New World Order or Hype: Challenging the Dollar's Dominance

Recent reporting, particularly in alternative media, has given the impression that the greenback is on its way out. We take a closer look here.

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On June 11, the International Monetary Fund (IMF) again warned of the "stealth erosion" of the US dollar's dominance. According to the organization, the USD's share of global central bank reserves dropped from over 70% in 2000 to about 55% in the final quarter of 2023. This downturn in dollar reserves has been the subject of much debate between those who argue that the greenback is in terminal decline and others who contend that the currency's dominance is unassailable, at least for now. This debate comes amid the rise of other currencies, such as the Chinese renminbi and Australian dollar, and reports that new alternatives are on the horizon.

Despite current trends, data suggests that the USD's share of global reserves, while lower than in previous decades, is considerably higher than alternatives such as the Japanese yen, British pound, and Chinese renminbi. With approximately 88% of all foreign exchange transactions carried out using the dollar and no viable alternatives on the market, the greenback will likely remain the global reserve standard for years to come. In this article, we explore how judgments as to the greenback's imminent demise are, at the very least, premature and likely the product of great power posturing.

De-dollarization

The greenback's centrality in global trade and finance began with the Bretton Woods Conference of 1944, where participating countries agreed to abandon their ability to adjust their currencies unilaterally. Instead, all currencies would be fixed to the USD, which was fixed to gold. The currency's dominance increased in 1974, when Saudi Arabia, the world's largest oil exporter, agreed to sell its oil exclusively in USD, which began trading at a floating exchange rate in 1973. Other oil exporters followed suit, giving rise to what became known as the 'petrodollar,' paving the way for the USD to dominate the trade of oil, by far the world's most traded commodity. Today, no currency matches the various functions of the USD. The US dollar is the most widely accepted means of buying and selling goods internationally and the standard by which trading partners value their goods and services.

Over the years, various countries have spearheaded movements to reduce dependence on the US dollar. These efforts come amid rising concerns that Washington is increasingly weaponizing the greenback by shutting off some countries' access to it by closing financial channels and freezing central bank assets – measures collectively referred to as 'sanctions.' Russia is currently the world's most sanctioned country following its 2022 invasion of Ukraine, and other countries, such as Iran and North Korea, have been subjected to extensive and crippling sanctions for decades. Recent news that US authorities plan to use seized Russian assets to pay for Ukraine's war efforts and reconstruction has greatly added to these concerns.  

Recent sanctions on Russia have spurred fears of a weaponized dollar on the global stage. Image source

A lack of viable alternatives

The fundamental problem with de-dollarization is the lack of a viable alternative. In 2009, the US Department of Treasury identified several criteria for a currency to gain trade and financial dominance. For any such currency, the underlying economy must be sizable and essential in international trade. Moreover, its financial markets must be open, with stable macroeconomic policies and ease of currency convertibility also playing a role. Although the euro meets both criteria, it lacks the political diversification needed to serve as an alternate currency, as EU monetary policymakers tend to mirror their US counterparts. According to this assessment, the Chinese renminbi is the closest challenger to the greenback. Although it comes from a massive globalized economy, it does not come from an open financial market.

The renminbi is also structurally constrained by several factors. First, limited amounts of the currency are available outside China, making it difficult for its meaningful adoption on a global scale. China uses capital controls to severely restrict the movement of its currency in and out of the country, which is also detrimental to business confidence. The renminbi is not fully convertible, meaning it cannot be freely traded or converted into other currencies. China's ongoing economic slowdown has only worsened the resultant lack of international confidence. As a recent sign of this diminished confidence, investors have been routinely selling Chinese government bonds since early 2022, with bond holdings down $15 billion in March 2023 alone.

The global trust deficit in China goes far beyond its economy. Unfavorable opinions of China among those living in advanced economies peaked at the height of the COVID-19 pandemic and have subsided little since then. Regionally, many Southeast and East Asian countries have retaliated against China's aggressive diplomacy and saber-rattling over territorial disputes. In key Chinese trading partners such as Australia, public opinion has plummeted following China's extensive tactics of economic coercion in recent years. Developing countries such as Sri Lanka and Pakistan have been trapped by Chinese debt.

China's extensive financial integration with the US economy also renders the idea of a renminbi-led de-dollarization moot. Despite being a vocal proponent of decoupling from the greenback, China regularly purchases vast sums of USD, hinting at robust demand for the currency in the Chinese banking system. More importantly, China parks its excess liquidity in US treasury bonds, the levels of which have not drastically decreased over the last decade despite geopolitical upsets between Beijing and Washington. In fact, the USD's share in Chinese reserves has been more or less stable since 2015.

The Chinese yuan faces many obstacles to toppling the greenback that many see as insurmountable. Image source

Is a BRICS currency feasible?

In recent months, there has been a considerable amount of media buzz surrounding the concept of a common currency between the BRICS bloc of countries that could challenge the greenback's dominance. Russian President Vladimir Putin first floated the idea in June 2022 and has suggested that the currency could be backed by gold. Alternatively, international media reports have indicated that it may be modeled on the IMF's Special Drawing Rights (SDR) asset, a unique reserve asset used to supplement the official currency reserves of member countries but not an official currency itself. However, the creation of a BRICS currency is almost certainly doomed to fail, partly because there is a clear divergence in how BRICS member states view de-dollarization.

For instance, Russia's de-dollarization efforts began in the early 2000s to de-risk its banking sector, among other goals. Since 2014, these efforts have entirely focused on reducing sanctions risks. In contrast, India views de-dollarization through the narrow lens of hedging against trade volatility, with alternate currency use accounting for only a small but growing part of its international trade. Alternatively, China's view of de-dollarization primarily focuses on internationalizing the renminbi, which has been a nominal pillar of its economic policy at least since the 2008 global financial crisis but contrasts sharply with its strict capital controls.

Geopolitical considerations will further undercut the formation of a BRICS currency. The first step to collectively establish the basis for a joint tender would involve increased trade in an alternative currency used by many BRICS members, the renminbi. India is unlikely to agree to any move that promotes the renminbi amid border tensions with China, especially as this would implicitly signal Chinese leadership of the bloc. India is also moving closer to the US for security reasons, further preventing it from wholeheartedly pledging support to a China-led political order. Similarly, Russia will likely be wary of Chinese leadership on the world stage, given the historical strategic rivalry between it and Beijing.

Material constraints are another factor likely to hinder the launch of a BRICS currency. For one, trade between BRICS members is quite limited, although it is increasing quickly. Moreover, there is no good way to underwrite a BRICS currency. For example, the share of gold held by founding BRICS members has been falling steadily, with the notable exception of Russia, giving what other member states could see as an unacceptable advantage. Some have made the case for an oil-backed BRICS currency, though this too has its challenges, with researchers pointing out that such an arrangement would require a fixed exchange rate between a particular unit of oil and a unit of the BRICS currency. Should oil prices rise, BRICS currency holders would be virtually unable to transact at this fixed rate, requiring another round of negotiations.

These are likely some of the reasons why other BRICS members have been reluctant to back the concept of a common currency, which has primarily been a Russia-led media campaign. Last July, the Indian foreign minister pushed back against the prospect of a BRICS currency, saying, "There is no idea of a BRICS currency." Likewise, South Africa's finance minister said last August that "no one has ever tabled the issue of a BRICS currency, not even in informal meetings." Even the CEO of the New Development Bank, a financial institution created by the bloc, declared that "you cannot step outside of the dollar universe and operate in a parallel universe."

Despite the BRICS common currency's bleak prospects, the use of alternative currencies is very likely to increase over the coming years. The renminbi will likely lead the pack, with the currency's share in China's cross-border payments increasing by 47% from 2016 to 2021. As of March, its share in global payments rose to 4.7%, up from 2.37% in late 2022. The recent announcement that Saudi Arabia will settle some of its oil exports in yuan ends decades of dollar exclusivity. Other contenders include the Indian rupee, the growing use of which will probably be most apparent in intra-BRICS trade. India has signed agreements to transact across borders in its currency with Indonesia and the UAE, among others. Twenty-two countries have opened special bank accounts in India to settle trade in rupees.

Although the dollar will likely remain dominant, a growing amount of international trade will likely be settled by other currencies moving forward amid persistent fears of a weaponized dollar. Image source

Conclusion

The absence of a strong alternative currency and the limited adoption of other currencies in bilateral cross-border transactions indicate that the greenback is here to stay for the foreseeable future. The USD remains too entrenched in the global financial system to be easily eliminated. However, the US' growing weaponization of the dollar could continue to spark concerns even among friendly countries that they could be next. These concerns could slowly bolster the de-dollarization movement in the coming years.