De-Dollarization
What it Means, Why it's Happening, and What it Could Lead to
Introduction
Recently, there have been a lot of talks about de-dollarization and its potential impact on the global economy. As there are different opinions about this phenomenon, ranging from dismissing it to seeing it as a major shift in the global economy, in this article, we will review this topic from multiple perspectives. We seek to answer four main questions: Is de-dollarization real? What causes it? What are the consequences of de-dollarization? And how far can it go? To ensure well-rounded coverage, we will include a variety of opinions in the article and explore different points of view.
What is de-dollarization?
De-dollarization refers to the process of reducing the role of the US dollar in international trade, finance, and investment, resulting in the use of alternative currencies.
Is it actually happening?
In accordance with the International Monetary Fund (IMF) report - yes. This trend has been on the rise for years, with the share of the US dollar declining from its peak of 72% in 2001 to 58-59% in 2022, the lowest it has been in 25 years. While this decline may seem significant, it is not the lowest share the dollar has had, which was below 50% in the late 80s-90s.
Why is it happening?
Several factors have led to the decline in the US dollar's share in the global economy. One significant reason is the growing use of other currencies such as the Euro, British Pound, Japanese yen, Australian dollar, Canadian dollar, and Chinese renminbi. Central banks have been diversifying their reserves to manage risks associated with a specific currency, causing a decline in the US dollar's share. This is also can be seen in the IMF report.
Another reason that has contributed to the acceleration of de-dollarization is the recent geopolitical events. The US sanctions implemented to freeze Russian central bank assets signalled to many countries that disagree with US policy to reduce their dependence on US dollars. For instance, China and Saudi Arabia are discussing with several countries the possibility of moving trade toward local currencies. And Russia and China have moved a significant part of their trade into local currencies.
Those events have fuelled a broader discussion about the emergence of a multi-polar world, where multiple powerful regional blocks hold significant influence, rather than the global dominance of the United States. Some countries and blocs, such as BRICS and ASEAN, have explored the idea of utilizing local currencies for trade or creating new ones. For example, Brazil and Argentina are discussing plans for a Latin American currency and BRICS in discussions of the blog currency. As their share in the global economy grows, such decisions may have a negative impact on the value of the US dollar. In fact, the BRICS bloc recently surpassed the G7 in terms of economic size. However, the full impact of such changes remains to be seen, as it takes time for countries to align on a new approach and implement it. Furthermore, it is unlikely that all transactions will shift toward local currencies, so the overall impact on the US dollar's value may be limited.
What are the consequences of de-dollarization?
The consequences of de-dollarization are not clear-cut, and there are different opinions regarding their effects. Some experts argue that using local currencies in trade can have benefits, such as allowing companies to manage FOREX risks better and make revenues more predictable, while reducing the need for a middleman in some transactions. Conversely, volatile exchange rates in some currencies can cause additional problems for exporters.
Other experts argue that there are risks for the US economy resulting from de-dollarization. For instance, as the strong dollar makes it cheaper to buy foreign goods and borrow money, a potential reduction of the dollar share could lead to higher prices and inflation on one hand and higher costs of borrowing on the other. This could make it difficult for the US to pay for its debt, considering it is now more than 100% of its GDP.
However, some experts do not agree with this perspective and do not see such risks as particularly high or dramatic. They highlight that the change will not happen overnight and that the economy will have time to adapt to it. Additionally, a cheaper dollar could make US goods more competitive, leading to increased export and reduced borrowing needs.
From a geopolitical standpoint, a lower share of the US dollar will also reduce the US's ability to impose economic sanctions on other countries and hence will reduce its Global influence.
How far can it go?
Experts also do not agree on how far the de-dollarization can go on and how much and how fast the share of the dollar could decline. Some believe that the US dollar could lose its position as the dominant currency in global finance and be replaced by several other regional currencies. The growing share of emerging economies in the global GDP and their appetite to move their trade to local/regional currencies are some of the factors that could contribute to this outcome. One more factor that can accelerate and deepen the transition is the increase in the US debt, debt ceiling discussions and potential default of the US on its debt. This scenario is very unlikely but can have a big impact on trustworthiness of dollar.
However, other experts believe that the decline will not be dramatic because the US dollar is the dominant currency that is used as a benchmark for different assets and commodities. Additionally, there are no sizable alternatives that provide the same level of financial system maturity. Currencies such as the Chinese renminbi cannot replace the dollar because China still has current account restrictions, and other currencies such as the Euro and Japanese yen have their own risks related to high debt loads. Finally, some of the proposed alternative currencies are currently pegged to dollar.