One of the more intriguing financial trends that has gained popularity in recent years is the de-dollarization movement. De-dollarization is an effort by a growing number of countries to reduce the role of the U.S. dollar in international trade. Countries like Russia, India, China, Brazil and Malaysia, among others, are seeking to set up trade channels using currencies other than the almighty dollar. With so much of the world economy reshaping itself in the post-pandemic landscape, is the reserve status of the U.S. dollar going to be the next domino to fall?
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To answer that question, it’s important to understand how the dollar got to its current status and why some folks wish to change it.
History of the Reserve Currency
For centuries, the world has had what’s known as a reserve currency. A reserve currency is the currency in which the majority of the world’s international transactions are handled. Historically, reserve currencies have been the currencies of a series of European colonial powers, including Spain, France and England at various points. These empires often backed their currencies with precious metals, typically gold, in addition to the implicit backing of the state.
Following World War I, the British economy struggled to regain its vigor. Much of the world’s gold flowed from London to New York for safekeeping and speculation in the roaring 1920s U.S. equity bull market. America’s dominant role in World War II further cemented New York as the financial capital of the world, and the dollar as its most important currency. The greenback was formally made the world’s reserve currency in 1944 as a result of the Bretton Woods Agreement, a status that sterling had previously held.
The timeline then fast forwards to 1971. In that year, President Richard Nixon abandoned the gold standard. From that point on, the dollar has been backed not by precious metal, but purely by the full faith and credit of the U.S. government. And since 1971, numerous people have called for the end of the U.S. dollar as the world’s reserve currency. Will the 2020s be the tipping point when these calls turn into action?
Why the Dollar Is King
There are several factors that have led to the dollar maintaining its international reserve currency status. One is the so-called petrodollar. The vast majority of the world’s oil transactions occur in dollars. As the global oil trade amounts to billions of dollars per day and all countries need energy, this creates a great deal of demand for dollars to facilitate these transactions.
While oil is the most obvious example, there’s a broader need for a world unit of exchange. Consider a scenario where a Brazilian farmer sells soybeans to a Japanese condiments company. It’s highly unlikely that the Japanese firm would have Brazil’s currency, the real, on hand to pay the farmer. Similarly, the Brazilian grower is not going to want to accept Japanese yen in exchange for their soybeans. Thus, the logical solution is to use an intermediary to convert yen into dollars, buy the soybeans with dollars and then have the producer convert those dollars into their local currency.
To that point, the Federal Reserve estimates that between 1999 and 2019, the dollar accounted for 96% of international trade transactions in the Americas, 74% in Asia and 79% around the rest of the globe. Globally, banks used dollars for approximately 60% of their nondomestic deposits and loans. And in the foreign exchange market today, the U.S. dollar is on one side of almost 90% of all transactions.
There has been much discussion about trying to create an alternative to the dollar. The euro looked like it might have a chance at the turn of the century. But the 2008 financial crisis and various political and economic shocks in Europe since then have diminished the standing of a central European currency as a world standard. Japan has its own issues with a stagnant economy and shrinking population. China is unlikely to become a reserve currency anytime soon given the extreme capital controls that its government places on the use of the yuan.
All other potential candidates are likely too small to be a reserve currency. The Swiss franc, for example, is known as a stable and well-regarded currency. However, the economy it’s tied to is tiny and would not be able to support the huge capital flows required of an international reserve currency.
Renewed De-dollarization Movement
After a period of stability on the monetary front, 2022 and 2023 brought renewed calls for a meaningful alternative to the dollar. This movement started in 2022, when the U.S. imposed all-encompassing sanctions against Russia following that country’s invasion of neighboring Ukraine. Various other world leaders took umbrage at the idea that the U.S. could freeze their funds due to any sort of diplomatic or military dispute.
Inflation is also weakening the standing of the dollar on the international stage. Since the 1980s, the U.S. has maintained an average low and steady inflation rate, giving savers around the world the confidence to hold their assets in dollars. In recent years, however, inflation soared to previously unimaginable levels, calling into question the security and stability of the dollar for long-term savings and investments.
Against this backdrop, leaders of countries such as China, India and Brazil have been calling for moves to trade directly with each other in their own currencies while cutting the U.S. dollar out of the equation. This would incrementally diminish the role and importance of dollars while creating a multipolar financial world where the next tier of economies would have significantly more say in global affairs.
Russia and South Africa, along with the aforementioned three countries, comprise what’s known as BRICS, a group of emerging countries in a loose economic alliance to counter Western influence. In 2023, BRICS agreed to induct six new countries into its bloc: Argentina, Egypt, Ethiopia, Iran, Saudi Arabia and the United Arab Emirates. These admittances make even more imposing a group of nations that already accounts for about 40% of the global population. At the 2024 BRICS Summit, Russian President Vladimir Putin spoke out about the so-called weaponization of the dollar.
“The dollar is being used as a weapon. We really see that this is so. I think that this is a big mistake by those who do this,” Putin said.
He also noted that nearly 95% of trade between Russia and China now takes place in rubles and yuan, bypassing the dollar. Russia is also reportedly working on developing an alternative international payments system to the Belgium-based Swift system.
But more importantly, BRICS members have floated the idea of creating a single BRICS currency to use to transact with one another. Russia even recently unveiled a prototype BRICS banknote, but there appears to have been little actual progress in creating a functional BRICS currency or payment system at this point.
While no BRICS currency is imminent, the idea is out there and it’s no longer a harebrained and fringe concept. A future counterweight to the greenback could take several different forms, such as a central bank digital currency, a stablecoin, a basket of existing BRICS currencies or even a currency backed by precious metals like gold and silver.
Is De-Dollarization Coming?
The good news for Americans is that the value of the dollar has held up well in recent years, despite growing U.S. debt and inflation. In fact, the U.S. Dollar Index is up 6.6% overall in the past five years. Unfortunately, it has reversed course somewhat in the past six months, dropping about 0.7%.
Bank of America economist Claudio Irigoyen recently discussed international fears surrounding U.S. debt levels and the impact that debt could have on the dollar in the long term. Irigoyen says the U.S. will likely not default on its massive debt load, but global economists are concerned the U.S. will instead choose to erode away the value of that debt via inflation.
“If the U.S. moves to a point where the preferred policy is one of financial repression that allows to inflate the debt away, the market will start wondering about alternatives to the dollar as a store of value,” Irigoyen said in a note.
The price of gold has risen about 81% in the past five years to new all-time highs, nearly keeping pace with the S&P 500. Some see this rise as a red flag for the dollar, but Irigoyen says there is simply not enough gold to replace the dollar without major deflationary pressures.
Another, somewhat more radical idea is that Bitcoin could begin to absorb a portion of global central banks’ reserves, as the cryptocurrency famously has a fixed supply and is managing to gain more and more mainstream acceptance. In 2021, El Salvador became the first country in the world to accept Bitcoin as legal tender, and in early 2024, the first spot Bitcoin ETFs began trading on American exchanges.
“Even though the share of the dollar in global foreign exchange reserves has fallen by 10 (percentage points) over the last two decades, the drop in the dollar as a reserve currency has not been matched by significant increases in the share of other traditional reserve currencies,” Irigoyen said.
Instead, central banks around the world have simply taken a more diversified approach, incorporating currencies of smaller economies such as Australia and Canada.
Michael Landsberg, chief investment officer at Landsberg Bennett Private Wealth Management, says investors concerned about a weakening dollar or potential de-dollarization have ways to play defense.
“Our main message to investors is to continue to diversify portfolios outside of the U.S. to take advantage of stronger growth and a falling dollar. India continues to be our most preferred non-U.S. country for opportunities in stocks, but most of emerging and developed Asia are set up with good growth and a weakening dollar,” Landsberg says.
The iShares MSCI India ETF (ticker: INDA) is one popular way to take a diversified approach to Indian equities. The Vanguard FTSE Pacific ETF (VPL) offers diversified equity exposure to advanced Asia Pacific economies, such as Japan, Australia and South Korea.
Investors that are concerned about the complete collapse of the dollar and potential global de-dollarization can also easily invest in gold via SPDR Gold Shares (GLD).
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De-Dollarization: What Would Happen if the Dollar Lost Reserve Currency Status? originally appeared on usnews.com
Update 11/07/24: This story was previously published at an earlier date and has been updated with new information.
