BELFAST – During the US presidential campaign, Donald Trump pledged to make de-dollarization – efforts to reduce global reliance on the greenback – too costly to contemplate, vowing to impose 100% tariffs on countries that shun the currency. But such a move, part of a broader tariff agenda that the president-elect seems determined to enact, would do little to stop the dollar’s demise.
The greenback remains the most important means of exchange and effective store of value, making it the preferred currency for international trade and finance, as well as for foreign-exchange reserves held by central banks to ensure a steady supply of imports and insure against currency crises and macroeconomic instability. But as the world’s economic center of gravity shifts east, de-dollarization is accelerating.
The dollar’s share of foreign-exchange reserves fell from a peak of 72% in 2002 to 59% in 2023, driven by increased demand for non-traditional reserve currencies – especially the Chinese renminbi. Moreover, the global oil trade was almost exclusively settled in dollars until last year, when one-fifth of these transactions were denominated in other currencies.
Several factors have contributed to this shift. Global South countries have become the drivers of global economic growth, changing the dynamics of global trade and energy markets. An increasingly multipolar world has ushered in a new age of currency competition, while technological and financial innovations have made it less expensive and more efficient to use local-currency settlement (LCS) for bilateral trade.
Trump, seemingly aware of the enormous economic and geopolitical benefits conferred by the dollar’s status as the world’s main reserve currency, would like to halt this process. After all, the United States is one of the few countries in the highly integrated world economy that still has effective monetary sovereignty – namely, the ability to set and achieve its economic and monetary-policy objectives without regard for other countries.
By contrast, as the eurodollar market became the backbone of the privatized international monetary system, more countries issued dollar-denominated
sovereign debt, increasing their reliance on the greenback. In 2011, then-Chinese President Hu Jintao put it plainly: “The monetary policy of the United States has a major impact on global liquidity and capital flows, and therefore, the liquidity of the US dollar should be kept at a reasonable and stable level.”
Although a recent study by the Federal Reserve Bank of New York singles out geopolitical distance from the US and financial sanctions as the main drivers of decreasing demand for the US dollar, de-dollarization is not driven exclusively or even largely by America’s overreliance on the dollar as a foreign-policy tool. Rather, many governments are encouraging the use of instruments denominated in their national unit of account to capture the welfare gains associated with having an international currency.
Perhaps the most successful example of this was Europe’s monetary integration, which gave rise to the euro, now a strong second to the dollar, accounting for around 20% of global reserves and over half the EU’s exports worldwide. In 2022, roughly 52% of goods that the European Union imported from non-EU countries, and around 59% of goods that the bloc exported to these countries, were invoiced in euros.
Following in the EU’s footsteps, Global South countries are leveraging new technologies to promote the use of LCS for bilateral trade, which can ease balance-of-payments constraints and sustain economic growth. China, for example, has developed its own Cross-Border Interbank Payment System, established bilateral swap lines with nearly 40 foreign central banks, and successfully pushed to denominate oil contracts in renminbi. Total Energies and China National Offshore Oil Corporation concluded China’s first purchase of liquefied natural gas in renminbi through the Shanghai Petroleum and Natural Gas Exchange last year.
In 2022, the Reserve Bank of India established a mechanism to enable international trade settlement in rupees, which could save around $30 billion in dollar outflows if used for Russian oil imports. Among the BRICS+ countries (Brazil, Russia, India, China, South Africa, Egypt, Ethiopia, Iran, and the United Arab Emirates), trade settled in national currencies has reportedly surpassed that in dollars. Cross-border investment in local currency is also set to rise, with the BRICS’ New Development Bank raising its local-currency lending from about 22% to 30% by 2026 to mitigate the impact of foreign-exchange fluctuations and remove cash-flow bottlenecks in financing projects.
For emerging and developing economies, de-dollarization can also mitigate the adverse spillover effects of the US Federal Reserve’s policymaking. The Fed’s most recent aggressive tightening cycle has exacerbated macroeconomic instability and dampened growth, ensnaring more and more countries in the middle-income trap and preventing global income convergence. As research by the International Monetary Fund shows, a sudden stop in capital flows to an emerging-market economy leads to an average 4.5% decline in GDP growth that year, and a 2.2% decline the following year.
De-dollarization may also reduce the need to hoard reserves, a form of insurance against external shocks and financial volatility that implies massive opportunity costs for emerging and developing economies. These countries’ monetary authorities could instead invest in higher-yielding assets, thereby generating more resources to meet development challenges, including investments that strengthen resilience to climate change.
Precautionary reserves are especially damaging for low-income countries with higher credit risks and larger interest-rate spreads, as they often involve reverse carry trades. Bangladesh currently holds a record $46.4 billion in low-yielding currency reserves to stabilize the taka while paying more than 8% interest on its sovereign bonds.
The Nobel laureate economist Joseph E. Stiglitz estimated the annual cost of reserve hoarding for developing countries at more than $300 billion – 2% of their combined GDP – in the mid-2000s. That figure is undoubtedly higher today, given the increase in excess reserves and the growing number of countries with sub-investment-grade credit ratings accessing international capital markets.
To be sure, de-dollarization also serves as a hedge against US financial sanctions, which are expected to proliferate under Trump. But the myriad other benefits of pursuing such a policy, especially in terms of macroeconomic management and growth, are huge, and will likely outweigh the costs of the retaliatory tariffs that Trump has promised to impose on currency competitors.
The process may be slow-moving. Powerful network externalities, coupled with the depth and liquidity of the US capital markets, have made it difficult to dislodge the dollar, even though America lost its status as the world’s largest trading economy more than a decade ago. But the shift to non-traditional reserve currencies in an increasingly multipolar economic system, and the growing importance of the cross-border use of national currencies in fueling growth and achieving global income convergence, suggests de-dollarization will continue. And a tsunami of tariffs and sanctions under the next US administration will surely help it along.
Copyright: Project Syndicate, 2024.