The concept of ” De- dollarization” has garnered considerable interest within the context of recent global economic changes. The term pertains to the phenomenon wherein nations and economic agents endeavour to diminish their reliance on the US dollar as a reserve currency, medium of exchange, and unit of account. The preeminent status of the US dollar in the worldwide financial system has been a longstanding phenomenon. However, the ongoing trend towards dedollarization is a significant development that carries extensive implications for the prospects of global trade, investment, and monetary policy.
The significance of dedollarization within the global economy is of utmost importance. In the contemporary globalised era, the establishment of a financially stable and just system is imperative. The excessive dependence on the US dollar as a reserve currency has resulted in susceptibilities and disparities within the worldwide economy. The burgeoning economic influence of emerging markets and their inclination towards a financially robust and diversified system has spurred a keen interest in the concept of dedollarization. Hence, it is imperative for economists, policymakers, and market participants to comprehend the underlying determinants of this phenomenon and its prospective ramifications.
The ongoing process of de-dollarization in the global economy
Following WWII, the United States effectively met the demands of Western nations by creating an abundant supply of the single currency. Later, the process spread over the globe, and the dollar became the international reserve currency and a widely accepted common currency. However, the process of de-dollarization began on the eve of the previous century, when the globe saw the emergence of China and the establishment of a single currency in Europe. The US dollar presently accounts for around 58% of total global official reserves in 2023, down from 73% in 2001, when it was the “indisputable hegemonic reserve.” As a result, the dollar’s hegemonic status began to wane.
On the other hand, the development of China and India, as well as the BRICS’ unified single currency proposal, provide a new risk to the dollar’s sustainability. Furthermore, the scale of the Chinese and Indian economies represents a real challenge to the dollar. According to the IMF, China will provide 34.9% of global growth in 2023, while India will contribute 15.4%.
Moreover, the Ukraine crisis and sanctions have pushed the matter to the point where the world has seen the consequences of reliance on a single currency. The dollar’s proportion of global reserves decrease last year at a rate ten times that of the previous two decades, as a number of nations sought alternatives after Russia’s invasion of Ukraine, which provoked sanctions.
However, the growing significance of cryptocurrency in contemporary times cannot be disregarded. Cryptocurrencies possess the capability to facilitate de-dollarization as they present a substitute to conventional fiat currencies, such as the US dollar. Cryptocurrencies, due to their decentralized nature and lack of association with any specific government or nation, are not susceptible to the same geopolitical and economic influences that can impact conventional currencies.
The increasing adoption of cryptocurrencies for transactions and as a means of preserving value may potentially diminish the demand for conventional fiat currencies, such as the US dollar. The potential outcome of this scenario is a reduction in the prevalence of the US dollar as the primary reserve currency globally, and a shift towards a more heterogeneous currency system.
As a consequence, several nations have seen a de-dollarization movement during the last year. Argentina and Brazil have considered the creation of a unified currency for their two major economies. Former South-east Asian leaders met in Singapore to discuss measures to wean themselves from the US currency. The UAE and India are discussing the use of the Indian rupee for non-oil goods, indicating a move away from the dollar. Furthermore, Saudi Arabia, a traditionally staunch US ally, has showed interest in trading in foreign currencies for the first time in 48 years. These trends indicate that the global economy is shifting away from the US dollar as the primary reserve currency.
Pros and cons of de-dollarization
The possible effect of de-dollarization on global financial stability is a big problem. Changes in the composition of global reserve assets can lead to shifts in capital flows and changes in asset prices, potentially creating financial instability, particularly in emerging markets and countries with substantial dollar-denominated debt. As a result, policymakers must stay diligent in monitoring these dynamics and taking necessary actions to protect financial stability.
Another pressing issue is developing a credible alternative to the US currency. A strong economy, deep and liquid financial markets, and good monetary and fiscal policy frameworks are required to sustain an alternative reserve currency. At the moment, no one currency entirely fits these requirements, but the euro and the Chinese yuan have made progress. As a result, policymakers should explore promoting a multicurrency reserve system to give the advantages of diversity while minimising the possible costs of de-dollarization.
Furthermore, de-dollarization may cause higher volatility in currency exchange rates, especially in the early stages of the shift. Exchange rate changes may have an influence on trade, investment, and capital movements, especially in countries with less established financial markets or fewer regulatory measures to regulate volatility. Policymakers and market players must keep a careful eye on these developments and implement appropriate policy measures to avoid any disruptions. While de-dollarization has the potential to reduce developing nations’ exposure to variations in US monetary policy and increase their monetary autonomy, it also has problems and possible consequences. For nations with less established financial systems, developing deep and liquid domestic financial markets may be difficult. Furthermore, the transition’s potential costs may be high, putting a strain on scarce resources.
On the other hand, De-dollarization brings both benefits and difficulties in the context of the start-up environment. While improved access to finance in nations transitioning away from the US dollar may encourage local and regional investment, international investment may be hampered by currency worries. Cross-border transactions may grow more complicated, resulting in greater transaction costs and operational difficulties.
Moreover, market volatility may rise as markets respond to new currency dynamics, forcing start-ups to successfully manage financial risks. Increased regional cooperation, on the other hand, might stimulate innovation by providing possibilities for entrepreneurs to work on new technology and business models. Regulatory changes may necessitate start-ups adapting to new restrictions and adjusting their business strategies.
Who will benefit?
The response to the question at hand is not easily determined and is subject to a multitude of variables, including but not limited to the scope and speed of the procedure, the measures that countries implement in reaction, and the condition of the worldwide financial system in its entirety.
In the short run, de-dollarization may prove advantageous for nations with substantial US dollar-denominated debts. Emerging economies have been disproportionately affected by the COVID-19 pandemic and the ensuing economic downturn. Emerging economies have been disproportionately affected by the current situation. As the depreciation of the US dollar occurs, the burden of their debt is somewhat alleviated, thereby facilitating the repayment of their debts. Furthermore, it could be argued that these countries may have greater ease in accessing financial markets that are less susceptible to the influence of the US dollar.
Equally, countries possessing a substantial quantity of assets denominated in US dollars face the prospect of incurring financial losses in the event of a further depreciation of the US dollar. A depreciation in the worth of the US currency would lead to a reduction in the value of substantial amounts of US Treasury bonds that are possessed by nations like China and Japan.
On the other hand, should the process of de-dollarization result in a global financial system that is more multipolar and reflective of the economic and political influence of the nations involved, there is potential for long-term benefits to accrue to these countries.
To summarise, the appearance of prospective rivals to the United States dollar and the continuous de-dollarization procedure indicates the shifting dynamics of the worldwide economy and the expanding impact of developing economies. The process of de-dollarization is characterised by limitations and challenges that render its outcome unpredictable. However, it is evident that this phenomenon is a reaction to the necessity of establishing a more diverse global financial system. The potential ramifications of de-dollarization may confer advantages upon select nations while simultaneously presenting obstacles for others. However, the trajectory of worldwide currencies will ultimately hinge upon a multitude of factors, such as governmental regulations, the pace of the transition, and the condition of the global financial landscape. The potential outcomes of de-dollarization on the global financial system in terms of stability and equity, as well as its potential to exacerbate economic and political tensions, are yet to be determined.
– S. M. Saifee Islam is a Research Associate at the KRF Center for Bangladesh and Global Affairs (CBGA).