Since the start of 2023, many “de-dollarization” events have taken place.
Russia and Iran jointly announced the launch of cryptocurrencies for international trade. Saudi Arabia gave approval for selling oil in currencies other than the US dollar. Argentina and Brazil planned to establish common currencies. Brazil and China agreed to stop using the US dollar as an intermediate currency.
The term “de-dollarization” has become worthy of some real focus, especially at a time when the globalization of the Chinese renminbi is on an uptrend.
There are two key short-term reasons why de-dollarization has picked up pace.
The first is the Russia-Ukraine conflict. A series of financial sanctions against Russia by the United States from February 2022, and criticism of the move by several organizations including the International Monetary Fund and celebrities, have shaken confidence in the dollar and the common currency in large parts of Europe.
The second reason is the US fiscal deficit and debt.
The US fiscal deficit to GDP ratio was at 15 percent in 2020 — during COVID-19. The US’ national debt, which was $10 trillion in 2008, has risen to $31.4 trillion and is likely to expand further, seriously affecting people’s confidence in the long-term stability of the dollar.
The process of de-dollarization is also partly a process of portfolio adjustments by global investors. If people’s confidence in the dollar weakens, they will naturally reduce their holdings of various financial assets denominated in US dollars.
There are also two factors affecting the long term.
First, the share of US GDP and foreign trade in the global total has declined. At the end of World War II, the US’ GDP accounted for 56 percent of the world’s total. By 2020, however, it had fallen to 24 percent, a decline of more than half of its original share.
Its share of foreign trade in the global total has also fallen to less than 10 percent from 32 percent during the same period.
The second reason is the rise of other currencies.
Unlike the early days following World War II, when the US dollar and the British pound sterling were the only global currencies, there are more currencies competing for bigger roles on the global stage currently, from the euro to other nontraditional reserve currencies that have a certain place of their own, thereby weakening the dollar’s position to a certain extent.
Ongoing, but long-lasting
De-dollarization will be a long-term process and there are three major reasons for this.
One, there were more declarations concerning de-dollarization than real actions; most of the statements only express a willingness to seek other settlement currencies in international trade. These are diversification attempts that do not exclude US dollar solutions.
As a matter of fact, in most cases, trade is still mainly settled in US dollars. However, increasing the use of other currencies for settlement and reserves can help nations avoid risks brought on by an excessive dependence on the US dollar.
Two, since 1914, when the dollar began to dominate, the role of the currency in the global monetary system has been volatile. In 1914, the dollar’s share of the global reserve monetary system was zero, but a decade later it had soared to 70 percent, surpassing the British pound sterling for the first time. In 1944, it fell to 18 percent, but recovered to 84 percent in 1971. It again declined to 48 percent in 1990, but climbed to around 70 percent in 2000.Now, it stands at 58.4 percent, according to figures recorded early this year. Yet, it is hard to say that the de-dollarization recently attracting the eyeballs of ordinary people will create a permanent change of the dollar’s position. Nobody can guarantee the share of dollar will not rebound or even significantly rebound in the future.
Three, although the dollar’s status as a reserve currency has declined in the past several years, it is still way ahead of the second-placed currency. According to the latest data, the US dollar currently still accounts for 88 percent of global foreign exchange transactions and has shown an upward trend in the past two years, with the size of offshore dollars increasing from $7.8 trillion to $8.3 trillion during the period.
In general, the overall US economy is still strong, especially its well-developed financial market, whose development is more mature than that of other regions of the world. This will be key to the dollar’s ability to remain the most important international currency for a long time. Although some of the advantages of the US, such as its economic scale, liquidity and credibility, will gradually weaken over the long run, the US will continue to maintain a great advantage in these aspects.
Flaws in current system
The current international reserve system, which dates back to the Bretton Woods Conference in 1944, is characterized by a dollar-centric focus. Although the system collapsed in 1973, the dollar’s status as the dominant international reserve currency did not change significantly due to the highly developed and open financial markets of the US, and especially its status in the treasury market. The share of the dollar in the global reserve currency composition has remained above 60 percent.
Charles Kindleberger, a renowned US economic historian, said that under a system denominated by the dollar, the US can provide a free trade arrangement and be the lender of last resort, thereby contributing to world financial stability. This may have been the original intention and legitimacy of the Bretton Woods system.
However, such a dollar-centric reserve monetary system is inherently unstable and unfair, especially since the 1960s, as the situation has changed. The global financial stability has often suffered from the “Triffin Dilemma” and more recently the “New Triffin Dilemma”. On the one hand, the demand for dollar liquidity was rising due to a need to expand trade, which required the US to expand its current account deficit in order to increase the supply of dollars. But the increase in the supply of dollars eventually led to a depreciation of the dollar and currency turmoil. Since the late 1980s, the demand for safe dollar assets, such as US treasury bills, has risen, which in turn required the US government to maintain widening fiscal deficits and national debt. Similarly, the increase in the supply of dollars and US bonds eventually compromised the safety of US dollar assets, leading to a crisis of US dollars and bonds.
On the other hand, under such a system, US monetary policy has a huge spillover, severely impacting the economic and financial stability of the rest of the world due to the functioning of the global financial cycle.
For example, the implementation and withdrawal of quantitative easing after the subprime mortgage crisis in 2008 had a huge impact on emerging market economies. Unlimited quantitative easing since March 2020 has also triggered a rapid rise in global liquidity and inflationary pressures. In the past two years, the US Federal Reserve’s aggressive interest rate hikes have once again had an impact on global economic and financial stability, especially in emerging market economies.
What can China do?
Building a diversified reserve system is one of the most practical solutions and the internationalization of the RMB will undoubtedly play an important role in such a system. However, it will require greater efforts to make the RMB a pillar of diversified reserve currencies in future. Efforts can be made in, but not limited to, the following fields.
First, China should ensure sustained and stable economic growth through deepening reforms and opening-up, while actively enhancing its comprehensive strength. This is the very basis for the internationalization of the RMB.
Second, the country should continue to reform the domestic financial market and accelerate the indepth development and opening-up of the financial market. In particular, financial regulators can accelerate the building of the treasury bond market, and strive to increase its internationalization. They should also accelerate the development of the foreign exchange derivatives market, provide sufficient exchange rate hedging tools for foreign investors to use and hold RMB, and reduce related risks and costs.
Third, China can appropriately speed up the two-way opening of financial accounts. After years of exploration, China has accumulated experience in making monetary and exchange rate policies, conducting macro-prudential management and financial supervision, has mastered more policy tools, and is able to cope with general cross-border capital flow shocks. Of course, it is still necessary to improve regulatory capacity.
Fourth, the government should accelerate the market-oriented reform of the exchange rate system and expand the flexibility of the RMB exchange rate system.
Fifth, the country can further improve its legal system and business environment. The ultimate success of RMB internationalization depends on the full trust of overseas institutions and individuals in China’s economy and business environment. Therefore, it really matters whether a good institutional environment is close enough to international standards or not.
Sixth, China should actively participate in global economic and financial governance, in the IMF, for example, and promote the share of RMB in the Special Drawing Rights. Based on international economic policy dialogue mechanisms such as the G20, China should seek its due role in major international economic and financial affairs, and strive to assume more international responsibilities.
At present, due to the impacts of COVID-19 and the interest rate hikes by the US Fed, many emerging market economies are facing serious sovereign debt risks. China can participate more actively in global attempts ensuring financial safety and strengthen monetary and financial cooperation with these emerging economies by expanding bilateral swap agreements.
The writer is the director of the Center for International Finance Studies at the Central University of Finance and Economics in Beijing. This article first appeared in China Daily. Search “de-dollarization” or “de-dollarisation” here for more articles on this subject.