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The de-dollarisation debate has resurfaced prominently following recent natural gas agreements between France and China. Earlier, discussions at the 2023 BRICS summit in Johannesburg included the possibility of a new BRICS currency and greater reliance on local currencies for trade between member states. These two events indicate the growing de-dollarisation trend. This trend aims to reduce reliance on the dollar by diversifying reserves, using alternative trade currencies, and developing new financial systems. The strategy is to render US sanctions useless as a strategic foreign policy tool.
Trade structures, exchange rates, transaction efficiency, and commodity pricing are all being influenced by a combination of geopolitical anxieties, economic schemes, and market pressures. A deliberate, combined effort is underway to lessen global reliance on the U.S. dollar in commerce, finance, and reserves. De-dollarisation is a major factor in reshaping global trade.
How did the de-dollarisation originate?
The Bretton Woods Agreement of 1944 established the U.S. dollar as the world’s principal reserve currency. America’s powerful economy and the dollar’s special link to gold boosted global confidence in the currency. The U.S., however, left the gold standard in 1971. However, the dollar remained dominant because of its reliable reputation and the robust US economy.
Aware of the dollar’s global power, the United States used sanctions against Cuba, China and on the pretext of containing communism during the Cold War. After the Soviet Union’s fall, the USA became the sole hegemon. It misused the dollar’s power to pursue geopolitical ambitions. Sanctions were imposed on Russia, Venezuela, Iran, and other nations. Using the dollar as a weapon has spurred a global search for alternatives to the dollar in trade.
But the 21st century witnessed phenomenal economic growth of China and India. This transformed the global economic dynamic and boosted de-dollarisation’s momentum. China’s Belt and Road Initiative or BRI has increased yuan’s global use. China and Russia have expanded their bilateral trade using yuan and rubles. India is paying Russia for oil in rupees. Moreover, the BRICS countries (Brazil, Russia, India, China, and South Africa) are considering a shared currency or enhanced regional monetary systems to decrease their reliance on the US dollar.
Central banks of many countries are increasing their reserves by stockpiling assets like gold and SDRs, or Special Drawing Rights. SDRs are an international reserve asset created by the International Monetary Fund (IMF) to supplement its member countries’ official reserves. They can be exchanged among governments for freely usable currencies in times of need. The World Gold Council reported that several central banks purchased a record 1,136 tonnes of gold in 2022, motivated by geopolitical events and a desire to diversify away from the dollar.
What are the possible consequences of de-dollarisation?
De-dollarisation can help stabilise the exchange rates of countries that depend heavily on the dollar. They can reduce the effects of the dollar’s volatility by using local or other currencies in trade. Many are already doing it. For instance, ASEAN’s Local Currency Settlement Framework reduces reliance on the dollar, thus lessening the impact of U.S. monetary policy changes on trade.
China’s BRI seeks to stabilise the finances of participating nations by using the yuan in infrastructure projects, which reduces the risks of a volatile dollar. Consequently, the sharp appreciation of the dollar is less risky for BRI countries than for those facing economic distress.
While de-dollarisation presents benefits, challenges like increased transaction costs and complexities exist. Businesses and financial institutions must carefully manage exchange rates, conversion costs, and varying regulations when engaging in cross-border trade with multiple currencies. For instance, when Indian machinery is sold to a Brazilian importer with rupee payments, the exchange rate between the Real and Rupee impacts both parties. Hedging tools, currency swaps, and sophisticated financial systems can drive up expenses. Furthermore, nations with currencies lacking global liquidity might struggle to find trading partners willing to accept them.
Nonetheless, the long-term strategic advantages of lessening dollar dependence are worth the short-term costs, despite difficulties. Financial innovations, including blockchain payments and regional clearinghouses, are created to make multi-currency trade settlements more efficient.
How will it impact commodity markets?
A reduced reliance on the US dollar can have a significant impact on commodity markets, especially for oil, natural gas, and metals, which are mostly priced in USD. The acceptance of alternative currencies by major oil producers could disrupt global dollar demand and pricing. Presently, the petrodollar system strengthens the dollar’s global power.
China and Saudi Arabia arrived at a yuan-based pricing in the 2023 oil deal. Successful implementation of these agreements may undermine the petrodollar and increase the yuan’s international standing. If these changes become widespread, demand for dollar reserves will fall, resulting in a weaker dollar. Sanctioned countries, including Russia, mostly use non-dollar methods for oil trading. But this shift from the dollar to regional currencies as the main pricing benchmark may fragment the commodity market.
Global payment currency rankings from SWIFT place the yuan fifth, ahead of the Canadian dollar and Swiss franc. The global use of the yuan for payments rose continuously, hitting 3.6% in 2023. The yuan’s international presence is larger thanks to China’s BRI. It provides infrastructure loans in yuan to countries in Asia, Africa, and the Middle East. Yet, the yuan’s rise to become the world’s primary currency faces substantial obstacles. China’s opaque financial system and strict capital controls make it less desirable. To internationalise the yuan, China should ease capital controls and foster market confidence, says Cornell professor Eswar Prasad.
Elsewhere, the Association of Southeast Asian Nations (ASEAN) promotes the use of local currencies for regional trade. The Local Currency Settlement (LCS) system is now in use in Malaysia, Thailand, and Indonesia, enabling direct transactions in local currencies.
Likewise, Brazil, Russia, India, China, and South Africa intend to decrease their reliance on the US dollar. With Western sanctions in place, Russia’s trade with China and India has expanded, using currencies like the ruble and rupee.
How will the dollar’s decline affect its share in global reserves?
The IMF reports a decline in the US dollar’s global reserve share, from approximately 71% in 1999 to around 58% in 2023. This downturn shows a wider pattern of nations spreading their reserves across various currencies (like euros, yuan, and yen) and assets (including gold). Russia and China hold substantially fewer US dollar reserves now. Russia’s central bank uses gold, euros, and yuan as reserves to counteract sanctions. China increased its gold holdings and diversified its currency holdings. Several nations use SDRs.
What challenges does the multipolar currency system face?
Although a multipolar financial system is emerging, alternative currencies still face many obstacles. Slowdowns in the Eurozone and Japan negatively impact the euro, yen, and other world currencies. A globally trusted, stable, and liquid currency is needed as a global reserve. The Bank for International Settlements states that the dollar accounts for approximately 90% of worldwide forex trading. Its power is derived from the trust of global investors, bolstered by the United States. It enjoys a stable Treasury market, a strong legal framework, and a resilient economy. Global investors turn to the dollar during crises such as the COVID-19 pandemic and the 2008 financial crisis because of its safe-haven status. Its key role in trading commodities such as oil and gold highlights its global financial importance. UC Berkeley’s Barry Eichengreen says no currency rivals the dollar in terms of trust, liquidity, and scale.
Creating financial systems for alternative currencies (including clearinghouses, payment systems, and regulations) requires collaboration and patience. While CIPS (Cross-Border Interbank Payment System) and SPFS (System for Transfer of Financial Messages) are alternatives to SWIFT, their global influence is limited. As you know, SWIFT stands for Society for Worldwide Interbank Financial Telecommunication. It is a global messaging network used by banks and financial institutions to securely transmit information and instructions through a standardised system of codes.
How will the trend of de-dollarisation pan out in the future?
Nations are increasingly pursuing economic sovereignty and sanctions resilience, fuelling the growth of de-dollarisation. In response to Western sanctions, Russia now uses rubles and yuan. China’s economic surge has dramatically sped up this change, as the yuan becomes more prominent in Asian, African, and Middle Eastern trade. Increased yuan-based lending has led to a 3.6% global payment share for the yuan in 2023, surpassing the Canadian and Swiss francs.
Motivated by strategic and economic factors, France and the European Union show growing support for de-dollarisation. President Macron emphasised Europe’s decreasing dependence on the US dollar as vital for strategic independence. Over-reliance on the U.S. dollar exposes them to unpredictable U.S. foreign policy. European leaders see diversification as both an economic and a geopolitical imperative. Through diverse currency reserves and new trade systems, the European Union hopes to become less vulnerable to changes in U.S. monetary policy. Global economic volatility stemming from dollar-dominated financial systems was dramatically exposed by the 2022 Federal Reserve rate hikes; widespread currency devaluation and higher import costs underscored the necessity of a more balanced approach.
Strategic BRICS partnerships provide the EU with added opportunities. By working with this growing economic bloc, France and its European partners can boost trade and investment ties with Africa and Asia. The growth of BRICS aligns with Europe’s aim for a global financial system that is more balanced and less dominated by the US dollar.
A multipolar global financial system is emerging, driven by growing de-dollarisation. Representing about 20% of global reserves (IMF), the euro continues to be a powerful alternative. The euro’s rise in energy and trade deals could seriously threaten the dollar’s leading position.
India’s UPI and China’s digital yuan showcase new ways to make payments locally and globally. The BRICS plan for a shared currency or better local currency exchange marks significant progress towards a more varied global financial system.
Yet, shifting from the dollar presents complexities. For a currency to be globally accepted, it must be trustworthy, liquid, stable, and financially transparent. Alternative currencies face major hurdles because of China’s capital controls and the Eurozone’s economic divisions. Although the dollar’s dominance continues, its power is expected to decline slowly, possibly leading to a fairer, more flexible global financial system that avoids any one currency’s total control.
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