Why we can’t count on the dollar’s downfall

The de-dollarization train is certainly picking up pace. Over the past few weeks, there have been growing suggestions that the dollar is about to lose its status as the dominant international currency.

In recent months, Malaysia's Prime Minister declared there is “no reason for Malaysia to continue depending on the dollar”, while China welcomed talks about a potential Asian Monetary Fund. Simultaneously, international transactions in yuan have risen while China and France recently completed their first LNG transaction in CNY.

China and Saudi Arabia have agreed to build a refinery for ¥83.7bn CNY without any payment in USD. Russian companies have issued bonds in CNY for a record amount of 7bn USD in 2022. Additionally, the Yuan has replaced the euro as Brazil’s second major foreign exchange reserve. It’s therefore unsurprising that talk about the end of the dollar and China’s inevitable takeover is on the rise.

However, we’ve heard this song before. Some brief research found several articles published in English-speaking newspapers in 1975. The headlines stated that OPEC was looking to sever all ties with the U.S. dollar. Kuwait’s oil minister at that time triumphantly announced a plan to enable oil prices to be denominated in a range of currencies (without specifying which currencies) excluding the US dollar. Of course, the plan failed to materialise.

A similar case occurred in 2019 when the first oil contracts in CNY were issued. This was presented as a new step toward the de-dollarization of the world. Frankly, the plan has been unsuccessful thus far.

About 90% of all oil transactions are in USD, and according to the BIS report, nearly 88% of international trade is in USD. Ultimately, the dollar certainly hasn’t surrendered its healthy lead.

The Dollar’s Dominance

There is a multitude of positions that the dollar holds in global exchange that would make it extremely difficult for an alternative currency to surpass it as the world’s main reserve. A particular vantage point that the USD holds is that the majority of the world’s debt is issued in dollars. To settle dollar debt, one must have access to dollars. This creates a global reliance on the currency that would be extremely difficult to navigate away from.

In a similar vein, most of the world’s oil trade is conducted in dollars, particularly in the Middle East. Despite recent speculation that the petrodollar system may be at risk, this is another avenue of global dependency on the dollar that would prove highly complicated to replace.

Last year, it was announced that Saudi Arabia would consider using yuan rather than dollars for Chinese oil sales which sparked talks of a post-dollar world. More recently, China and Russia were reportedly ready to challenge the petrodollar. Despite rumours and conjecture, the dollar has remained the principal oil currency for over 50 years, while less than 3% of global oil exchanges are made in yuan. Needless to say, the dollar remains steadfast for now.

There are also a range of basic structural factors favouring a dollar-centric global monetary system. The dollar benefits from being extremely liquid, but the Yuan is not. The dollar is freely convertible, while the Yuan is not.

Fundamentally, the United States has the most powerful economy and military in the world whilst also being the globe’s largest oil producer. All of this leaves China with clear incentives to keep the U.S. dollar.

Another interesting factor that reasserts the dollar’s dominance is the role of military cooperation and involvement. A recent study published in October 2022 by Fed economist, Colin Weiss, establishes a clear correlation between the proportion of dollars held in a country’s foreign exchange reserves and the military relationship it has with the United States. Weiss illuminates that ¾ of the global U.S. dollar reserves are held by countries which have an established military connection with the United States.

Even in the unlikely scenario that the dollar drops off in international trade and debt denomination, it still has the means to retain its dominance due to a deep military authority.

Looking to the future

The dollar’s strong and deep-rooted position as an international currency should not be misinterpreted as invulnerability. In the long run, the only way the US can accommodate the growing global demand for safe assets is by stretching its fiscal and financial capacities, which could strain investors’ trust in the dollar and lead to volatility and self-fulfilling crises.

Reliance on the dollar as a single currency also creates an obvious imbalance both for the US and the dependent nations. It hollows out the U.S. domestic industrial capacity in exchange for widening the external reach of the political and military influence of the country.

That said, barring a transformative shift in geopolitical and economic power, the U.S. dollar will likely continue to be the keystone of the global economy for the foreseeable future.

Over the past centuries, one reserve currency was replaced by another, but it won’t happen this time. We are slowly but surely entering a more decentralized global monetary system where the U.S. dollar will retain its position as the main reserve currency alongside several competitors including the yuan. Such a move will benefit global economies, but none more so than the US economy.