Are days of dollar dominance numbered in global commerce and finance?

Historically, there were two national currencies – the British pound and the Dutch gulden – that played an important role as world reserve currencies and money of world commerce. But they were not nearly as dominant as the U.S. dollar has been after World War II. Today well over half of the foreign currencies held in reserve by national central banks are dollars and about half of world trade and debt transactions are settled in the U.S. currency. And with an astonishing 85% share, the dollar reigns supreme in currency exchanges.

America derives advantages from its global currency, which is a key symbol of its superpower status. The Federal Reserve can print greenbacks – de facto – at will without causing inflation at home. The global preference for the dollar allows the U.S. – through its structural trade deficit – to consume more than it produces on a sustained basis, compensating for the low internal savings with foreign capital inflows. But there are downsides. For example, the excess global demand for the greenback tends to enhance its value, thus making U.S. manufacturing less competitive internationally.

There has been a lot of buzz lately about the ongoing decline of the dollar or “de-dollarization” of the global economy. What explains these concerns? In terms of the broader underlying forces, America’s share in world GDP (currently one-quarter) and international trade (13%) has been trending downwards, creating a growing mismatch with the dollar’s outsize global weight.

To achieve its foreign policy goals, Washington has increasingly weaponized the dollar against geopolitical adversaries. For example, Iran, Venezuela and Russia were excluded from the dollar-dominated SWIFT cross-border interbank payments system. Following Russia’s invasion of Ukraine in 2022, Washington has prohibited American banks to do business with Russian entities and frozen assets held in the U.S. by the central bank of Russia. The growing use of financial sanctions encourages de-dollarization. As Elon Musk, Tesla’s CEO, put it: “If you weaponize the dollar enough times, other countries will stop using it.”

The deepening strategic rivalry between the United States, China and Russia has a bearing on the dollar. China and Russia are openly striving for a post-American international order in which the dollar would be significantly diminished. Russia has rapidly de-dollarized its economy in favor of China’s renminbi.

For Beijing, the grand strategic aim of a multipolar world is unimaginable without a multiple currency system in which the renminbi plays a role commensurate with China’s weight as number one exporter and the second largest economy. China has a long game, “internationalizing” the renminbi step by step mostly at the expense of the dollar.

After Ukraine, Beijing is keenly aware of what kind of financial sanctions would await it after forcibly taking over Taiwan. China has already created an independent cross-border payment system and established bilateral currency swap lines with more than fifty central banks to increase the renminbi’s external liquidity. And the renminbi is making gains: in 2023, it has become the most widely used currency for cross-border transactions in China, overtaking the dollar for the first time.

In the face of crippling U.S. financial sanctions, more and more governments in the Global South feel the need to restrict dollar-denominated trade and money transactions. In particular, the BRICS group (China, India, Russia, Brazil, South Africa, soon to be extended by six new members) is thinking about a common reserve currency as an alternative to the dollar. If prospectively something viable comes out of this plan at all, it will most likely center around the renminbi, which is destined to be the de facto BRICS common currency. Financial innovations such as central bank digital currencies offer China another option for de-dollarization and to diminish the impact of potential dollar-based sanctions.

Much of the ongoing debate about the “impending demise of the dollar” is misguided and propagandistic. But in the long term it is realistic to expect an evolution toward a tripolar – dollar, euro, renminbi – currency system, in which the hegemonic role of the dollar would gradually decrease, yet retaining its leading role for some time to come. The dollar’s reserve currency status has already fallen in the past two decades, from 72% in 2000 to 58% in 2022 (euro and yuan shares in 2022 were 20% and 3%, respectively). The downward trend will continue, especially if Washington does not curb the urge for uncontrolled weaponization of the dollar for geopolitical aims. At the end of the day, both the world at large and the United States would benefit from a less hegemonic dollar.

KEYWORDS   BRICS, de-dollarization, financial sanctions, renminbi internationalization, tripolar currency system