The US dollar’s decade-long dominance as a reserve currency, medium of exchange, or unit of account is threatened as more developing countries clamour for de-dollarisation. This increasing de-dollarisation initiative pushes for less dependency on the US dollar.
For decades, the US dollar has maintained its dominance in the global economy, with central banks, treasuries, and major corporations holding a substantial portion of their foreign exchange assets in US dollars. Traditionally, a nation’s currency value was determined by the assets it held. However, as a result of significant expenditures during the Cold War and Vietnam War, the US had a negative balance of payments crisis by 1970. Consequently, then-President Richard Nixon decided in 1971 to end the convertibility of the US dollar into gold, thereby removing it from the nation’s asset backing.
The value of the US dollar was now determined not by the assets held by the American government, but by its global demand. The US began printing more and more dollars to meet the need for the greenback after introducing “Petro Dollars.” Petrodollars are currency paid to nations that export oil in exchange for exports. The petrodollar arose as an economic notion in the 1970s, when rising US purchases of increasingly expensive crude oil boosted foreign producers’ dollar holdings. Many countries worldwide made transactions in US dollars because the US was the largest contributor to international organisations like the IMF and the World Bank.
For the past four decades, the US government has engaged in continuous money printing to meet the global demand for liquidity while also supporting domestic spending. As a result, the US dollar has emerged as the bedrock of the global "monetary and financial culture" that governs the world
— British Herald (@BritishHeraldUK) May 20, 2023
What is De-dollarisation?
De-dollarisation refers to the process of replacing the US dollar’s functions in international transactions, which include valuation, payment, and value storage. The US dollar is widely used in international transactions as a trade, investment, and reserve currency. When an economy takes measures to reduce its reliance on the US dollar in both international and domestic economic transactions, it can be seen as initiating the de-dollarisation process.
Emerging economies and developing nations have been taking steps to enhance regional and functional currency cooperation while limiting their usage of US dollars. This shift aims to mitigate exchange rate, debt, and asset risks associated with excessive dependence on the US dollar for settlement, valuation, and reserves. The de-dollarisation trend represents a significant moment with far-reaching implications for global trade, investment, and monetary policy.
This is the first time in the history that the Chinese Yuan has outpaced U.S Dollar in the cross border transactions deals.
— Financial Summit (@FinSummit) May 19, 2023
What is next for the U.S. Dollar? pic.twitter.com/P0c9SaFkDv
Weaponisation of Reserve Currency
The US dollar is the most widely used reserve currency in the world. Analysts predict that deploying it as a financial weapon will lead to many countries diversifying their investments in alternative currencies. Zongyuan Zoe Liu, a fellow for international political economics at the Council on Foreign Relations, warned, “The more we use it [USD], the more other countries are going to diversify due to geopolitical reasons.”
Sanctions imposed by Western nations following Russia’s invasion of Ukraine resulted in the exclusion of several major Russian financial institutions from the dollar-denominated Swift financial messaging service. When the US withdrew from the Iran nuclear deal in 2018 and immediately isolated the nation from the global financial system, the EU opposed similar actions.
According to French Finance Minister Bruno Le Maire, ex-US President Donald Trump’s efforts in 2018 to coerce Europe into embracing US foreign policy on Iran resulted in a serious backlash from EU companies and politicians, particularly supporters of a more autonomous European foreign policy. Meanwhile, French Foreign Minister Jean-Yves Le Drian has previously condemned the US’ extraterritorial sanctions, stating that European businesses should not be forced to pay for US foreign policy decisions.
Analysing how sanctions are weaponising the US dollar, Reuters referred to a 2022 report released by Bank of America analysts, led by Michael Hartnett, noting that “US dollar debasement (is the) ultimate outcome as dollar weaponised in the new era of sanctions.”
Russia has been lowering its dollar holdings since Western sanctions were imposed following Moscow’s annexation of Crimea in 2014. Russia declared in 2021 that it would sell all US dollar assets in its National Wealth Fund and increase holdings in euros, Chinese yuan, and gold.
US Treasury Secretary Janet Yellen acknowledged that “there is a risk when we use financial sanctions that are linked to the role of the dollar...that over time it could undermine the hegemony of the dollar.”
Though the dollar is unlikely to be replaced as the world’s reserve currency anytime soon, any sustained trend away from the greenback may result in a more fragmented global economy, in which payments are more evenly distributed across currencies such as the dollar, euro, and yuan.
5 Countries Are Ditching the US Dollar#TRENDS #knowledge #infographic #US_Dollar #Chinese_yuan pic.twitter.com/4rKH12HIm2
— TRENDS Research & Advisory (@TrendsRA) May 22, 2023
Concerns of de-dollarisation recently emerged due to geopolitical conflicts that may support other currencies, such as the euro, the Chinese yuan, or even a planned unified currency among the so-called BRICS nations — Brazil, Russia, India, China, and South Africa.
Similarly, ASEAN’s finance ministers and central bank governors met in Bali, Indonesia, at the end of March and resolved to strengthen the region’s usage of local currencies and minimise reliance on the US dollar or other major international currencies for cross-border trade and investment.
The BRICS countries are working on developing a unified currency to minimise their dependency on the US dollar; its leaders intend to discuss this issue at the upcoming leaders’ summit in South Africa.
The US has imposed severe financial and economic sanctions on Iran and Russia, limiting their ability to utilise US currency. Iran, Russia, and other nations have started the process of de-dollarisation. There are also more emergent bilateral and international non-US dollar currency settlement agreements.
For instance, Russia began exploring options for ruble-based payment for energy supply. Additionally, Bangladesh, Kazakhstan, and Laos were intensifying talks with China to increase the use of the yuan. Whereas, India has begun asserting the rupee’s internationalisation and, only last month, began negotiating a bilateral payment arrangement with the UAE, Malaysia and Nigeria.
Emerging Use of Chinese Yuan
China has maintained one of the world’s highest economic growth rates for more than a quarter-century and over 800 million people were lifted out of poverty in just a few decades. It has the second-biggest economy after the US based on market exchange rates, and the world’s largest economy based on purchasing power. The yuan is presently the world’s fifth most traded currency.
Russia increased its trade with China as it was isolated from international financial markets. Russia began receiving payments in yuan for coal and gas, and Moscow raised its yuan holdings in foreign currency reserves. According to Bloomberg, the yuan is currently Russia’s most traded currency.
As Russia’s use of the yuan increased, other nations observed and acknowledged an opportunity to reduce their own reliance on the dollar. France is willing to accept yuan payment for liquefied natural gas purchased from China’s state-owned oil business. A Brazilian bank operated by a Chinese state bank has become the first in Latin America to participate directly in the Cross-Border Interbank Payment System (CIPS), China’s payment system.
Chinese banks are increasing their efforts to promote the yuan’s international use. They are reporting a rise in cross-border yuan activity due to the country’s booming trade with Russia and ties with the Middle East.
According to official figures, the yuan surpassed the dollar as the most frequently used currency for cross-border transactions in China in March. Based on Reuters calculations using statistics from the State Administration of Foreign Exchange, yuan cross-border transfers and receipts reached a record $549.9 billion in March, up from $434.5 billion the previous month.
'70% of cross-border settlements between Russia and China are already conducted in national currencies – rubles and yuan' - Russian Prime Minister Mikhail Mishustin https://t.co/JtFmVioj36 pic.twitter.com/iStK4RZDPk
— RT (@RT_com) May 25, 2023
Russia: Given the market volatility, Russia ceased purchasing foreign money in late January 2022. The following month, Moscow was subjected to severe Western sanctions after invading Ukraine and suspended its currency intervention programme. By June 2022, a global task force led by the US had frozen nearly $300 billion in assets held by Russia’s Central Bank.
Russia resumed its currency intervention programme in January this year, starting with the yuan. Russia’s intended purchase of the Chinese currency would be reversing its yuan sales from reserves to finance its budget deficit, which hit $29 billion in the first quarter of 2023.
China Construction Bank and Agricultural Bank of China (AgBank) stated total assets at their Moscow subsidiaries increased 3.3 times and 1.4 times, respectively, in 2022, despite Russia being severely sanctioned by the West.
Brazil: In 2019, China and Brazil agreed to use their respective national currencies in bilateral trade. Last month, both countries agreed to increase bilateral trade and lessen reliance on the US currency. The agreement calls for using the Chinese yuan and the Brazilian real instead of the US dollar in trade transactions.
Bangladesh: Bangladesh will pay its pending payments to Russia in Chinese yuan rather than dollars. It was announced that Dhaka would pay Moscow $110 million in Chinese yuan for the currently under-construction Rooppur power project.
Bangladesh will use a Chinese bank to settle its payments with Russia, most likely using its yuan reserves. Russian recipients will get payments through China’s CIPS, the yuan-driven alternative to the SWIFT system.
Argentina: Argentina’s government announced in April that it would begin paying for Chinese imports in yuan rather than dollars to replenish the nation’s depleting dollar reserves. It intends to pay around $1 billion in Chinese imports in yuan rather than dollars, followed by approximately $790 million in monthly purchases in yuan.
Chinese yuan surpasses the euro to become Brazil's second currency in foreign reserves, accounting for 5.37% of Brazilian central bank holdings at the end of 2022, comparing with the euro's 4.74% share, said the Central Bank of Brazil on Fri. pic.twitter.com/6Zin3RHwpx
— Global Times (@globaltimesnews) April 1, 2023
Middle East: In December, Chinese President Xi Jinping informed leaders of Middle Eastern countries that China would strive to purchase oil and gas in yuan. This move would help Beijing’s objective of internationalising the yuan and lessen the influence of the US dollar on world trade.
For example, Iran and China discussed extending the use of the yuan and the Iranian rial in bilateral trade in February 2023. According to Iranian Economy Minister Ehsan Khandouz, “The yuan already accounts for a considerable part of trade between the two sides. However, the process of using the Chinese currency needed to be eased, and the Central Bank of Iran is negotiating with the Chinese to address the issues.”
In February, Iraq’s central bank said it would enable trade with China to be settled directly in yuan for the first time to enhance access to foreign currency. The government’s economic adviser, Mudhir Salih, told Reuters, “It is the first time imports would be financed from China in yuan, as Iraqi imports from China have been financed in (US) dollars only.”
Saudi Arabia: The Export-Import Bank of China (China EximBank), a major Chinese policy bank, announced that it had made the first loan cooperation in yuan with Saudi National Bank, the largest Saudi Arabian bank. Such a move will make financial cooperation easier within the context of China’s Belt and Road Initiative (BRI).
China and Saudi Arabia have achieved significant success in developing synergy between their goals and pursuing bilateral cooperation in various fields in recent years. In 2022, Saudi Arabia remained the single largest oil supplier to China. Last year, bilateral trade reached $116 billion, a 33.1 percent increase over the previous year.
So, Will the Chinese Yuan Replace the US Dollar?
China’s development, combined with the potential of geopolitical alignment, has prompted some to speculate that the Chinese yuan could replace the US dollar as the world’s reserve currency. According to the Economist, China’s leaders seek to raise the yuan’s status as a reserve currency. Some analysts believe this is possible, given the size of China’s economy and the strength of its exports.
Meanwhile, predictions that the yuan will surpass the dollar remain on the downside. The current consensus is that while the balance of power between the yuan and the dollar will shift, it will not be decisive.
According to economist Peter C. Earle, de-dollarisation has begun as new trade agreements promote rivals, but the greenback will likely remain a worldwide currency. Earle added that despite the gains made by competitors, the dollar will likely continue to be a global currency.
The large scale of the US economy, the breadth of its economic links, and the significant obstacles to switching currencies would give rise to major transitions that might take decades. Earle rightly pointed out that the yuan is virtually pegged to the dollar, which makes it ill-suited to become the world’s global currency. Only a 2% range against a daily midpoint established by China’s central bank is permitted for yuan trading.
Stanford historian Niall Ferguson argues that the “inertia” of the global financial system proves that concerns about the yuan rapidly replacing the dollar are baseless.
The yuan would not even be the greatest danger to the dollar. If it ever comes to that, the widespread use of the European currency in worldwide trade is something to consider. Based on data from the Bank of International Settlements (BIS), the euro accounted for one side of 30% of all daily global transactions as of April 2022, surpassing China’s yuan, which was used in 7% of all transactions.
Additionally, it was stated in the BIS report, that the US continues to dominate the global foreign exchange market. An average daily turnover with the USD on one side of the exchange would be $6.6 trillion.
Thus, the dollar’s role remains paramount. The transparency of the US capital markets is its foundation, supported by the country’s military dominance and legal system. Hence, stability is the most significant reason for countries to be inclined towards using the dollar, and as long as Washington is able to maintain this, the dollar is going nowhere.
However, despite the analysis that the USD is unlikely to be devalued anytime soon, the US must consider the increasing de-dollarisation trends. Therefore, in the long term, the US should be concerned about concerted efforts to replace the dollar rather than remaining satisfied with the stability of the USD.