Russian central bank assets and triggering a default on the country’s sovereign debt. However, sanctions should be used cautiously as the U.S. does not want to overprescribe them, which could encourage other nations to turn towards using other currencies. Following the sanctions on Russia, an increasing number of countries, including U.S. partners such as India, have explored ways to continue trading with Russia that don’t involve the dollar. In most part this was to take advantage of discounted Russian oil and gas. Meanwhile, the Chinese renminbi has become the most-traded currency in Russia, bumping up its global share.
This month the BRICS furthered discussions around a common currency, although it was not part of the official summit agenda. This probably won’t happen. If anything, China would lead the implementation of a single unit of exchange and this would be the Yuan. However, China’s currency accounts for a very small portion of foreign exchange reserves, and their policymakers’ control over the exchange rate makes it unlikely to quickly gain traction amongst international players in favour of free markets. Furthermore, why would China, an output-ran country, want to appreciate their real exchange rate which would make their exports less competitive? India’s Foreign Secretary also expressed scepticism about the idea earlier this month.
Coordination amongst the vastly different and lesser developed BRICS economies is also a long shot. South Africa cannot even maintain a functioning electricity grid in its capital(s), Russia has scared away most multinational companies indefinitely due to high risks of doing business there blended with political turmoil and one of BRICS’ newest members, Argentina, has an inflation rate of 113%. Two of its newest members, Saudi Arabia and the UAE, are more promising candidates — although both of their currencies are currently pegged to the USD.
There is simply no viable alternative to the dollar, for now… Arguably, the biggest threat to the USD dominance is actually the United States itself, namely the uncertain future of its monetary policy, political system, foreign policy and ballooning national debt.
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