Factum Perspective: Putting de-dollarization in perspective

By Rumeth Jayasinghe

“Our country is crashing and will soon no longer be the world standard, which will be our greatest defeat frankly in 200 years. There will be no defeat like that will take us away from being even a great power.”

Donald Trump

In its simplest sense, de-dollarization refers to the global shift towards reducing reliance on the US dollar as a reserve currency, medium of exchange, or unit of account. Some experts frame this as a shift towards alternative currencies – that is, except the dollar – in global transactions.

For 80 years, the US dollar has remained the dominant currency, due to its wide acceptance and liquidity. This dominance was reinforced by the Bretton Woods Agreement in the 1940s.

Today the US dollar is used in 88% of all international transactions, making it the most used currency in trade worldwide. It is also the most held reserve currency. Important commodities such as crude oil and natural are priced in the dollar.

Despite its dominance in international trade, countries such as Russia and China have been persuading other nations to use alternative currencies, often in preference to their currencies, the yuan and the ruble respectively.

This call seems to have been heeded to some extent. In May 2023, Argentina announced it would pay for Chinese imports in yuan, while Brazilian President Lula De Silva called on the BRICS nations (Brazil, Russia, India, China, and South Africa) to create a common currency for global transactions.

Given the growth in the movement for de-dollarization, it is therefore important to understand its history and its background.

Bretton Woods Agreement

Following the end of World War II, America’s global dominant role expanded, transforming New York into the world’s financial capital and the US dollar into the world’s most important currency.

In 1944, the Bretton Woods Agreement created an international foreign exchange system which made the US dollar the de facto global reserve currency. In line with the original Bretton Woods framework, all other currencies of the signatories would be pegged to the US dollar. In return, its value would be backed by gold reserves.

This agreement continued for more than 20 years until Richard Nixon decided to end the convertibility of the dollar in the early 1970s. That marked the end of the Bretton Woods Agreement.

In 1973, the dollar was cemented as the petrodollar after the US and Saudi Arabia reached an agreement on the oil trade in exchange for military concessions.

The origins of de-dollarization

The idea of establishing an Asian Monetary Fund emerged in 1997, after the economies of South-East Asia were devastated by an economic crisis. Japanese authorities proposed an Asian Monetary Fund, an institution which would help Asian economies to overcome financial challenges. At one level it posed a direct threat to the IMF.

Despite it being the first movement to call for a shift from the IMF, the idea of creating an Asian Monetary Fund never took off since it posed a challenge to US influence in Asia as well. It led to a disagreement between Japan and the US, and the US opposed the idea. Interestingly enough, China also did not approve of Japan’s proposal, mainly due to its strained relationship with Tokyo.

The BRICS currency

Recently, the BRICS Group explored the possibility of creating a common currency for cross-border transactions, and reducing the influence of the dollar.

In April 2023, Deputy Chairman of the Russian Duma Alexander Babakov announced that the BRICS nations were on the way to creating a new currency for global trade, which would be backed by commodities such as gold and rare earth materials.

This statement was backed by Brazilian President Lula da Silva, who contended, rather frankly, that he saw no reason why countries should base their trade on the dollar.

However, BRICS has not been united or unified on where it wants to go with de-dollarization. A few weeks ago, India distanced itself from calls for a BRICS currency, after Foreign Minister Jaishankar contended that India would not support such a proposal. In response a Chinese think-tank demanded India’s expulsion from the group, framing the country as the weakest link in it.

China – Brazil agreement

In the aftermath of Lula da Silva’s visit to China last March, Brazil and China signed an agreement to conduct bilateral trade in their national currencies, that is the Brazilian Real and the Chinese Yuan, thus eliminating the US Dollar in bilateral trade.

The agreement will enable the two countries to conduct and if possible expand trade amounting to USD 150 billion annually using their national currencies. Both countries have acknowledged that the agreement will help them reduce the transaction costs between and encourage investments.

The Russian invasion of Ukraine

The sanctions placed on Russia following its invasion of Ukraine last year have made it difficult for the country to use the US dollar in global trade. Russian banks have been removed from the SWIFT system and assets worth USD 630 billion have been frozen.

Such developments compelled Russian banks and businesses to move into alternative currencies. Since 2022, Russia has conducted most of its trade with China with the yuan. The country has also entered a rupee-ruble agreement with India.

Today, despite or more correctly because of sanctions, Russia trades with many countries and in many national currencies, including across the Middle East and the Eurasian Economic Union.

Reasons for de-dollarization

1. The descent of the dollar

The US dollar’s share in global reserves is declining considerably. The Chinese yuan currently sits fifth in global reserve rankings, with 2.7% share. The main reason for the yuan’s rise has been Chinese investments and economic partnerships with other countries.

2. The growth in regional bilateral trade

Other currencies like the ruble and Indian rupee have also seen growth, also due to agreements with other countries. Indeed, around 60 countries or more are trading with other countries using their respective currencies. Bilateral trade agreements have played a part in this process. A good example of this would be the agreement between Sri Lanka and Mauritius to use the rupee in bilateral trade.

3. The Russia-Ukraine War

The US’s response to the Russian invasion of Ukraine, through the expulsion of Russian banks from the SWIFT system and the freezing of Russian assets, raised fears of the US weaponizing the dollar. This strengthened an already active movement towards reducing reliance on the dollar, across the Global South in particular. Many countries have also expressed a desire to leave SWIFT, with Russia and China trying to create a new financial messaging system for international transactions.

Advantages of de-dollarization

De-dollarization can help countries shield themselves from the fallout of US monetary policy. Currently, for instance, any appreciation in the US dollar relative to other currencies, due to a decision by the US Federal Reserve to raise interest rates, can make it harder for countries to repay their foreign debt.

In that sense, de-dollarization increases the monetary autonomy of a country. It gives countries the leeway and the breathing space to boost economic activity. De-dollarization could also come in handy for economies such as China and India, as it can help such countries to boost their currencies and improve their development prospects while projecting their influence regionally and globally.

Disadvantages of de-dollarization

De-dollarization also has its disadvantages. When countries change from the US dollar to another currency, transaction costs come into play. Countries require proper banking infrastructure, finance regulations, and sufficient reserves to make de-dollarization a reality. It poses a threat to international trade as well, mainly due to uncertainties and disruptions in investment flows and international transactions.

Since a lot of international trade is conducted with the dollar, some countries would be reluctant to accept alternative currencies such as yuan or ruble in international transactions.

The future of de-dollarization

De-dollarization has been ongoing for many years, but since of late it has gained momentum rapidly. When dealing with this process, countries should understand its pros and cons before coming to a decision. They should act neutral and stay unbiased.

Though de-dollarization is being discussed widely, the dollar still acts as the king of all currencies. Whether its usage will drop or not remains highly debatable, if unpredictable. The growth of other currencies and the change in world order shows that the next five or six years will be crucial in deciding whether the US dollar will retain its dominant position in that order.

Rumeth Jayasinghe is a student who is currently pursuing economics for his higher studies. Having done his A Levels in 2022, he has a wide range of interests, including international relations, sports diplomacy, and music. He can be reached at rumethj17@gmail.com.

Factum is an Asia-Pacific focused think tank on International Relations, Tech Cooperation and Strategic Communications accessible via www.factum.lk.

The views expressed here are the author’s own and do not necessarily reflect the organization’s.