The Dollar’s Demise? Experts Analyze the Impact of Increasing De-Dollarization on Global Markets

2023-06-03 05:52:00

Currency experts dare not sound like the Cassandras who embarrassingly predicted the imminent demise of the dollar numerous times over the past century. And yet, looking at this sudden wave of deals aimed at circumventing the dollar, they spot the kind of significant action, however small and gradual, that used to be lacking in the past.

For many world leaders, the reasons for taking these steps are strikingly similar. They say the dollar is becoming a weapon, being used to push American foreign policy priorities and punish those who oppose them.

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Nowhere has this been more evident than in Russia, where USA has dealt an unprecedented financial blow to the regime of Vladimir Putin in response to the invasion of Ukraine. The Biden government has imposed sanctions, frozen hundreds of billions of dollars of Moscow’s foreign exchange reserves and, in concert with Western allies, has virtually driven the country out of the global banking system. For much of the world, it has been a stark reminder of their own dependence on the dollar, whatever they think of the war.

And that’s the dilemma facing Washington officials: increasingly relying on the dollar to fight their geopolitical battles, not only do they risk damaging the dollar’s pre-eminent place in world markets, but they could ultimately undermine its ability to exert influence on the world stage. According to Daniel Mcdowell, author of Bucking the Buck: US Financial Sanctions and the International Backlash Against the Dollar, to ensure long-term effectiveness, it is often best to leave sanctions as a threat and not carry them out.

“Now, a rational actor who knows that they might find themselves in that situation in the future will prepare for that scenario, and that makes their coercive threats, their deterrent threats, less effective.said McDowell, director of university studies in the political science department at Syracuse University. “The change may be marginal now, but even if it ultimately culminates in something that doesn’t dethrone the dollar”, is still important because of how “can reduce US economic power”.

To be sure, part of the dollar’s move away is being orchestrated by China. President Xi Jinping wants the yuan to play a bigger role in the global financial system, and his government has made expanding the currency’s use abroad a priority.

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However, much of this momentum is taking place without the involvement of Beijing.

India, which is not a strategic ally of China, and Malaysia announced a new mechanism for bilateral rupee trade in April.. It is part of a broader effort by the Narendra Modi government, which has not joined the US-led campaign of sanctions against Russia, to avoid the dollar in at least some international transactions.

A month later, the Association of Southeast Asian Nations agreed to boost the use of its members’ currencies for regional trade and investment.

And South Korea and Indonesia signed an agreement a few weeks ago to promote the direct exchange of the won and the rupee..

Brazilian President Luiz Inácio Lula da Silva lashed out at the dominance of the dollar during a visit to Shanghai in April. Standing at a podium surrounded by the flags of Brazil, Russia, India, China and South Africa, the so-called BRICS nations, asked the world’s largest developing economies to come up with an alternative to replace the greenback in foreign trade, asking “who decided that the dollar was the (trade) currency after the end of the gold parity?”.

The use of the dollar as a reserve currency is on the decline.

It dated back to the early 1970s, when the post-World War II agreement known as Bretton Woods, which had made the dollar the center of world finance, was unraveling. The collapse of the agreement did not affect the pre-eminent position of the dollar. To this day, it is the world’s dominant reserve currency, which has fueled demand for US bonds and allowed the country to run huge trade and budget deficits.

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The centrality of currency in the global payment system also allows the United States to exert unique influence over the economic destiny of other nations.

According to the most recent data from the Bank for International Settlements, about 88% of all global currency transactions, even those that do not involve the United States or US companies, are made in dollars. Because banks that handle cross-border dollar flows maintain accounts at the Federal Reserve, they are susceptible to US sanctions.

Although the campaign of financial punishments against Russia is the most recent and prominent example, both the Democratic and Republican administrations have resorted to sanctions against countries such as Libya, Syria, Iran and Venezuela in recent years.

According to a recent report from the Center for Economic and Policy Research, the Biden Administration has made an average of 1,151 new designations a year on the Office of Foreign Assets Control’s list of specially designated persons. The number is higher than the average of 975 during the Trump Administration and 544 during President Obama’s first four-year term.

“Countries have suffered for decades from the dominance of the US dollarsaid Jonathan Wood, director of global affairs at consultancy Control Risks. “The more aggressive and expansive use of US sanctions in recent years reinforces this malaise, and coincides with the demands of major emerging markets for a new distribution of global power.”.

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A Treasury official referred Bloomberg to comments made by Secretary Janet Yellen in a mid-April interview with CNN, acknowledging that “there is a risk, when we use financial sanctions that are tied to the role of the dollar, that may over time undermine the hegemony of the dollar.”

But he pointed out that the greenback “it is used as a world currency for reasons that are not easy for other countries to find an alternative with the same properties”.

Market watchers agree. Although more and more countries want to reduce their dependence on the dollar, few expect their pre-eminent position in world trade and finance to be threatened any time soon.

First, there is little sign that another coin can offer the same level of stability, liquidity, and security. Furthermore, the vast majority of America’s allied advanced economies, which account for more than 50% of the world’s gross domestic product, have shown little urgency in abandoning the greenback.

In fact, the dollar has rallied against most of its major peers since the United States stepped up its sanctions against Russia last year, a sign that any deterioration in its global status is likely to be a long, slow process.

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“I don’t see any asset going to replace the dollar as the dominant currency in the next generationsays George Boubouras, a three-decade veteran of the markets and director of research at K2 Asset Management in Melbourne. “Nothing comes close to the might of the American economy. China has its problems with an aging population, and the euro has had a hard time gaining ground. The dollar will not be dethroned in the foreseeable future”.

BRICS reaction

However, the pace of de-dollarization continues in the developing world.

Pakistan wants to pay for Russian crude imports in yuan, the country’s energy minister said last month, while earlier this year the United Arab Emirates announced it was in the early stages of talks with India to boost trade. no oil tanker in rupees.

Earlier this week, the BRICS countries asked the bloc’s purpose-built bank for guidance on the workings of a possible new common currency, including how it could shield member countries from the impact of sanctions such as those imposed on Russia. .

“Undoubtedly, de-dollarization is accelerating and will continue in the coming years.”, said Vishnu Varathan, head of economics and strategy at Mizuho Bank Ltd. in Singapore. “The United States made a calculated decision to use the dollar to inflict pain, and there are likely to be long-term consequences.”.

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