The de-dollarization of the global economy has been a burning issue since the beginning of this year, making it the subject of a great deal of debate among financial players.
The subject itself is nothing new, but there has been a sharp upsurge of interest in it since the beginning of the year, as demonstrated by the 600% increase in discussions about the dollar’s future on platforms like Twitter and Reddit in Q1 2023. So what’s stoking the uncertainty around the dollar’s status as the global reserve currency? There are two main factors:
- The sharp depreciation of the dollar since last autumn (-12%), which is part of an environment where banking turmoil and the risk of default on the sovereign debt of the United States are intertwined, and
- The proliferation of bilateral exchanges between countries wishing to reduce their dependency on the USD as an intermediary in settling transactions.
Recently, nations involved in key trade flows have explored ways to transact without the dollar. Russia and China, as well as Brazil and China, are in talks to develop operational systems for trading exclusively in local currencies (ruble and yuan/real and yuan).
Why the dollar still dominates
The dollar has been the international currency underlying the exchange rate system as we know it today for some 80 years, stemming from the Bretton Woods Agreement in 1944. Moreover, for many years now, the dollar has been the most widely traded currency in the world, and the one that accounts for the largest share of foreign exchange reserves held by central banks to cover domestic economic needs.
The dominance of the dollar in the global economy — much of the world’s commodities and trade transactions are denominated in dollars — makes the US currency an essential asset for any country that is not self-sufficient and has external needs (i.e., virtually all the world’s economies). For some emerging economies, the dollar shortage is an added source of economic distress, as witnessed by last year’s crisis in Sri Lanka.
Faced with this extremely dominant position, some countries have been thinking about ways to reduce the dollar’s influence and the effects of dependence. One particular goal is to avoid being exposed to fluctuations in the US currency, which can prove very harmful — especially for net-importing countries. The latest example is the sharp rise in the value of the US currency over the 2021–2022 period, which soared to a 20-year high against a basket of currencies. The aftermath was turbulence in several emerging counties.
Are there viable alternatives to replace the USD in global reserves?
The de-dollarization of the global economy is a legitimate issue worth investigating, never more so than now. In the aftermath of COVID, there’s a growing awareness of the dangers of globalization.
So can we really do without the dollar? Yes, a decrease in the use of the dollar could be understood as part of a trend toward greater regionalization of the world economy, which favors the use of local currencies. On the other hand, it is difficult to imagine a world without the dollar, simply due to the lack of any credible rival capable of snatching its crown.
If we think in terms of economic and financial weight, only the euro and the yuan appear today as potential rivals. However, the lack of political stability in Europe related to the absence of coordination and cohesion around a common project limits the expansion of the euro. The control imposed by the Chinese authorities on its markets and economy is also a major constraint to the wider use of the yuan in international trade.
Although China is in direct competition with the United States for the status of the world’s largest economy, the yuan remains a “dwarf” in the currency world. It is only the fifth most used currency in international payments on the SWIFT network and accounts for slightly more than 2% of trade. According to the Bank for International Settlements, the yuan was involved in only 7% of daily foreign exchange transactions in 2022, compared to 88.5% for the dollar.
The dollar’s status, therefore, is not really in question for the time being. There is indeed a fundamental trend toward a reduction in the use of the dollar — the share of the dollar in global reserves has been falling steadily for 30 years — as part of a strategy aimed at diversifying risks and reducing exchange rate exposure. It also reflects the broader regionalization of the economy with a priority on local currencies.
A long view of the greenback
The inability of currencies such as the yuan and the euro to compete with the dominance of the greenback mitigates the real threat of the dollar’s downfall — at least in the short term. I predict that the dollar will continue to dominate the world of foreign exchange and international trade, even though its influence could gradually diminish over time.
In theory, the dollar could continue to diminish and its credit rating might deteriorate sharply if the US were to default on its debt this year. It would be the first default in its history (the debt ceiling is currently frozen), but this scenario is not the expectation of markets as of today.
The recent polarization of debates around a de-dollarization of the global economy might be a signal for the US authorities to push for a further depreciation of the currency, which would temporarily alleviate the negative sentiment toward it.
So, there will be no de-dollarization in the near future. Though the USD’s influence will likely wane in the long term and possibly see a more extensive depreciation in the short term, its role in today’s global economy is integral — and talk of drastic shifts to the status quo is mostly unfounded.
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