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Throughout the latter half of the 20th century and into the 21st, the US has solidified the dollar’s position as the dominant global currency for trade, finance, and foreign exchange currency reserves.
Between 1999 and 2019, the dollar accounted for 96 percent of trade invoices in the Americas, with the Asia-Pacific region standing at 74 percent and the rest of the world at 79 percent.
In terms of finance and banking, the US claims the highest share of the bond market at 39 percent ($51.3 trillion). The dollar is also the dominant currency for banking claims and liabilities, standing at just over 60 percent for the former and under 60 percent for the latter.
In addition to this, the dollar’s share of world foreign exchange reserve currencies remains larger than all other currencies’ shares combined, standing at 58.3 percent after peaking at 72.7 percent in the second quarter of 2001.
This dollar dominance in all aspects of the economic system has led to BRICS (Brazil, Russia, India, China, South Africa) and some of their partners to look to diversify transactions away from the dollar—but will it work?
Amr Adly, a political-economist at the American University in Cairo, identified for Business Forward three variables to look at to see whether the yuan or another currency may replace the dollar.
The first question he asked is “how homogenous the interests of the member states are?” Adly referenced the rivalry between India and China to illustrate that the process is not so simple. India would likely want to see the rupee used more extensively as well, and it has already tried to achieve this through negotiations with Russia, for example, although those were recently suspended.
The second variable of concern is the cost of de-dollarization. “Dollar-denominated transactions stand for at least 80 percent of international trade and even more in financial markets,” Adly said, adding that “China itself amassed its reserves in dollars with the US being the biggest investment destination.” This poignant point shows just how entrenched the dollar is; even a country that stands to gain a lot from de-dollarization, such as China, has an interest in the dollar remaining dominant. It will, in the end, be a game of balance.
In terms of the resilience of the dollar, Adly asks “to what extent can the current US-led global governance structures accommodate the interests of the rising powers without collapsing?” The answer to this question is not clear, and is up for debate, to say the least. It does not seem like the US is making a lot of room for rising powers that do not play on its terms, such as through the trade war with China.
To determine whether BRICS can challenge the dominance of the dollar, we have to look at the underlying reasons behind such a move, what action has been taken, and the implications of de-dollarization.
Motivations to de-dollarize
There are several reasons for BRICS to seek de-dollarization. One motivation that is particularly pertinent for Russia and China is of a geopolitical dimension.
With the US dollar as the world’s dominant currency, the US becomes capable of imposing damaging sanctions on any state it so desires. This was seen with western sanctions (including the euro and the yen) on Russia after its invasion of Ukraine and sanctions on Iran before that. Although most observers agree that sanctions on Russia were justified as it violated the central tenets of the UN Charter, many argue that sanctions on Iran were counterproductive as they strengthened the hardline position antagonizing the US and hurt individuals and civil society more than the government. Moreover, Iran did not violate the nuclear nonproliferation treaty, yet got sanctioned regardless.
This tendency to impose unilateral sanctions outside of the (admittedly inherently flawed) UN Security Council framework has made rival states wary of the dollar dominance’s role in upholding the United States’ position as the global police force. De-dollarization would lessen the United States’ ability to police global and regional powers to its liking.
Another important aspect to consider is that global markets and worldwide economies are highly responsive to US markets and economic policy, in part because the dollar is the de facto trade, finance, and world reserve currency. Appreciations or depreciations of the US dollar directly affect countries, especially those with an unbalanced current account. Countries with a current account deficit who import much more than they export would be negatively affected by the appreciation of the dollar. This hit Egypt recently and added to its economic crisis. On the flip side, countries with a current account surplus who export much more than they import, such as China, would be affected by a depreciation of the dollar as it means that the value of their exports declines when converted to local currency.
Furthermore, interest rate hikes or cuts by the Fed also affect markets, particularly in developing countries reliant on hot money. As seen by the recent successive interest rate hikes, some investments are shifted away from high-interest, high-risk markets and over to the dollar which, being the dominant currency, is as safe a bet as any—and has a higher return on investments than before. This leads to developing countries’ central banks increasing the interest rates to recover some of that lost investment, coming at a higher cost and further indebtedness.
Facilitating trade and finance
In addition to breaking free from US dominance, there is a motivation to break free from dollar and other hard currency-based loans. Partners lending in hard currencies, either bilaterally or through multilateral institutions such as the International Monetary Fund and the World Bank, typically place stringent conditions on financing and only take on loans with guaranteed returns on investment that are not high risk. De-dollarization would come with a diversification of financing institutions and the currencies used, making finance more accessible.
Trade would also be easier to conduct as there becomes less of an impetus to import using dollars and more acceptance of using local currencies in trade, further strengthening a diverse currency landscape on the world stage.
The New Development Bank and a BRICS currency
In 2014, BRICS established the New Development Bank (NDB) with the intention of easing access to finance for its members and moving away from the dollar through providing loans in local currency. Last April, NDB president Dilma Roussef said that the bank plans to provide 30 percent of its loans between 2022 and 2026 in local currency. In addition to BRICS, Egypt, the UAE, and Bangladesh are members, with Uruguay’s membership being processed.
Besides the bank, there are other initiatives launched or being considered. For instance, Russian president Vladimir Putin revealed last June that the creation of an international reserve currency “based on the basket of currencies” of BRICS countries is “under review”. Leaders are expected to discuss the possibility of creating a common currency for the bloc when they meet in South Africa in August. As a reserve currency, it would not be used by individuals in everyday transactions, but rather be used to bolster countries’ central bank reserves. Perhaps bonds denominated by this currency could be issued, and trade between BRICS countries would likely take place in this currency.
However, some analysts doubt this idea’s merits. Paul Mcnamara, an investment director at GAM, wrote that BRICS is “not an especially useful economic term” as it “marries an economic superpower in China with a potential one in India with three essentially stagnant commodity exporters.” Mcnamara added that “the economies are dramatically different in terms of trade, growth, and financial openness” which makes it difficult to design a common currency—difficulty pricing common currencies has already been illustrated with the euro, particularly during the 2010 debt crisis with Greece and Germany having different needs for the euro. The common currency typically moves closer to Germany’s expectations. Moreover, Brazil, for example, is heavily dependent on the dollar.
Using local currencies
The biggest threat to the US dollar, however, is movement towards using other currencies in practice, without a formal institution to shake things up. This makes sense as the dollar is currently a de facto world currency so it must be challenged de facto, and not necessarily de jure. There are some initiatives to use local currencies other than the Chinese yuan—also known as the renminbi—in trade, but nothing concrete yet. Egypt, for example, is considering the use of partners’ local currencies for commodity trade, which should somewhat ease the hard currency shortage. China, India, and Russia were named as potential partners by supply minister Aly Moselhy.
However, most de-dollarization initiatives involve the yuan, the currency most qualified to challenge the dollar. Backed by a rapidly growing economy (although it has slowed down due to Covid) China is seen to be an emerging economic superpower. The East Asian country is first in total 1978-2020 global exports, with 14.7 percent compared with the United States’ 8.1 percent, and the world’s top manufacturer with a 28.7 percent share of manufacturing output, ahead of the United States’ 16.8 percent.
China’s significant economic influence sees the renminbi rising as an alternative to the dollar. Saudi Arabia is considering accepting oil sales to China in yuan. This may become something of a paradigm shift if widely implemented. However, Bloomberg columnist Javier Blas described the petroyuan narrative as an “illusion,” citing the lack of its mention in the statements coming out of the December 2022 Saudi-Chinese summit.
Regardless, there is movement with other countries as well. Argentina announced, last April, that it will pay for Chinese imports in yuan rather than dollars. This comes as the South American country faces a dollar shortage, taking advantage of the large trade volume with China. Brazil and Russia are also cooperating with China to use the renminbi internationally.
Adding onto this, US dollar foreign exchange reserves dropped to 59 percent of global foreign exchange reserves in 2020 and again in 2022, its lowest point in 20 years, according to the IMF.
Along with this, Egypt, Saudi Arabia, and Turkey are considering joining BRICS, with other countries such as Argentina, Indonesia, and Mexico reportedly interested as well. Any of these countries joining would only bolster BRICS as an influential bloc of rising economies and an alternative to the US-led economic order. It would also open up further opportunities for south-south cooperation and ease access to financing for countries like Egypt.
If these actions prove to be ultra-effective, there will be notable implications for the dollar, the economic system, and the United States’ position in the global economy.
Current and future outlook
Nobody believes the US is going anywhere. However, the United States’ privileged economic position is in large part due to the dollar dominance. Accordingly, even partly moving away from the dollar as a global currency means the US reaps less of an outsized advantage compared to the (undeniably strong) power of its economy, which is, again, fueled by the dollar privilege.
On the flipside, de-dollarization would see China benefit from its effects, as the yuan would be seen by many states, particularly those in the Global South, as a natural replacement for the dollar. While there would be no renminbi dominance per se, China would still benefit politically and economically from centralizing itself in the global sphere.
The dollar remains
Adly stated that the dollar will not be replaced “anytime soon”. Veteran economist Adel Beshai agrees and notes a critical point in the debate: even if trade is conducted in various currencies, “it won’t shake the dollar for the simple reason that world trade, no matter how large it is, is a fraction of the financial dealings of the dollar at the world level.”
Indeed, while global trade hit 32 trillion dollars in 2022, the US bond market alone is worth over 51 trillion dollars, and this isn’t even counting dollar-denominated bonds issued by other countries. Clearly, even if there is a degree of currency diversification in global trade, the size of financial markets and the dominance of the dollar in those markets means the US will retain its privileged position for a while.
A more egalitarian system?
However, some de-dollarization may prove to be quite positive for developing states. Easing access to finance means, with effective economic management, faster and more efficient development. It also means structural pressures related to hard currency shortages would be lessened, which is a significant factor for economies such as Egypt’s. Current account imbalances, while they would still need to be addressed eventually, would not be as detrimental if they can be partially paid for using alternate currencies. And, as previously mentioned, it lessens global markets’ dependency on the dollar, so conflicts between US economic interests and global economic interests, particularly in the Global South, such as interest rate hikes by the Fed, are not as damaging.
It remains to be seen, however, whether BRICS can follow through on even their gradual de-dollarization plans. If they do, it may be the beginning of a paradigm shift, at least in certain circles.