The US dollar has been the world’s dominant reserve currency for decades. However, some countries are now seeking to move away from the dollar, a process known as dedollarisation. This article examines the meaning, causes, effects, and future of dedollarisation.
What is Dedollarisation?
Dedollarisation refers to the effort by countries to reduce their dependence on the US dollar, including in international trade and as a reserve currency. It involves substituting the dollar with alternative currencies for financial stability and sovereignty.
The dollarisation of an economy happens when it adopts the US dollar as its national currency or links its national currency to the dollar. The opposite, dedollarisation, is when an economy tries to limit this dependence on the dollar and rely more on other currencies.
Reasons Behind Dedollarisation Trend
Several factors are driving more countries to dedollarise lately:
Reducing Risks of US Sanctions
The US often imposes financial sanctions against nations it is in conflict with. This includes blocking access to dollar transactions and US financial systems. Moving away from the dollar reduces this risk.
Attaining Financial Sovereignty
Relying on an external currency gives the issuing country power over monetary policy. Adopting a national currency or alternative international currency allows more domestic control.
Diversifying Foreign Exchange Reserves
Maintaining dollar-denominated assets leaves countries vulnerable to fluctuations. Diversifying into other reserve currencies creates a more balanced portfolio.
Development of Alternative Payment Systems
The rise of alternative cross-border payment channels like SWIFT alternatives enables trade without relying on US systems.
Reducing Trade Costs
Using an external currency leads to conversion costs and exchange rate risks. Trading directly with national or alternative currencies reduces such costs.
Shifting Global Power Dynamics
As the global economic center of gravity moves east, dedollarisation accelerates the transition away from overdependence on the US.
Major Dedollarisation Efforts Around the World
Here are some notable examples of dedollarisation by region:
Russia
Russia has been moving aggressively away from the dollar since Western sanctions in 2014. It has slashed the dollar’s share in exports and reserves while promoting ruble-denominated trade.
China
China is prioritizing cross-border trade in renminbi rather than dollars. It is also converting some reserves into gold and other currencies, and developing alternative payment systems.
European Union
The EU is aiming to internationalize the euro as an alternative reserve currency. It has allowed energy imports in euros and developed the INSTEX channel to bypass dollar transactions with Iran.
India
India has reduced the dollar’s share in foreign exchange reserves over the years while increasing gold and Euro holdings. It has also developed alternatives such as rupee-rial trade with Iran.
ASEAN Countries
Nations like Indonesia and Thailand are trying to reduce dollar dependence by invoicing trade in local currencies and limiting dollar exposure in debt markets.
Persian Gulf
Qatar has diversified foreign reserves away from the dollar following its rift with Saudi Arabia and other Arab states. It raised the limit on yuan holdings in reserves in 2020.
Latin America
Countries like Uruguay favour trade in pesos and reals over dollars. The SUCRE currency framework lets members like Ecuador trade without using dollars.
Effects of Dedollarisation
Dedollarisation has several implications, both for the US and countries moving away from the dollar:
Reduced Dollar Demand
Lower demand for the dollar means less support for its value, which can undermine its strength as a global reserve currency. However, alternatives are still limited.
Constrained US Monetary Policy
Other central banks decreasing their purchases of US Treasuries will constrain the Federal Reserve’s ability to pursue expansionary monetary policy.
Limited Impact of US Sanctions
The efficacy of US sanctions through the financial system will be reduced as more transactions avoid dollar settlement and US entities.
Currency Volatility
Transitioning to a multicurrency reserve system will lead to higher currency fluctuations as cross-rates become more sensitive.
Trade and Investment Boost
Trading in local currencies lowers hedging costs and risk, leading to greater cross-border commerce. It supports better regional integration.
Financial Independence
Relying on national currencies and regional alternatives grants nations more control over their monetary policy and financial systems.
Overall, reduced global dollar dominance has geopolitical implications in altering US financial power. But it also carries risks of introducing more currency instability.
Future Outlook on Dedollarisation
Dedollarisation is gaining momentum, but how far will it go? Here are some perspectives:
Incremental Change More Likely
Despite dedollarisation efforts, profound shifts away from the dollar are unlikely in the near future given the lack of alternatives with sufficient scale.
Depends on US Approach
Aggressive, unilateral actions by the US could accelerate dedollarisation, while a more consultative approach would retain dollar centrality.
Role of Alternatives
The rise of options like the yuan, euro and blockchain platforms will determine how quickly the dollar’s dominance erodes.
Tech Impact
Innovations like CBDCs and crypto could hasten a multicurrency global system, while reducing the need for reserves.
Regionalization First
Dedollarisation may progress more at a regional level first, via mechanisms like the SUCRE, before going global.
Overall, while dollar dominance will decline gradually, a sweeping global abandonment of the dollar seems far-fetched currently. The pace and extent depend on US policy as well as alternatives developing further.
Conclusion
Dedollarisation is gaining momentum but is still in early stages, given the dollar’s entrenched position. While an orderly reduction of dollar dependence can benefit global stability, excessive volatility during the transition poses risks. The future of the dollar hinges on how constructively the US leverages its status as issuer of the dominant reserve currency. Meanwhile, countries diversifying away from the dollar must implement policy changes prudently. Actively building up currency alternatives will also facilitate smoother dedollarisation. With careful global coordination, dollar hegemony can give way to a more equitable multicurrency system.
