THE RUSSIA-UKRAINE WAR, burgeoning debt of advanced nations and rising inflation in the West have turned Mission Impossible into a mission that might be possible. The U.S. dollar, which enjoyed the status of the world's reserve currency since World War-II, is now facing threats from many corners.
Recently, Brazil's President Luiz Inácio Lula da Silva appealed to BRICS nations to come up with an alternative currency to replace the dollar in foreign trade. Brazil and China agreed to use their own currencies while settling financial transactions, by-passing the US greenback. Saudi Arabia has also expressed its willingness to trade in currencies besides the dollar. Russian oil companies are settling oil trades in rouble and renminbi (RMB).
Not only RMB, the Indian rupee is also making strides in bilateral trade settlements. India and the U.A.E. are in talks to use the rupee to trade non-oil commodities, in a shift away from the U.S. dollar. India and Malaysia have also reached a bilateral agreement to settle trades in the rupee in addition to the current modes of settlement in other currencies. Moreover, the Centre has granted approvals in 60 cases for opening Special Rupee Vostro Accounts for correspondent banks from over one-and-a-half dozen nations. In mid-April, Bangladesh became the 19th nation to settle bilateral trade with India in rupees by opening Vostro accounts in SBI and ICICI Bank. The 18 others include Germany, the U.K., Russia, Israel, Singapore, New Zealand, Myanmar, Fiji, Sri Lanka, Mauritius, Botswana, Guyana, Kenya, Malaysia, Oman, Seychelles, Tanzania and Uganda.
It's not only the BRICS, but even France, a NATO member, has said that Europe should reduce dependence on the U.S. dollar. France recently settled its first gas trade in RMB.
So, is the dollar losing its sheen? Has the time come for a multi-polar reserve system where a coalition of currencies starting with 'R', mainly Brazilian real, Russian rouble, Chinese renminbi, Indian rupee, South African rand, Saudi riyal, Indonesian rupiah and Malaysian ringgit will usurp dollar dominance? Is the world headed towards de-dollarisation of the financial system?
Dollar: The Reserve Currency
The U.S. dollar emerged as a global reserve currency through the Bretton Woods agreement in 1944. Once the agreement came to an end in 1971, the Petro Dollar regime shaped global trade, where oil traded and settled in U.S. dollars.
Siddharth Singhai, founder and chief investment officer of Ironhold Capital, a U.S.-based hedge fund, says the Petro Dollar regime gave a lot of credence to the U.S. greenback. Explaining the maths behind oil trade, Singhai says at $100 million barrel per day, global crude export at $100 per barrel translates into around $3.6 trillion supply for annual global oil trades. “Oil and gas trade settlements in renminbi, rouble or rupee will adversely affect the dollar, but to what extent is a bit difficult to assess now,” he adds.
The U.S. dollar as reserve accumulation by manufacturers, including China and Japan, or oil & gas producers such as Norway and Saudi Arabia is a source of funding in Western markets. According to data from the U.S. Treasury, foreign nations have bought $3.7 trillion of U.S. Treasuries (UST) in which Japan and China are the biggest holders of U.S. debt with $1.1 trillion and $859 billion, respectively, at the end of January 2023. India is at the 11th position with $232 billion worth of US Treasuries ownership.
"Officials and private investors around the world have become dependent on financial assets denominated in U.S. dollars, mainly because of the lack of viable alternatives. UST, representing borrowing by the U.S. government, is still seen as the safest of financial assets worldwide. Therein lies the genesis of the Dollar Trap," writes economist Eswar Prasad in his book The Dollar Trap.
Ritesh Jain, co-founder of Canada-based hedge fund Pinetree Macro, says the Petro Dollar regime worked when U.S. debt/GDP was low and West Asian nations needed a U.S. military umbrella. "Today China is the biggest buyer of Saudi crude, while the U.S. does not want to share its GDP with the rest of the world, and relations between Saudi and Iran are thawing," says Jain. The world is moving from dollar hegemony to multi-currency, but it will not happen overnight, he adds.
According to the Federal Reserve research report of October 2021, since 1999-2019, the U.S. dollar accounted for 96% of trade invoicing in the Americas, 74% in the APAC and 79% in the rest of the world.
As per the International Monetary Fund, at the end of 2022, global forex stood at $11.96 trillion in which allocated reserves in currencies stood at $11.088 trillion. The U.S. dollar's share in allocated forex reserves was 58.36%, a 26-year low, but still miles ahead of second-placed euro at 20.47%.
The greenback also draws its strength from the highly liquid U.S. financial markets. In 2022, the global bond market was worth $133 trillion, in which the U.S. market alone was valued at over $51 trillion, while the Chinese market with $20.9 trillion, or 16%, of the global total was a distant second. With $1.3 trillion, or 1% of the global total, the Indian bond market looked tiny compared with the U.S. and China.
But the situation is changing. Developing nations are fascinated with the rising clout of the BRICS in general, and China in particular. The GDP of BRICS nations has surpassed the GDP of G-7 on purchasing power parity, according to U.K.-based research firm Acorn Macro Consulting. The size of the RMB bloc has climbed to 29% of global GDP from 15% in 2000. During the same period, the size of dollar currency blocs has declined from 50% of global GDP to 34%, says a Morgan Stanley report.
RMB is estimated at 7% of international transactions as per data from SWIFT. Foreign central banks across the globe held renminbi reserves worth $298.44 billion, or 2.98% of foreign currency reserves globally, in foreign central banks at the end of Q42022. These numbers appear no match to the clout of the dollar, but as a coalition with BRICS nations, a common currency could emerge as a strong rival to the greenback. Also, if more countries start trading in their fiat currencies, there are chances that the IMF SDR basket may become a de-facto reserve currency against which all other currencies are pegged. China has been pushing this agenda.
Impact of Russia-Ukraine War
The Russia-Ukraine war has triggered such a slew of actions against the dollar that it seems that the world had been awaiting an opportunity to challenge its hegemony. Countries, including China and Russia, have realised the threat of exchanging their produce for the dollar, whose value, and access is controlled by the U.S. After the war, more nations are eager to diversify their forex reserves so that their financial security may not depend upon their relationship with Washington.
A two-pronged transformation in the global financial system is leading the swifter downfall of the dollar: One, the increasing willingness between two countries to use their own fiat currencies for trade; and second, faster adaptation of alternatives to SWIFT. China has already launched e-CNY, digital yuan, in January 2022 as their sovereign cryptocurrency. Its CIPS is an alternative to SWIFT, albeit of a much smaller scale.
Experts rule out any major threat to the dollar in the short term. Harvey Campbell, professor, Duke University, North Carolina, says throughout history, the baton has been passed in terms of reserve currency and there is no indication that the U.S. dollar will lose its global currency status. However, it is naive to think the dollar will be a reserve currency forever, he adds.
Alfonso Peccatiello, former bond manager and author of investment newsletter, The Macro Compass, believes dollar-denominated debt by non-bank borrowers outside the U.S. worth $13 trillion will act as a deterrent in dethroning the greenback. "If you decide to sell commodities in another currency and stop the organic inflow of dollars, how will debtors service dollar-denominated loans?" he asks.
Jain of Pinetree Macro also rules out RMB replacing dollar as the reserve currency. "A reserve currency should be ready to run current account deficit so as to share its GDP with the rest of the world and China does not fulfil this condition," he says.
Greenback stands tall due to its nature of full convertibility, which means dollars can be exchanged for any other currency at market rates without any significant restrictions. Also, the U.S. has rarely imposed capital control (except in 2008) that makes dollars fungible and accessible for global trade. Whereas, India and China have partially convertible currency and tough capital control measures.
Campbell thinks the dollar will face strong competition from tokenised assets rather than other fiat currencies. "There will be many ways to pay for things — perhaps a token backed by gold or silver, stocks, land, etc. This fundamentally changes transaction mechanisms and renders the idea of reserve currency largely irrelevant."
He thinks the world is moving from one dominated by fiat currencies to where there are millions of currencies where transactions are secure, cheap, and fast. "Fiat currencies will be used to pay taxes and as a way for a government to pay state employees," he sums up.