In recent times, the global stage has witnessed a series of events that have reignited debates about the future of the US dollar as the world’s predominant currency. As geopolitical rivalries intensify, the aftermath of Russia’s involvement in Ukraine’s conflict, and the ongoing debate over the US debt ceiling in Washington, the dollar’s status has come under fresh scrutiny.
Speculation about de-dollarisation gained traction following Russia’s sanctions-induced isolation from the global financial system last year, leading to increased belief that non-US allies would seek to diversify their reserves away from the dollar. These developments have prompted an exploration of arguments both for and against the notion of de-dollarisation.
Proponents of de-dollarisation point to the declining share of the dollar in official foreign exchange (FX) reserves, which reached a 20-year low of 58% in the fourth quarter of 2022, as reported by the International Monetary Fund. This downward trend becomes even more pronounced when adjusted for exchange rates, indicating a significant shift away from the dollar in real terms. Notable countries such as Saudi Arabia, China, India, and Turkey have begun reconsidering their reliance on the dollar, exploring alternative currencies for diversification.
However, taking a longer-term perspective, critics argue that while the dollar’s share in central banks’ foreign reserves did reach a two-decade low, the decline has been gradual, and the current level is comparable to that of 1995. Central banks traditionally hold significant reserves in dollars to stabilize exchange rates during economic crises. If a currency weakens excessively against the dollar, essential commodities, such as oil, become more expensive, leading to higher living costs and inflation. Consequently, many currencies, including the Hong Kong dollar and the Panamanian balboa, are pegged to the dollar to mitigate such risks.
Moreover, the dollar has historically maintained a firm grip on commodity trading, enabling the United States to exert control over market access for producer nations such as Russia, Venezuela, and Iran. Nevertheless, the dynamics of global trade are changing. For instance, India has started purchasing Russian oil using the UAE dirham and the Russian ruble. China, too, has shifted to the yuan for buying Russian oil, coal, and metals, marking a significant departure from the dominance of the dollar. The yuan’s share of global over-the-counter forex transactions has risen from nearly negligible levels 15 years ago to 7%, according to the Bank for International Settlements. The emergence of alternative trade currencies is driven by concerns among nations about the potential consequences of falling on the wrong side of US sanctions.
However, transitioning away from the dollar would entail a complex and extensive network of exporters, importers, currency traders, debt issuers, and lenders independently deciding to adopt alternative currencies—a highly unlikely scenario. The dollar currently accounts for approximately 90% of global forex transactions, representing a staggering $6.6 trillion in 2022, as reported by the Bank for International Settlements. Moreover, around half of all offshore debt is denominated in dollars, and approximately half of global trade is invoiced in dollars. The interconnected nature of the dollar’s functions makes simultaneous behavioral changes by banks, firms, and governments exceedingly challenging to achieve.
While a single currency may not emerge as a direct successor to the dollar, the rise of various alternatives could lead to the creation of a multipolar world. Nations are increasingly recognizing the importance of diversification beyond one or two dominant reserve asset blocks. Central banks across the globe are exploring a broader range of assets, including corporate debt, tangible assets like real estate, and other currencies, signaling an ongoing process of transformation. Mark Tinker, the managing director of Tosca fund Hong Kong, asserts that the use of the dollar in the global system will likely decline as a result.
Nonetheless, the foundation of the dollar’s supremacy lies in the $23 trillion US Treasury market, which serves as a safe haven for businesses seeking cash alternatives due to the absence of guaranteed deposit insurance for large bank deposits. The depth, liquidity, and perceived safety of the Treasury market contribute significantly to the dollar’s position as a leading reserve currency. Brad Setser, a fellow at the Council on Foreign Relations, highlights the vast international holdings of US Treasuries, emphasizing that there is currently no credible alternative. Although Germany’s bond market exceeds $2 trillion, it is relatively small in comparison. Additionally, while commodities producers may agree to trade with China in yuan, complications arise when it comes to channeling funds into Chinese government bonds due to difficulties in opening accounts and regulatory uncertainties. In contrast, trading Treasuries can be easily facilitated through mobile applications from anywhere around the world, further solidifying the dollar’s unshakeable foundation.
As the global landscape continues to evolve, discussions surrounding the future of the dollar persist. While de-dollarisation remains an ongoing topic of debate, the dollar’s enduring dominance appears rooted in its vast reach, extensive liquidity, and the unrivaled appeal of the US Treasury market. As nations explore alternatives and diversify their holdings, the path towards a multipolar world beckons.
