De-Dollarization, Beginning of the End?

June 07, 2023

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Let’s face the fact, the world today is dollarized. Most of the world’s trade is settled in US dollars. The dollar is ubiquitously usable and certainly welcome everywhere you travel around the world – even including today’s Russia, which is essentially engaged in a proxy war against the U.S. Most nations’ central banks hold dollar assets as a major part of their foreign exchange reserves. The dollar-based international economic order builds on a global monetary system established after the World War II. But today that system is starting to show signs of cracking, and maybe, just maybe, we are seeing the beginning of the end of the dollar era. 

 

A new multipolar currency system consisting of a few other currencies seems to be slowly emerging. Aside from the euro, the British pound, the Japanese yen, China’s RMB yuan is another currency that has seen substantial growth in popularity over the last few years, partly as a result of the Chinese government’s effort to internationalize its currency, and partly due to China’s increasing weight in the global economic system. Here is a snapshot of the current status of RMB’s internationalization level. 

 

First, let’s look at the SWIFT system, which is the world’s predominant banking transaction system, which accounts for an overwhelming majority of all financial transactions every year. The RMB currently is the fifth most used currency worldwide, accounting for nearly 3% of all SWIFT’s payment volume. But it needs to be pointed out that many transactions do not pass through the SWIFT system at all. There are also other payment system alternatives out there built by China and Russia. So, the SWIFT’s representation of RMB’s worldwide usage is somewhat of an underestimate.

 

According to data from the People’s Bank of China, which is China’s central bank, total RMB cross-border trade settlement increased by 17% to nearly RMB 8 trillion yuan in 2021. The proportion of trade settlement in RMB as a percentage of China’s own total trade in that year increased to 21% from 18% in 2020. 

 

This is not surprising after all, as China has been the world’s largest trading nation for over a decade by now, and also an increasingly important source of foreign direct investment in many other countries, in lockstep with Chinese cooperation projects’ expanding global footprint and the government’s Belt and Road Initiative. 

 

Another factor driving RMB’s expansion has to do with the fact that China has signed bilateral currency swap agreement with several countries, including recently Brazil and Saudi Arabia, and subsequently set up regional RMB clearing houses in these countries to further facilitate the use of RMB. 

 

Aside from the RMB’s increasing share as a payment settlement currency in global trade, foreign investors’ participation in China’s capital markets is another good indicator of the RMB’s popularity. Again, according to data from the People’s Bank of China as of March 2022, overseas institutional investors held RMB 4 trillion yuan, or 2.9% of the outstanding amount of bonds under custody in China’s bond market. In the equity market, overseas institutional investors and individuals held RMB 3.19 trillion yuan of Chinese stocks, an increase of nearly 90% compared to the same period in 2021. 

 

Another gauge of a currency’s popularity regards its role as a reserve currency held by foreign governments. In this area, the RMB is also steadily advancing. Shares of RMB holdings in central banks’ foreign exchange reserves have seen substantial increase. For instance, Brazil’s central bank holds 5% of its foreign exchange reserves in RMB at the end of 2021. Russia is another country where its central bank is betting big on the RMB. Before the conflict in Ukraine, it already put about 14% of its foreign exchange reserves in RMB, and now has increased its share even more significantly as a result of the financial sanctions from the West.  

 

Probably a defining barometer of the RMB’s prospects in global financial markets is its share in the International Monetary Fund’s (IMF) Special Drawing Rights (SDR). This is a composite currency used as a last resort backup for countries that land in balance of payment difficulties. In the last round of the IMF’s review, the RMB’s weight has surpassed the British pound and the Japanese yen to reach 12.28%, only after the dollar and the euro.  

 

Notwithstanding the RMB’s impressive march towards the international arena, perhaps a more significant development underlying the trend towards a multipolar currency world is the ongoing discussions in many capitals about using regional currencies for trade payment settlements to deliberately bypass the dollar. 

 

A few ASEAN countries have come out to state such a desire. For example, Perry Warjiyo, governor of the Indonesian central bank, said on March 31 at the end of the ninth ASEAN Finance Ministers and Central Bank Governors Meeting in Bali, Indonesia, that using local currencies for cross-border trade and investment would reinforce financial resilience in the region. Indonesia would create a task force to study the feasibility of using local currencies, instead of the dollar, in regional trade.

 

“There is no reason why countries like Malaysia continue to rely on the dollar,” Malaysian Prime Minister Anwar Ibrahim told the Malaysian parliament on April 4. Malaysia is currently negotiating with China to use the RMB and the Malaysian ringgit for bilateral trade settlement. Anwar has also re-proposed establishing an Asian Monetary Fund.

 

Brazilian President Luiz Inácio Lula da Silva is a big fan of bypassing the dollar. During the visit to the New Development Bank, or NDB, in Shanghai, as a part of his state visit to China, Lula said, “Why can’t an institution like the BRICS bank have a currency to finance trade relations between Brazil and China, between Brazil and all the other BRICS countries? Who decided that the dollar was the currency after the end of gold parity?” Expectedly, China and Brazil signed an agreement to use RMB and Brazilian real in bilateral transactions in March this year. 

 

Believe it or not, the trend towards de-dollarization is also being actively pushed by the U.S. itself as well, as manifested in its numerous sanctions against several countries, most notably Russia and Iran these days, both of which are important oil producing countries. The war in Ukraine, the resulting sanctions and the confiscation of Russian assets by the West further inflicted great damages to the stature of the dollar, as US Secretary of the Treasury Janet Yellen once pointed out. Even assets of private citizens of sanctioned countries are now in danger of being confiscated. That scared the hell out of a lot billionaires to stay out of the dollar.

 

The West’s sanctions against Russia have also caused a rapid run-up of key commodity prices, leading up to high-flying inflation in Europe and the North America. Russia is a major supplier of a few key agriculture commodities and strategic mineral resources. Since last year, the US Federal Reserve’s interest rate hike campaign as a means to fight inflation has undergone several rounds already. Predictably the dollar has rapidly appreciated, resulting in an exodus of capital around the world back to the U.S. The moves of the Federal Reserve have generated adverse international impacts. Many countries have been trapped into crises of currency depreciation, capital outflow and imported inflation. 

 

The worsening of the balance of payment situation in many countries has caused many economists in these emerging market economies to propose to counter the risk imposed by the dollar by preparing for a multipolar currency world. Aside from advocating alternative currencies to settle trade, they are also advocating reducing holdings of US Treasury bonds, bilateral currency swap agreements, bloc monetary fund, regional currency cooperation, etc.

 

In short, we have articulated about some of the economic forces underlying the trend toward de-dollarization and a multipolar currency world. But realistically speaking, this could be a long process in the making. Even a piece of worthless green paper that nevertheless used to rule the world would still take some time for the market to discover its true value. There are historical precedents. 

 

Historically debased coins took a bit of time to be driven out of the market. For example, the wicked trick of wholesale exports of debased coins to foreign states was indeed practiced in the seventeenth century in Europe, lasting almost two decades. At the time, French, Italian and Dutch merchants shipped across the Mediterranean about 200 million pieces of mostly copper coins with a thin silver coating, called luigini, as silver money in exchange for Ottoman imports. This created a bizarre but legendary chapter in the numismatics history that some Turkish economic historian described as the “biggest counterfeiting scheme in history!”

 

Today the greenback is printed of course. All currencies are printed for that matter. What’s driving their popularity is fundamentally the strength of the economy standing behind them. In that regard, probably the most promising currency likely to take a bite out of – certainly not replace – dollar’s lion share among several currencies in the global monetary system is still China’s RMB. 

 

China’s GDP growth rate is still ahead of that of the U.S., the European Union, the UK, and Japan. And that little edge – about 2 percentage points – looks to be able to maintain for at least five more years, albeit gradually getting smaller. China’s status as the global trade powerhouse still looks unshakable, as it develops venerable prowess in a few key technologies of the future that are important in driving exports, including solar power, wind power, batteries and electric cars. In the first quarter of this year, China surpassed Japan to be the world’s largest exporter of automobiles. 

 

China’s trade pattern appears to be undergoing a structural change. Today China’s largest trading partner is no longer the U.S., nor the European Union, but the ASEAN market. ASEAN countries are in the process of introducing their own local currency settlement framework, and China’s RMB internationalization is part of China’s ongoing dialogue with the ASEAN regarding trade settlement. 

 

China’s trade with BRICS countries is also increasing rapidly, particularly with respect to Russia in the aftermath of the war in Ukraine. China has signed bilateral local currency settlement agreement or framework with Russia and Brazil. Bilateral trade between China and Russia stood at over US$73 billion in the first four months of this year, surging over 40% year-on-year. For the whole year, total trade could possibly reach close to US$250 billion. Note that over 70% of trade between China and Russia is already settled in RMB and ruble. 

 

Practically China’s entire trade with the Global South could eventually be subject to the RMB fold. China certainly takes a cautious, gradual approach to minimize its risk exposure, when it comes to establishing bilateral trade settlement agreements using the RMB. Nevertheless that part of the world represents the most vibrant, the fastest growing economies right now. What does it mean for China, and for the world? It means better opportunities ahead for the RMB.  

 

In short, there is no doubt that the world is starting to embrace currency multipolarity, where several currencies are getting to be increasingly lining up seriously behind the US dollar in global trade, investment, and functioning as the reserve currencies for many countries, with the Chinese RMB being one of the strong contenders. But there is also no doubt that this process will take a long time to work out as shown empirically throughout history. 

 

The odd thing is that the dollar’s floundering stature continues to be hijacked by Washington national security politics. For a long time, the foreign policy apparatus in the U.S. has developed an addiction to weaponizing the dollar every time it sees convenient to impose sanctions against a country. This has been done accumulatively upon many countries for the last seventy years, many of which were unilateral actions without the United Nations’ authorization. At some point there will be a reckoning. 

 

 

 

 

 

 

 

 

 

 

 

Please note: The above contents only represent the views of the author, and do not necessarily represent the views or positions of Taihe Institute.

 

This article is from the March issue of TI Observer (TIO), which is a monthly publication devoted to bringing China and the rest of the world closer together by facilitating mutual understanding and promoting exchanges of views. If you are interested in knowing more about the October issue, please click here:

http://www.taiheinstitute.org/Content/2023/05-31/1621340940.html

 

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