De-dollarisation of reserve currency: Reality checks

Abdullah A. Dewan | Monday, 4 November 2019

Sporadic hiccups of de-dollarisation moves by Chinese yuan and the euro notwithstanding, the US dollar has been enjoying the envious status of the world's most predominant reserve currency for decades. To undermine the dollar's status, a consortium of three entities, namely the European Union (EU), China  and Russia are displaying some manoeuvres toward de-dollarisation of the reserve currency.

There are several factors which seem to have brought them together to achieve a common goal of having a competing currency on the global stage. One oft-quoted factor which Anne Korin of the US-based think tank Institute for the Analysis of Global Security (MSNBC online posting on Wednesday, October 30, 2019) has emphasised is the growing annoyance of sovereign countries for being subjected to US jurisdiction while making transactions in dollars. Since all such transactions are required to be cleared through an American bank, the dollar-using entities become subject to US jurisdiction even if they have nothing to do with the US per se. 

One recent highly contentious issue is the US's  unilateral withdrawal from the 2018 Iran nuclear deal followed by re-imposition of US sanctions on Iran. The deal took five years of strenuous negotiation with Iran by P5+1 countries (five permanent members of the UN Security Council, China, France, Russian Federation, the United Kingdom, and the United States, and Germany).

The US's unilateral actions did not go well with the remaining five signatories of the nuclear agreement. The situation made European multinational companies susceptible to penalty from Washington if they violate any provisions of the sanctions. Europe wants to engage in trade and commerce with Iran since Tehran lived up to the provisions of the nuclear deal verbatim. Russia, one of the largest reserve holders, unloaded about $100 billion worth of dollar-denominated reserves following new rounds of US sanctions, and instead acquired nearly $90 billion euro and yuan-dominated assets in the second quarter of 2018 (European Central Bank or ECB report). All these factors caused the resurrection of a move by the three major entities to consider de-dollarisation of the global reserve currency or weaken the dollar's reign. 

The US trade policies - albeit driven by national interest - have also caused some consternation to many countries, motivating them to diversify their portfolio of foreign currency reserves. Central banks around the globe hold dollars, often in the form of US Treasuries, as backup funds to withstand eruption of a crisis and also to facilitate international transactions. For example, currencies like the euro and, more recently, the yuan have intruded into that diversified portfolio. So not all central bank eggs are in one dollar-denominated basket. The share of yuan reserves reached almost 2.0 per cent in 2018 - nearly double compared with early 2017. The euro is the second most popular reserves with a global share just under 21 per cent. The dollar's share of reserves stood around 62 per cent - down 7.0 per cent from the 1992 level when the EU monetary union was constituted. 

If not the dollar, then what other currencies could replace the roles traditionally played by the greenback. China has tried to internationalise the use of yuan through the introduction of yuan-denominated crude oil futures (referred to as petro-yuan) and pay for imported crude in its own currency rather than the dollar. In her posting, Anne Korin argues that since nearly 90 per cent of oil is traded in dollar, and if the petro-yuan can take a big bite in oil transactions then, of course, it will trigger the "beginning of a nudge in the direction of de-dollarisation". However, she added that "while the petro-yuan may be a necessary condition for the international abandonment of the dollar, it's not sufficient to make it happen on its own".

It may be noted that for a currency to qualify as global reserve currency, the holding country must satisfy four prerequisites. The reserve holding country (a) must have a large and advanced economy, (b) must be able to withstand internal and external pressures (shocks), both short-term and long-term; (c) must exude global confidence in long-term stability and economic prosperity; (4) must have liquid and transparent financial markets.

Only the US economy and its financial system satisfy all four prerequisites. The US economy, with gross domestic product (GDP) of nearly $21 trillion, is the largest, most flexible, and open enough to accommodate large trade deficits caused by the US dollar's predominant status. Besides, the US has been the most stable country with democratic system, rule of law, effective checks and balances, and free media which have made it the most reliable economy for domestic and foreign investors.

Currently, neither the euro nor the yuan satisfy all four prerequisites to be a reserve currency to replace the dollar. For euro to become a global currency, the eurozone crisis diminished that possibility by revealing that the currency of a monetary union constituted by independent political entities (fiscal policy activisms affect the value of a currency) cannot be viable as a global reserve currency.

The dollar is not only the official currency of the US, it is also the official currency of five US territories and seven sovereign nations. In addition, it's the quasi-official currency of many other nations that commonly accept dollars in addition to a local currency. In 2018, more than 368 million people throughout the world collectively used the dollar as their official currency of exchange which, in turn, translated into more than $20 trillion dollars of economic activity.

An estimated $580 billion are in circulation outside the US border, which constitutes 65 per cent of all dollar bills printed. More than one-third of the world's GDP comes from countries that peg their currencies to the dollar. That includes seven countries that have adopted the US dollar as their domestic currency and another 89 countries which keep their currency in a tight trading range relative to the dollar. In the foreign exchange market, the dollar reigns with nearly 90 per cent of forex trading. The dollar is just one of the world's 185 currencies but most of the remaining 184 currencies are used for domestic transactions.

Over the years, economies around the world have become more and more integrated and interdependent. The financial transactions may be better served by having more than one viable reserve currency.

While the status of the dollar as the most acceptable reserve currency is not yet threatened, America's gaping rabbit hole of debt is worrisome. China is digging itself out of its own debt rabbit hole while accumulating gold which has a very strong store of value. China is also forming trading alliances with countries (such as Iran) that are becoming less and less dependent on dollar-based transactions. Besides, Beijing has been expanding its trade using its own gold- and petro-dollar based contracts. Russia has been trading natural gas with other countries for years as well. What about Europe? Well, EU was created to facilitate trade and commerce between member countries while lessening their dependence on external currencies. Thus, what we are observing is the emergence of a multi-polar world with waning of global dependence of the dollar. 

As of 2019, non-dollar payments in international trade and commerce are few and far between. Barring some unforeseen and irretrievable calamitous event it will not be an easy sail for an alternative currency to compete with the dollar. However, many experts talk about a futuristic alternative - invention of global digital money - to be a global currency of choice. Well, until such a futuristic time when a global digital money system is invented and widely accepted, the US dollar will reign as the global reserve currency.

Dr Abdullah A Dewan, formerly a physicist and a nuclear engineer at BAEC, is Professor of Economics at Eastern Michigan University, USA.

[email protected]