De-Dollarisation: Uncle Sam Gets a Bitter Pill
(No one expects it to happen overnight, but the idea is fast gaining currency among policy makers from New Delhi to Riyadh and from Singapore to South Africa.)
Slowly but surely, the status of the US Dollar as the world's reserve currency is coming under threat as more and more nations switch over to trade settlement in local currency units. This may lead to a de-dollarized global economic order later than sooner.)
The world is at war with the United States of America!!!! Sounds crazy? You are wrong. This is not a prank that has been trending on the internet. Nor is it a fake news circulating on short messaging apps on mobile phones world over. It is real.
And you may be surprised to find that it is not the traditional enemies of the US like Russia, China or Iran who are filling in for actors in the global theater of war against the US. You will find Uncle Sam’s natural allies like the European Union (EU), members of the 10-member Association of South Eastern Nations (ASEAN) and friendly nations like India and South Africa pitted against America. Sorry if you are not finding this news of the decade on the Breaking News sections of your favorite media. That is because no one wants to tell this story as it is.
Confused. Then read on.
The war we are talking about here is a currency war of a different kind. It is the war against the King Dollar, as the US currency has been referred to in the financial media in recent times, with all other sovereign nations except a dollarized Canada on the one side of the battle front and the US on the other side. In the world of high finance, this unfolding war against the King Dollar is often dubbed as de-dollarisation. Before moving on, some context looks essential.
Dollar Rules the World by Default
Arguably, the US Dollar has been ruling the global trade and finance for a longer period that no other currency has enjoyed in the past, and will not enjoy in the future. The dollar dominance is pretty evident from the fact that about 85% of all transactions in the global foreign exchange market which is pegged at a staggering $6.2 trillion per day is done in the US currency. The US dollar also makes for a large part of the reserves of all major central banks. Approximately 94% of the total global debt of $226 trillion in 2022 (IMF estimates) are dollar denominated.
If these conditions are not necessary conditions for the dollar to reign supreme in the global economy, then the US dollar is the currency of choice for international trade in all major commodities such as oil and metals like gold, silver or copper. Together these make for both necessary and sufficient conditions for the US dollar to remain on top despite the world’s largest military power running trade deficits of $100 billion a month with impunity. Another point to be noted here is that the US has one of the highest debt-to-GDP ratios which last year stood at approximately 124% of its GDP. Despite these facts, the US currency keeps appreciating, making other currencies cheaper.
How did the US greenback reach there? For an answer, you may have to time travel a bit to the seventies. The dollar’s rise to dominance can be traced back to the landmark deal the US has signed with Saudi Arabia to make all trade in oil in the US currency in 1970. Collapse of the post-war world II economic order built on the framework better known as the Bretton Woods System in 1971 put the US currency in commanding heights of the global economy. The third piece that solved the puzzle of dollar dominance is the supreme control of the US over the international payment gateway known as Society for Worldwide Interbank Financial Telecommunications better known as Swift. All these factors helped the US currency to dominate world economic order till date.
The immediate trigger that accelerated nations' search for an alternative to the US dollar to pay or receive their import and export bill is the rapid appreciation of the greenback against all major currencies. In 2022, the US currency has gained as much as 9% against a basket of major currencies with popular currency gauge US Dollar Index (DXY) closing the year at an all-time high.
You don’t need a Harvard degree in economics to understand that a super dollar is a double whammy for other countries as on the one hand it erodes the value of local currencies proportionately. On the other hand, it pushes up the cost of import of commodities like oil and gold since they are denominated in the US Dollars. In simple terms, a 1% appreciation of the US Dollar makes other currencies cheaper by 1%. This means they have to shell out more for their imports thus importing inflation transmitted through exchange rate. In other words, most countries are paying a heavy price for a rising dollar by default. That is none of their fault. For countries who have substantial debt on their balance sheet, debt servicing becomes a new headache since most debt is denominated in the US currency. These are the reasons pushing countries to a de-dollarized world economic order.
What is De-dollarization anyway?
For the uninitiated, here is the lowdown on de-dollarization. In a narrow sense, which is more relevant in the current context, de-dollarization refers to a scenario when sovereign nations use currency or currencies other than the US dollar for settling bi-lateral or multilateral trade subject to specific agreements. Such a local currency pact helps these countries insulate their economies from the American’s problems like inflation that led to the so-called Fed pivot to tighter monetary policy. The jumbo rate hikes by the US central bank have increased the alluring appeal of the US Dollar's perceived status as `safe haven’. This has led to dollars flowing back to the US,; putting precure on the external balance sheet or balance of payment positions of many countries.
De-dollarization crowd is getting bigger and bigger as more and more nations seek out to settle their trade in local currency units. The list of countries who are in various stages of de-dollarization include India, South Africa, Brazil, Australia, Egypt, and Saudi Arabia, the estranged ally of the US. Members of the European Union have been already trading in the block’s currency euro.
Southeast Asian nations are the latest to lose patience with Dollar supremacy. Japan, whose currency went on a tailspin recently after the meteoric rise of the US currency forcing the Bank of Japan to interfere in the market, is the latest to push the idea with its trade partners. The stance of Russia, China and Iran is well known. These nations are at the forefront of the de-dollarization drive for a longer time.
As the old adage goes, 'all good things come to an end’. And if the tidings in the different parts of the world economy is anything to go by, then the US dollar's good days have hit a home stretch. This is not to say that de-dollarization will happen tomorrow. But the idea is nevertheless fast gaining currency among policy makers across continents slowly but surely. To predict when it will happen is a long shot.
To say the least, though music is still going on, the party may soon end for the US Dollar as the rest of the world is no longer singing `Viva America’.