De-Dollarization, it’s a term we frequently hear about in the news these days. In March of this year, Fareed Zakaria, a well-noted IR specialist and foreign policy expert noted that, as the US dollar supremacy fades away, the US will face an era of reckoning. This comes against the backdrop of countries slowly shifting away from the US-Dollar.
Just recently, Brazilian President Lula da Silva sparked the debate again, asking why countries could not trade in currencies other than the US-Dollar. This concern was echoed by many other countries, particularly in the developing world. Subsequently, the shift away from the dollar is now gaining pace. Countries from across the world, led by BRICS nations, continue to call for trade in other currencies, contributing to the increasing number of countries that found another medium for their trade. There are several reasons for such a trend.
The Russian invasion of Ukraine was an immediate trigger, although the slow shift has been occurring for a while. The freezing of Russian Central Bank assets has not sat well with many countries, who fear that they might be targeted next. The US has been accused of weaponizing the dollar and punishing its adversaries through their economic dominance. The rise of China and the gradient shift to bipolarity or multipolarity might be the second factor to explain why countries want to ditch the dollar. But the obvious question is: if the dollar declines, which currency will take over? Will we have hundreds of currencies in circulation? Moreover, do countries want to trade in their own currency? If that is the case, it will be an economic nightmare.
In the last year, the talks between India and Russia about the ruble-rupee exchange rate reached a deadlock, as neither country could move forward. India has been buying Russian oil in Indian rupees. This export increased last year, leading Russia to have a huge trade surplus with India and extensive reserves of Indian rupees. However, due to sanctions and restrictions, Moscow could not use the newfound money. Trade between these two countries is now running into difficulty as neither side has a solution to end the stalemate. Proposals have been raised to use the Chinese yuan or UAE dirham as an alternative medium of exchange.
Many have floated the idea of the Chinese yuan as a replacement for the US dollar, with clear geopolitical implications attached. Other big players, like India, would definitely not like to trade in the Chinese yuan. And many countries worldwide are also skeptical about the actual stability of the Chinese currency. The Chinese Central Bank is not free, as it is in the US, because it is subject to capital controls. Furthermore, China has been accused multiple times of currency manipulation — deflating the currency to make exports cheaper and more competitive. These manipulations have been called out numerous times, leading to distrust towards the yuan. With that being said, why does the world use the US dollar? Apart from political pressure, it is because the US financial markets are flexible and well-governed. It is, first and foremost, the trust factor which aids the US dollar.
The other important question we need to ask is whether the Chinese really want the Chinese yuan to be a global currency? Economically, supplying the global
currency comes at a heavy price. The US dollar, being such, absorbs most of the massive economic implications that the world with a high trade and savings imbalance brings. Crises in various, even very distant, parts of the world impacts the domestic economy of the US. If the yuan takes the dollar’s place, China will see similar implications for its own economy. In short, the Yuan will be more vulnerable and China will find itself a victim of the impossible trinity, namely it will be impossible for it to have a fixed exchange rate and independent monetary policy if it allows for the free movement of money. This is the risk China does not want to take. So, it is no surprise that today China still remains one of the main benefactors of the US system as it holds a huge trade surplus with the US. Chinese exports constitute 19% of its GDP. If it allows its currency to appreciate, it will have a dampening impact on Chinese exports, since they will be more expensive and less competitive. For a country that is dependent on exports, China is better positioned with the status quo. Therefore, it makes economic sense for China to avoid having the Chinese yuan as the global currency. It might not be happy with the US-dominated system, but it would rather have that than the Chinese yuan as the globally circulating medium of exchange.
The doomsday for the US dollar is not in the near future. As displayed by the case of India and Russia, the rupee-ruble mechanism has clearly failed. We will see more of this as countries slowly realize that it is not so easy to overthrow or bypass the US dollar. The dollar is ingrained in our financial systems. Other currencies might be used for bilateral trade, but expanding it to multilateral trade is not yet on the table for the foreseeable future. For example, the probability of Tanzania using the Chinese yuan to trade with Ethiopia is currently quite remote.
On the other hand, establishing other currencies internationally also takes time. However, since geopolitical conditions have changed, some countries may be willing to take risks when trading with non-dollar currencies. One solution is to conduct bilateral trade in non-dollar currencies, which might have a spill-over effect and eventually undermine the dollar’s supremacy. In the future, countries may find ways to trade without using the US dollar.
Ultimately, the dominance of the US dollar comes from the trust it has built up and the US’ willingness to bear the costs and risks of supplying the global currency. People trust the US and its financial markets more than state-controlled Chinese markets, and the US has a weighty responsibility to hold on to this trust. However, for many countries, geopolitical considerations trump economics. If this is the case, the future will be keenly examined. That being said, the lack of clear alternatives keeps the dollar at the top.
So is the era of reckoning near? Geopolitical trends could possibly change the era of US dollar hegemony, but for now, the dollar is still the king.
Written by Adithyan Puthen Veettil; Edited by Viktor Kharyton
Photo credit to: Eric Prouzet, Unsplash