Why are countries moving towards de-Dollarization?

Faisal Khan

Source Link

We are seeing a global shift, as countries look for alternatives to the Greenback as the sole reserve currency — for various reasons

Let’s look at the historical perspective first. The US dollar has been the dominant currency in global trade and finance for decades, and its status as the world’s reserve currency has given the United States significant economic and geopolitical power. The dollar’s dominance has been driven by a number of historical factors, including the US’s position as the world’s largest economy, the strength and stability of the US financial system, and the country’s political and military power.

The first signs of this dominance started to show post the First World War — when the dollar began to displace the Pound Sterling as the international reserve currency and the U.S. also became a significant recipient of wartime gold inflows. This position strengthened further after World War II. The Bretton Woods Agreement of 1944 established the US dollar as the world’s reserve currency, and other countries agreed to peg their currencies to the dollar. U.S. ceased the direct convertibility of U.S. dollars to gold in 1971. This ended both the gold standard and the limit on the amount of currency that could be printed.

U.S. financial system’s strength and stability have also contributed to Greeback’s dominance as the global reserve currency. The US has a large and sophisticated financial system, with deep and liquid markets for a wide range of financial instruments. The US Federal Reserve, the country’s central bank, plays a critical role in maintaining the stability of the financial system and ensuring that the dollar remains the world’s reserve currency.

However, the dollar’s dominance is not without its challenges. The global financial crisis of 2008 highlighted some of the weaknesses of the US financial system, and there have been concerns about the country’s high levels of debt and its ability to maintain its economic and political power over the long term.

In recent years, there has been a trend towards de-dollarization, with some countries seeking to reduce their exposure to the US financial system by diversifying their currency reserves and increasing the use of alternative currencies. Recurring banking failures in the U.S. (pictured below) don’t really inspire much confidence, do they?

The U.S.’s status as the world’s reserve currency has significant economic and geopolitical benefits. The US can borrow money at lower interest rates than other countries because investors see US government bonds as a safe and stable investment. The dollar’s dominance also gives the US significant influence over global economic activity, allowing the country to use economic sanctions and other policies to exert pressure on other countries. And of course, it can just print more money when it needs it.

And it’s this overarching economic influence that is forcing other nations to test alternatives to reduce the dollar’s hegemony. Many countries believe that the United States uses this dominance as an economic weapon for arm-twisting other nations. Following the economic sanctions imposed by the United States and other Western nations against Russia in response to its invasion of Ukraine, Moscow and the Chinese government have been collaborating to reduce their reliance on the dollar and establish greater cooperation between their financial systems.

Since the invasion occurred in 2022, the Ruble-Yuan trade has increased by eighty-fold. Additionally, Russia and Iran are reportedly working together to launch a cryptocurrency backed by gold. Furthermore, central banks, particularly those of Russia and China, have been purchasing gold at the most rapid pace since 1967, as countries seek to diversify their reserves away from the dollar. And this is not just isolated to these two countries only.

Other countries have been discussing moving away from dollar dominance too — be it bilateral trade or foreign exchange reserves. For the first time in 48 years, Saudi Arabia said that the oil-rich nation is open to trading in currencies besides the U.S. dollar. Brazil and Argentina have discussed the creation of a common currency for the two largest economies in South America.

While there’s no denying that the US dollar’s dominance has waned significantly in the last two decades, it nonetheless comprises 60% of world foreign exchange reserves. I don’t see a swift end to this regime anytime soon, but the process has certainly started. Let’s just say, it’s the beginning of the end.