De-dollarization has recently become a hot topic, with countries worldwide exploring new economic and trade agreements to reduce their reliance on the US dollar. Former President Donald Trump warned that China is attempting to replace the Dollar with its RMB as the world’s primary currency. While Trump’s comments were aimed at attacking political rivals, they are not without merit. Even the U.S. Treasury Secretary Janet Yellen admitted in an interview on 16 April that imposing economic sanctions on Russia could undermine the US dollar’s dominance.
So, where does the de-dollarization trend come from, and how will it impact the global economy?
Reasons Behind the Rapid Shift Away from the US Dollar
According to a recent report by renowned fund manager Stephen Jen from Eurizon SLJ Capital and his colleague Joana Freire, the dollar’s share of global reserves has declined 10x times faster than the average over the past 20 years. The dollar now accounts for about 58% percent of total official global foreign exchange reserves, down from 73% percent in 2001.
The decline in the US dollar’s global reserve market share in 2022 is primarily due to tough Western sanctions on Russia, which have shocked emerging economies that hold large amounts of US dollars.
Another reason behind de-dollarization is the United States’ aggressive interest rate hikes. The Federal Reserve began rapidly raising interest rates last year to combat severe inflation, leading to a stronger dollar and putting pressure on other currencies. This has resulted in capital outflows and forced other countries to follow suit with rate hikes, affecting overall market stability.
Consequently, countries are considering de-dollarization to reduce their reliance on the dollar and mitigate the macroeconomic issues caused by its appreciation and fluctuations.
The Waves of De-Dollarization in 2023
While it’s too early to say if de-dollarization is happening, countries worldwide are taking steps to reduce their reliance on the US dollar in international trade. Here are some recent examples in 2023:
- China’s CNOOC and France’s TotalEnergies completed their first cross-border RMB settlement of a liquefied natural gas (LNG) transaction.
- Saudi Arabia, a traditional US ally in the Middle East, announced its decision to join the Shanghai Cooperation Organization, signaling a shift in the region’s balance of power.
- Brazil and Argentina announced plans to establish a common currency called the “SUR” (meaning “south”), which could become the world’s second-largest currency union after the euro.
- Brazil agreed to settle trade with China using their local currencies, a move that is seen as an essential step in Beijing’s push to internationalize the RMB and challenge the dollar’s status.
- Bangladesh and Russia agreed to use the RMB to pay for the construction of the Rooppur Nuclear Power Plant.
- Finance ministers and central bank governors from ASEAN countries discussed reducing their reliance on major currencies like the dollar, euro, yen, and pound.
The Long Road to Challenging the Dollar’s Dominance
Despite these developments, the US dollar has been the dominant currency in international finance and trade for nearly a century, and dethroning it will be no easy feat. The lack of viable alternatives, the high costs of transitioning, and the political and economic influence of the United States are all factors that could hinder the process of de-dollarization.
The Lack of Viable Alternatives
The euro and the RMB are often considered potential replacements for the US dollar, but neither currently matches the dollar regarding global acceptance, liquidity, or stability. As a result, it does not appear that any currency in the world can fully replace the US dollar at this time.
High Transition Costs
De-dollarization involves massive repricing of assets, which could be costly and time-consuming for governments and businesses. Trade relationships between countries may be disrupted or severed during the transition, leading to increased short-term trading costs, heightened local currency volatility, and friction with trading partners.
The US’s Political and Economic Influence
Since World War II, the United States has played a significant role in global affairs. Any move towards de-dollarization could potentially affect its interests or face political and economic pressure from the country.
The United States political influence is not necessarily oppressive. The stability and liquidity of the US dollar have contributed to the economic prosperity of many emerging economies. The use of the dollar for settlements has real economic benefits. Concerns about the stability and potential devaluation of their own currencies may make governments hesitant to adopt their domestic currencies fully in international trade.
A Lengthy Process
DBS Group Senior Economist Ma Tieying commented that the RMB has a long way to go to challenge the status of the US dollar. One critical factor depends on whether China fully opens its capital account and allows the yuan to be freely convertible. Ma said the process of de-dollarization is very lengthy, even though the RMB’s share in global payment settlements is increasing. A fully open Chinese capital account and a freely convertible yuan are necessary for investors to hold the currency. Ultimately, the situation largely depends on the openness of China’s capital account and the yuan’s free convertibility reform.
