De-Dollarization: Debunking the Myths
In this and our upcoming series of articles on De-Dollarization, we'll break down and explain how much validity there is to the arguments about the anticipated demise of the US Dollar.
Latest Update: October 2023
There is currently a growing concern among many investors and economists regarding potential de-dollarization, which refers to the diminishing role of the US dollar as the world's reserve currency. This shift would mark a significant change in the dominance of the United States currency and, consequently, undermine its economic influence globally.
What is De-Dollarization About?
Concerns about de-dollarization have gained a lot of traction lately, particularly following the eruption of war in Ukraine and the subsequent trade restrictions imposed on Russia and China. Given that these countries are major exporters, such restrictions would compel them to seek new trade agreements and conduct transactions using alternative currencies. Consequently, this would lead to a reduced demand for the US dollar and potentially initiate a downward spiral for the currency's global standing. The US dollar's anticipated decline is also attributed to the growing economic prowess and significance of China, which is poised to become the new most valuable player on the world stage. Add to all this the combined frustration of the "Global South" with the dominance of the United States, and one can quickly see how this could potentially turn into a toxic recipe of disaster for the dollar. Those, at least, are the arguments. Now let's find out how much weight they actually hold.
The Russo-Ukrainian conflict has intensified the discussion around de-dollarization, but it didn't start it, and the concept has decades-long roots. Way before the war began, some experts argued that the global financial dominance of the US dollar relied solely on the presence of the US military. The belief was that any country daring to abandon the use of the dollar in foreign trade would face swift American armed intervention. Without military support, the dollar's value would plummet, allowing other currencies to thrive. According to this argument, these American fears were used to justify the invasions of Iraq and Libya. Saddam Hussein's desire to sell oil in euros and Muammar Kaddafi's aspiration to establish an international gold standard for African nations were perceived as potential threats to the US dollar and its economy.
Some individuals perceive these narratives as coherent and even bet on the decline of the US dollar. Of course, the further we project into the future, the more probable it appears that the US dollar will eventually experience a serious downturn. However, presently, there are few compelling reasons to anticipate a near-future erosion of the US dollar's status. Why is that?
The answer is straightforward, and no, it's not due to the US military. It lies in the robustness of the US economy and currency, coupled with the inadequacy of the alternatives that were supposed to challenge the supremacy of the US currency.
It is widely acknowledged that the US economy stands as one of the strongest in the world, with its currency being highly reliable. In comparison, the currencies of China, Russia, and even the anticipated gold-backed BRICS currency (as they claim it will be) do not possess the same level of reliability as the US economy and the dollar. It is important to note that the notion of de-dollarization, despite generating significant discussion, holds minimal substance in reality.
Main Arguments for De-Dollarization
There are four key narratives that are being pushed forward to try and explain the inevitability of de-dollarization.
First Narrative
The first narrative revolves around the growing influence of the BRICS group of countries. BRICS, consisting of Brazil, Russia, India, China, and South Africa, comprises five major global economies. Four of these countries rank among the top ten most populous nations, which translates to significant economic potential. Brazil stands out as a major producer of wood and grain, Russia as a significant exporter of oil, minerals, and grain, and China as a prominent manufacturer of goods. The alliance formed by these countries undermines the dominance of the United States due to their substantial economies. Together, they account for 23% of the global GDP and represent over 30% of the world's population.
If those countries choose not to settle transactions in the US dollar, the demand for it will significantly decrease, resulting in de-dollarization. Furthermore, these countries have recently been utilizing their own currencies for internal trade.
Second Narrative
The second narrative also involves BRICS — there have been speculations that BRICS will create their own currency, most likely backed by gold. As gold is a tangible asset and the US dollar is a fiat currency, there is a shift towards increased trading with BRICS countries and the use of their currencies. This preference stems from the belief that receiving gold is more secure than relying on a fiat currency that could be devalued by an irresponsible government or central bank.
The first and second narratives point to the growing significance of China, Russia, Brazil, India, and South Africa, leading to enhanced trade relationships with these nations and a reduced reliance on the United States. Consequently, it is likely that countries worldwide will be incentivized to adopt the currencies of BRICS countries rather than the US dollar.
Third Narrative
The third narrative revolves around trade restrictions. Recently, the United States and the European Union have imposed trade restrictions on Russia, while the United States has also imposed trade restrictions on China. But why is this significant?
The importance lies in the fact that if China or Russia are unable to trade with the United States, they will seek alternative trading partners and potentially utilize their own currencies. As a result of these trade restrictions, other countries may opt to use rubles or renminbi when conducting trade with Russia or China. Consequently, this would lead to an increase in the reserves of these currencies and a decrease in US dollar reserves.
Fourth Narrative
The fourth narrative revolves around US monetary policy. Some authors, such as Mike Maloney, suggest that the US dollar is a feeble currency, relying mostly on the political and military might of the United States. According to this theory, this compels nations to trade goods (especially oil) in exchange for US dollars. To prevent rampant inflation and safeguard the US economy and the dollar itself, the Federal Reserve continues to print money and maintain low interest rates. Without American political influence, other countries would likely seek alternative currencies or even commodities like gold.
Currently, there is speculation about the global economy shifting away from the US dollar. Countries like China, Brazil, and several African nations are reportedly reducing their reliance on the dollar for trade. Moreover, some oil-producing countries, such as Iran, have halted oil sales in US dollars, which could potentially contribute to the de-dollarization trend. This has raised concerns about the possible collapse of the US dollar as a reserve currency. However, it is important to carefully consider whether this scenario will occur in the near future.
To assess the likelihood of a substantial decline in the importance of the US dollar, it is crucial to understand the sources of demand for the currency. Contrary to popular belief, it is not solely reliant on the military might of the United States. Countries like Russia and China, despite having significant military power, have not been able to establish their currencies as major players in international trade. This is primarily due to concerns about the reliability and strength of their economies.
Therefore, it is necessary to question the likelihood of de-dollarization happening in the near future. While there are discussions about reducing reliance on the US dollar, several factors suggest that a significant shift away from the currency is unlikely to occur anytime soon.
How Big is the BRICS Threat?
It's rather small. Why? There are two main reasons.
1. Instability of BRICS and Its Partners
The first reason is that the BRICS economic alliance lacks stability. There are numerous conflicts between the main members of BRICS, namely India, Russia, and China. Ongoing territorial disputes exist between India and China, as well as between Russia and China. This is crucial because it's impossible to maintain a strong alliance and trade union with countries that have fundamental conflicts over territory. Recently, China presented a map that claims parts of India and Russia as its own, which is a serious offence to China's supposed allies. Can you imagine the US declaring parts of Mexico or Canada as its territory?
However, it is worth noting that more countries have joined BRICS or are currently trading with China using the renminbi instead of the US dollar. Is this dangerous for the US dollar?
Not really.
Let's take a look at South Africa, a member of BRICS. It was once a relatively strong economy compared to other developed economies but is now beginning to resemble a failed state.
But what about other countries that cooperate with BRICS and trade with China?
Starting from January 1, 2024, several countries are set to join BRICS, including Saudi Arabia, the United Arab Emirates, Argentina, Iran, Egypt, and Ethiopia. Should this be cause for concern?
Not to a great extent. Ethiopia and Argentina constantly face serious economic issues, so they do not pose a real threat to the US dollar, since they are not significant producers or exporters. Iran is dealing with serious economic and social problems, and Egypt is a developing economy with strong trade ties to the US. It is doubtful that it would benefit Egypt to exclusively trade and align with BRICS.
What about Saudi Arabia and the UAE? These are wealthy developed economies.
Indeed, but the curse of oil still looms large. Saudi Arabia and the UAE are among the largest oil producers, and a significant portion of their wealth is still derived from the black gold. Their economies lack diversity (although that is gradually changing, but not fast enough) and, at present, rely too heavily on a single sector. This poses a problem for them as the world seeks to move away from oil as a primary source of energy. Additionally, they still maintain trade ties with the US, so the question remains the same as with Egypt. Will they sever their trade ties with the US? It's not likely, especially now that China is stirring up conflicts with its supposed allies.
There are also two crucial internal social issues: authoritarianism and the demographic decline of China and Russia. These countries are slowly experiencing a decrease in population, even faster than Europe. Furthermore, authoritarian regimes present imposing facades, but those eventually crumble. Countries with authoritarian governments suffer from transparency problems, thus eventually undermining foreign trust in their economic institutions, and autocratic rulers bring negative economic effects.
As you can see, there are numerous economic and socio-political issues plaguing BRICS countries, which weaken the group and undermine its economic significance. We'll delve deeper into each individual issue in our series on De-Dollarization.
2. Global Trade and De-Dollarization
The second reason is that the US dollar is a highly reliable and widely accepted currency, contrary to what de-dollarization theorists may admit. Its strength is not solely derived from its use in oil trade; it is extensively utilized in global trade for various goods. While oil trade accounts for only 6% of total global trade, the US dollar remains dominant, accounting for 96% of trade transactions in the Americas, 74% in the Asia-Pacific region, and 79% in the rest of the world (excluding Europe, where the euro dominates), according to Federal Reserve data from 1999-2019. Additionally, the US accounts for 19% of global oil production. Even if all other countries were to pay for oil with the Renminbi, the Chinese currency's share in total global trade would only increase by a maximum of 4.86 percentage points. While this is not insignificant, it is unlikely to displace the US dollar.
Countries across the globe trade in US dollars not out of necessity, but out of preference. Firstly, the US economy is immense, with numerous influential companies selling and importing goods worldwide. As the largest importer and second-largest exporter, trading with the United States requires the use of US dollars, leading to substantial demand for the currency.
Moreover, the demand for the US dollar is further bolstered by the self-sufficiency of the US economy. With vast resources and diverse production capabilities, the US is relatively insulated from the economic issues faced by other countries. Consequently, investors find solace in investing in US dollars and debt, as global issues have a lesser impact on their savings.
The stability of the US dollar is another reason why people prefer to trade in it. Prior to the pandemic, the Federal Reserve managed to maintain the inflation rate near its target, and even slightly below it at times. In contrast, the values of many other currencies fluctuate more significantly than the US dollar. As a result, people gravitate towards trading and saving in US dollars, as they offer greater reliability as a store of value. The stability of the US dollar surpasses that of other currencies, making it a preferred choice when companies encounter difficulties in agreeing on a common currency for trade.
In summary, the widespread use and preference for the US dollar stem from its reliability, global acceptance, and stability. These factors, combined with the size and self-sufficiency of the US economy, contribute to its enduring dominance in international trade.
The Current State of De-Dollarization
So far, we've primarily focused on BRICS, but what about other countries? Could they potentially undermine the position of the US dollar? Theoretically, it is possible, but it would take time. One undeniable fact about de-dollarization is that the share of the US dollar in the official exchange reserves of countries worldwide has declined significantly over the past two decades. In 2000, it stood at 72.5%, whereas in 2022, it has dropped to 60%. This represents a substantial decrease. However, despite this decline, has it caused the US dollar to lose its status as the global reserve currency? The answer is no.
Historically, the biggest threat to the US dollar's role in the global economy has been the Euro. Introduced as the shared currency of some of the world's largest economies, such as Germany, France, and Italy, the Euro has played a significant role in international trade among developed countries. Since its inception, the Euro's share in global exchange reserves has grown to 23% and has slightly declined to 20.5% in 2022.
It is worth noting that the decline in the US dollar's share in global reserves cannot be solely attributed to the Euro. Other currencies have also contributed to this trend. According to a 2022 graph prepared by the US Federal Reserve, the share of the Japanese Yen (6%) and other currencies has increased over time. Additionally, China's share has been growing and currently stands at around 3% as of 2023. However, the British pound's share remains relatively stable at 5%.
Source: US Federal Reserve
While the position of the US dollar has been somewhat undermined, particularly by the Euro and to a lesser extent by the Japanese Yen and the development of other countries, it has not lost its status as a global currency. Furthermore, no other currency has had such a significant impact on the global trade system as the US dollar.
Comparing this to the ongoing narrative surrounding BRICS, it is important to note that even the introduction of the Euro, despite being backed by strong and developed European economies, did not cause the downfall of the US dollar. Therefore, the likelihood of a group of developing countries with their own feuds being able to dethrone the US dollar is quite low.
To gain a comprehensive understanding of de-dollarization and the factors at play we will explore various topics, including politics, geopolitical dynamics, social issues, global trade, and monetary policies of major economies. We also delve into China's exchange rate manipulations and their potential consequences. This is the first in a series of articles that we will publish on de-dollarization, so stay tuned as we deconstruct and make sense of all the buzz surrounding the news.
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