The use of the US dollar by President Joe Biden to impose sanctions on Russia this year and new technical advancements all encourage countries to start undermining its hegemony and suddenly hunting for alternatives to the US dollar.
Some of the biggest economies in the world are looking for alternatives to the US dollar because they are sick of an overpowered and newly weaponized greenback.
De-dollarization is also being tested in small nations, including at least a dozen in Asia. Additionally, businesses all across the world are selling a historically large share of their debt in local currencies out of concern for future dollar strength.
Nobody is predicting that the dollar will lose its dominance as the main form of exchange any time soon. Demands for “peak dollar” have frequently turned out to be premature. But not very long ago, it was practically unheard of for nations to investigate payment methods that did not use US dollars or the SWIFT network, which is the foundation of the world financial system.
Now, the dollar’s inherent strength, its use by President Joe Biden to impose sanctions on Russia this year, and new technical advancements all encourage countries to start undermining its hegemony. Treasury officials chose not to comment on these events.
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“This will simply intensify the efforts in Russia and China to try to manage their part of the world economy without the dollar,” said Paul Tucker, a former deputy governor of the Bank of England in a Bloomberg podcast.
The Biden administration erred by turning the US dollar and the international payment system into weapons, according to John Mauldin, an investment strategist and head of Millennium Wave Advisors with more than three decades of market experience.
“That will force non-US investors and nations to diversify their holdings outside of the traditional safe haven of the US,” said Mauldin.
After the invasion of Ukraine, already-in-progress plans in Russia and China to promote their currencies for cross-border payments, including through the use of blockchain technologies, intensified rapidly. For instance, Russia started asking for payment in rubles for energy supplies.
Bangladesh, Kazakhstan, and Laos, among others, soon began stepping up negotiations with China to increase their usage of the yuan. India started promoting the globalization of the rupee more outspokenly, and only this month it began establishing a bilateral payment system with the United Arab Emirates.
But it seems like things are moving slowly. Due of Bangladesh’s significant trade deficit with China, for example, yuan accounts haven’t taken off there. Salim Afzal Shawon, chief of research at Dhaka-based BRAC EPL Stock Brokerage Ltd., said Bangladesh had attempted to pursue de-dollarization in its trade with China, but the flow was essentially one-sided.
The decision by the US and Europe to cut off Russia from the SWIFT global financial messaging system served as a major impetus for those plans. The majority of big Russian banks were forced to rely on their own, much smaller version of the network as a result of the action, which the French referred to as a “financial nuclear weapon” and cut them off from.
This had two effects. First, US sanctions on Russia raised concerns that the dollar would more permanently turn into an overt political tool. This worry was particularly shared by China, but it also extended beyond Beijing and Moscow. For instance, India is creating a homegrown payment system that resembles SWIFT in certain ways.
Second, economies in Asia are under additional pressure to take a side as a result of the US determination to utilise the currency as part of a more assertive type of economic statecraft. Without an alternate payment method, they would be forced to abide by or impose sanctions with which they would not agree, which would result in lost commerce with important partners.
“The complicating factor in this cycle is the wave of sanctions and seizures on USD holdings,” said Taimur Baig, managing director and chief economist at DBS Group Research in Singapore. “Given this backdrop, regional steps to reduce USD reliance are unsurprising.”
Governments across Asia are being pushed to go their own way by US sanctions against Russia, even though they would prefer to maintain relations with both countries and are reluctant to choose a winner in the US-China dispute. A political or nationalist undertone can occasionally be heard in the action, particularly resentment of Western pressure to impose sanctions on Russia.
Moscow tried to persuade India to choose a different system in order to keep trade flowing. A spokesman for the Myanmar government claimed that the dollar was being used “to bully smaller nations.” And Southeast Asian nations cited the incident as justification for increasing their use of local currencies in trade.
“Sanctions make it more difficult – by design – for countries and companies to remain neutral in geopolitical confrontations,” said Jonathan Wood, head of global risk analysis at Control Risks. “Countries will continue to weigh economic and strategic relationships. Companies are caught more than ever in the crossfire, and face ever more complex compliance obligations and other conflicting pressures.”
The dedollarization process is accelerating for more reasons than just the sanctions. Asian governments’ attempts at diversification have been more aggressive as a result of the US dollar’s rabid growth.
According to a dollar index published by Bloomberg, the dollar has risen by almost 7% this year, putting it on pace to record its largest annual gain since 2015. As the value of the dollar increased in September, every currency—from the British pound to the Indian rupee record lows.
For Asian countries, where food costs have risen, debt repayment burdens have gotten worse, and poverty levels have gotten worse, the strength of the dollar is a major problem.
As an example, Sri Lanka made its first-ever default on its dollar debt due to a rising dollar that made it impossible for the country to make payments. At one point, Vietnamese officials attributed fuel supply issues on the dollar’s gain.
Therefore, actions like India’s agreement with the UAE accelerate a long-running campaign to expand the use of the rupee and establish trade settlement agreements without using US currency.
In contrast, non-financial corporations’ sales of dollar-denominated bonds have fallen to a record-low 37% of the worldwide total in 2022. They have represented more than half of the debt sold in any one year on several occasions in the past decade.
Even if all of these actions might not have much of an immediate market impact, they might eventually cause the demand for the dollar to decline. For instance, the proportions of the Canadian dollar and the Chinese yuan in all currency trades are already gradually rising.
Another aspect aiding efforts to move away from the dollar is technological advancement.
As a byproduct of attempts to establish alternate payment networks—a drive that predates the soaring greenback—a number of economies are reducing their reliance on the dollar. Thailand, Malaysia, Indonesia, Singapore, and all these countries have established procedures that allow for local currency exchanges rather than dollar exchanges. Taiwanese citizens have access to a QR code payment system through Japan.
All things considered, the attempts are shifting the momentum farther away from a West-led system that has served as the cornerstone of international finance for more than 50 years. What’s developing is a three-tier system with the dollar remaining very much at the top and growing bilateral payment channels as well as alternate domains like the yuan that aim to capitalise on any potential US overreach.
Despite all the commotion and activity, it seems unlikely that the dollar’s hegemony status will be threatened very soon. The US economy’s size and strength are undisputed, Treasuries are still among the safest places to keep money, and the dollar makes up the majority of foreign exchange reserves.
For instance, even if the renminbi’s percentage of total foreign exchange trades has increased to 7%, 88% of these trades still contain a dollar component.
“It’s very hard to compete on the fiat front — we have the Russians doing that by forcing the use of rubles, and there’s wariness with the yuan as well,” said George Boubouras, three-decade markets veteran and head of research at hedge fund K2 Asset Management in Melbourne. “At the end of the day, investors still prefer liquid assets and in this sense, nothing can replace the dollar.”
However, the coordinated moves away from the dollar pose a threat to what Valéry Giscard d’Estaing, the then-French Finance Minister, famously referred to as the “exorbitant privilege” held by the US. He first used the phrase in the 1960s to explain how the US is protected from exchange-rate risk and projects its economic strength thanks to the dominance of the dollar.
And they may finally put to the test the entire Bretton Woods paradigm, which was negotiated at a hotel in a small New Hampshire hamlet at the end of World War II and established the dollar as the dominant currency.
According to Homin Lee, Asia macro strategist at Lombard Odier in Hong Kong, whose company manages the equivalent of $66 billion, the most recent initiatives “do indicate that the global trade and settlement platform that we’ve been using for decades may be beginning to fracture.”
“This entire network that was born out of the Bretton Woods system — the Eurodollar market in the 1970s and then the financial deregulation and the floating rates regime in the 1980s — this platform that we have developed so far may be beginning to shift in a more fundamental sense,” Lee said.
The end result: Although King Dollar may continue to rule supreme for many years to come, the growing momentum for the use of other currencies shows no signs of slowing down, especially if geopolitical wild cards continue to persuade leaders to act independently.
Ironically, the US government’s willingness to deploy its currency in geopolitical conflicts may make it harder for it to adopt these strategies in the future.
“The war in Ukraine and the sanctions on Russia will provide a very valuable lesson,” Indonesian Finance Minister Sri Mulyani Indrawati said last month at the Bloomberg CEO Forum on the sidelines of the G-20 meetings in Bali.
“Many countries feel they can do transactions directly — bilaterally — using their local currencies, which I think is good for the world to have a much more balanced use of currencies and payment systems.”