Changing World Order: De-Dollarization under Review
If we talk about history, post-World War II, with the 1944 Bretton Woods Agreement that pegged all international currencies to the dollar, which in turn was pegged to gold. Enshrined the dollar as the leading world currency for trade and reserves. And further made sure, via an agreement with Saudi Arabia in 1945, that oil was henceforth to be traded only in dollars, thus embarking its ascribed role as the world’s leading currency.
The use of a language by just one person, of course, is of no social value. The greater the number of people who speak a language, the more it can facilitate communication. Similarly, as a greater number of nations started keeping US dollars as foreign exchange reserves the importance of the currency grew to a limit that all possible trade became dollar-centric.
Additionally, the International Monetary Fund (IMF) suggested three conditions if a currency is to taken as an international currency. First, there needs to be confidence in its value and, therefore, in the issuing country’s inflation performance. In order to serve as an international unit of account and medium of exchange, a currency should have a stable value that is, its price relative to other currencies should provide sufficient information to economic agents, making it unnecessary for them to undertake costly investigations. High and variable inflation generates nominal exchange rate depreciation and uncertainty.
Second, there needs to be confidence in the political stability of the issuing government. Third, the issuing country should possess financial markets that are substantially free of controls, broad (that is, containing a wide variety of financial instruments), and deep (that is, having well-developed secondary markets). Well-developed financial markets contribute to the international demand for a country’s currency, reflecting central banks’ and other investors’ preferences for safe, liquid financial instruments.
The US dollar satisfied all three conditions. Hence since the middle of the 20th century, the United States dollar has been the dominant global reserve currency.
However, now the wind seems twirling around trade or exchange in terms of local or national currencies. It is allowing many countries to deal with other nations in a facile way. The China Daily, in 2023, reported that, 60 countries trade in their national currencies instead of the dollar. This phenomenon is known as De-dollarization. This article delves into this concept from basics to its implications.
What is De-Dollarization?
De-dollarization is the decrease in the process of dependence on the U.S. dollar for international trade, finance, and also as a reserve currency. It involves crafting a policy of diversification of the reserve currency, trade in some other currencies, and the construction of alternative financial systems.
Reasons for De-Dollarization
- Countries like China and Russia have been sanctioned in the past by the United States of America (USA). Thus, in order to reduce their vulnerability on the US Dollar, these nations are mitigating their risk associated to the financial system. Hence, leading the De-Dollarization.
- By reducing their dependence on the US Dollar, countries aim to stabilize their own currencies and protect their economies from dollar-related volatility. For instance, China’s Belt and Road Initiative promotes the use of the yuan in international trade, while Russia has increased its ruble and yuan trade.
- Countries are diversifying their reserves with other currencies and gold. This trend was observed more significantly when countries like Chin , India and Russian were purchasing gold through their central banks more abundantly.
- Recent small trends:
- Countries are entering agreements to trade in their national currencies. Russia & China have started their trade in rubles and yuan as mentioned above, and India & the UAE are discussing trading in rupees for non-oil commodities.
- To reduce dependence on the dollar, central banks in several countries have significantly increased their gold reserves. This move is made to back potential new currencies and provide a stable alternative to the US currency.
- China has introduced yuan-denominated oil futures, challenging the longstanding Petro-dollar system. This shift aims to enhance the global use of the yuan, particularly in oil trading.
The process of De-dollarization could potentially lead to the appreciation of the value of the local currency and moderate the geopolitical risks of the participating countries. However, de-dollarization might lead to short-term instability, since it is the broad acceptance of the alternative. It is, in other words, that more than a simple process, de-dollarization is very complex in most of its cases, driven by geopolitical, economic, and strategic reasons. It reflects global implications.
Impact of De-Dollarization on the USA
Fundamentally, de-dollarization would shift the balance of power among countries, and this could in turn reshape the global economy and markets.
The impact would be most acutely felt in the U.S., where de-dollarization would likely lead to a broad depreciation and underperformance of U.S. financial assets versus the rest of the world.
As per an article by JP Morgan, the effect of de-dollarization on U.S. growth is uncertain. While a structurally depressed dollar could raise U.S. competitiveness, it could also directly lower foreign investment in the U.S. economy. In addition, a weakening dollar could in principle create inflationary pressure in the U.S. by raising the cost of imported goods and services, though benchmark estimates suggest these effects may be relatively small.
China’s Role in De-Dollarization
The reduction of risks for China, concerning U.S. sanctions, results in the creation of a diversified financial infrastructure for the country, in the development of the use of Renminbi (RMB) in international transactions, and the economic partnership expansion throughout the world.
- Cross-Border Payment and Settlement Infrastructure (CIPS)
China had developed the Cross-Border Interbank Payment System, CIPS. It would be an alternative to the US-dominant SWIFT system. SWIFT systems allow most of the international financial transactions. This system is under the U.S. influence, as the country has immense supervisory powers. All the transactions that are done through SWIFT can be tracked through the U.S. Treasury and can be limited if it so deems fit. This is an important weapon that can be used to apply sanctions.
CIPS was established in 2015 and serves mostly as a clearinghouse for RMB. Towards the end of 2021, it had connected 1,259 foreign and domestic institutions, a far cry in scale from its founding. Though most transactions through CIPS are still passed on through SWIFT, the service is expected to become a more fully independent interbank messaging system.
- RMB’s transactions in international trade
China has been promoting the use of renminbi in international trade to reduce r eliance on the U.S. dollar. The move appears to be another piece in a grand strategy to free its economy from total U.S. control. By encouraging trading partners to settle in RMB, China can thus reduce the volume of transactions that have to go through dollar-denominated systems.
Trade between China and Russia has developed to be increasingly set off in their local currencies. This bypasses the dollar but at the same time, it affects economic relations between the two nations. China has also been trying to press similar arrangements with other countries participating in the Belt and Road Initiative and within the BRICS grouping, furthering the international use of the RMB.
- Gold Reserves
China has massively increased its gold reserves as part of a strategy to hedge economic risks and back the value of RMB. Gold represents stability where one can seek security in cases of economic crisis; Hence, it plays a very crucial role in China’s financial strategy. Owning huge reserves of gold will give China a chance to possibly gain confidence in its currency and insulate itself from external economic pressures, including those related to U.S. sanctions.
- Bilateral and Multilateral Financial Agreements
Besides this, it has also looked to bilateral and multilateral financial arrangements, which serve the purpose of deepening the existing sanctions buffer and increasing the use of the RMB. These mechanisms have been devised to develop an independent network of economic partners insulated from the U.S. financial system. For example, most of the promising trade taking place in RMB countries like Saudi Arabia involves conversations on pricing oil in yuan, rather than pricing it in dollars.
- U.S. Monetary Policy
The growing volatility in U.S. monetary policy has only helped China’s own efforts to promote the use of the RMB. Chinese policymakers have been open about their frustration over ad-hoc Federal Reserve policymaking that affects the global economy. By reducing dependence on the dollar, such a move might insulate China’s economy from control in U.S. monetary policy and rapid interest-rate hikes by the Federal Reserve, like those that occurred during the global financial crisis.
Russia’s Role in De-Dollarization
The de-dollarization moves of Russia are a distinctive combination of geopolitical pressure, economic strategy, and financial innovation. But while the case for what underpins China is somewhat fair, some clear differences in determinants impress upon Russia in this regard. Its geopolitical context, energy dominance, and strategic alliances.
- Geopolitical Technicalities and Sanctions Pressure
The relations between Russia and the West have grown quite tense, especially after the annexation of Crimea in 2014, raising the situation to such a level that the US and EU have placed gargantuan sanctions on Russia. Western response to the annexation of Crimea included placing sanctions on parts of Russia’s economy, such as finance, energy, and defense, which caused Russia to move quickly towards alternative methods of wipes to eliminate the risk of vulnerability to Western economic pressures.
In retaliation to these action plans, Russia designed a way to revamp the financial constraints, which involved an increased value of the transactions denominated in non-dollar currency, discarding the use of the dollar in trade with non-Western countries, and releasing its stock of U.S. assets. Stronger sanctions in the aftermath of the 2022 invasion of Ukraine have further fastened these efforts.
• SPFS (System for Transfer of Financial Messages): The money transfer system in RF allows transferring messages along with it. In contrast to SWIFT, the SPFS is an option that will allow Russia to continue to pass financial messages and make transactions even when it is under sanctions. It was gradually expanding interfacing with the countries’ systems in other countries to allow cross-border payments not to depend on SWIFT.
• National Payment System (Mir): Launched as an alternative to Visa or Mastercard, the Mir card system allows Russians to maintain domestic and international transactions even without Western financial services.
- Energy Exports and Ruble Settlements
Russia, a major energy export nation in the world, holds a big stand in the global energy markets. It has leveraged this opportunity to push forward ruble-denominated transactions, especially on the selling of its oil and gas. With this, it lowers its dependence on the dollar, further insulating its economy from the dollar-centric financial systems.
• Oil and Gas Transactions: Russia has taken to transacting oil and gas in rubles and other currencies with countries like China and India. This move would help not only to deceive bans but also increase its economic relations with the respective nations.
• Gazprom and Rosneft: Russian energy giants have been in the lead of the initiatives to price and settle in rubble contracts supporting the use of local currency in pricing and settlements in the international energy trade.
- Strategic Alliances
Russia, which is among the five countries that make up the EAEU, is fast and furiously pushing for the use of local currencies within this economic bloc as it moves to reduce regional dependence on the use of the dollar.
One of the main areas of de-dollarization is related to the strategic partnership between China and Russia. The countries took common actions aimed at extending the use of the ruble and the yuan for business. They collaborated in implementing a number of projects that serve as an instrument of economic rapprochement and mutual benefit.
• Bilateral Agreements: In addition, bilateral deals to trade in local currency between Russia and a series of its fellow trading partners effectively bypass the dollar; this includes deals with countries in Southeast Asia, Turkey, and Iran.
• BRICS: Russia also advocates for declining reliance on the dollar in the hope of increasing financial cooperation for trade and investment in local currencies among the BRICS.
- Other Developments in Financial Infrastructure
• Cryptocurrency: The country is currently working on the issues of using cryptocurrencies and a digital ruble in the overall strategy of de-dollarization. The technologies are designed to provide more purchasing power in international transactions and reduce reliance on normal traditional finance systems. Russia has been struggling to have cryptocurrency laws that will make digital transactions not only safe but under the control of the state.
• Digital Ruble Pilot: The Bank of Russia has opened projects for the digital ruble pilot to enable domestic and cross-border payments with the digital currency of the country’s central bank.
Although there is some joint motivation with China, Russia’s approach to de-dollarization is decisively shaped by its geopolitical challenges and strategies in the energy market, and above all by its general position on economic sovereignty. These were the points of exception that underlie the importance of Russia as a critical factor in the processes of global de-dollarization and the forging of a more multifaceted financial landscape.
India under the De-Dollarization
Over the recent period, India has been playing a major role in the global de-dollarization movement with the help of several key strategies. It has been pushing aggressively for bilateral trade agreements that favor the use of local currencies and reduce reliance on the dollar. At a BRICS level, it is encouraging the use of intra-group trade with local currencies. The Reserve Bank of India diversified the country’s foreign exchange reserves by increasing the purchase of gold and major other currencies.
An attempt to internationalize the rupee does not only include the encouragement of the neighboring country’s use in trade but also the development of a Unified Payments Interface for international transactions. India is also looking at developing a BRICS payment system and conducting energy transactions in other currencies with non-dollar currencies with countries such as Iran and the UAE. These measures are not only going to help reduce the dependency of India on the dollar but also increase the economic sovereignty and resilience of the country.
Way Forward
The transition away from the US dollar as the world’s reserve currency, known as de- dollarization, can be a complex and challenging process. One of the biggest challenges is the potential for devaluation or loss of trust in the new currency. If the new currency is not seen as being as stable or as liquid as the dollar, it could lead to economic instability and hinder financial transactions. It is therefore important to build confidence and trust in the new currency before making the switch.
Another challenge is that many commodities, such as gold and oil, are priced and traded in dollars. This means that shifting away from the dollar could complicate international transactions and make it more difficult to trade these commodities. This could also hamper foreign direct investment and capital flows. Countries with significant debt in USD will also face special challenges when trying to reduce their reliance on the dollar. If they suddenly move away from the dollar, their debt could become more expensive because their currency may lose value or exchange rates may fluctuate. This could lead to financial instability and make it more difficult to repay the debt.
Countries with less developed financial markets or limited policy tools may face greater challenges in managing exchange rate volatility. The successful management of these challenges is crucial for preserving global financial stability and sustaining economic growth. Therefore, these a number of potential risks and disruptions need to be carefully considered before embarking on a de-dollarization strategy.
Dhruv Kumar Singla
Dhruv Kumar Singla is Graduation Student at Gokhale Institute of Politics and Economics with a keen interest in Finance and Investment. He has been working upon research projects in the same area.
