In recent years, there has been a growing buzz around the concept of de-dollarization, with many suggesting that the US dollar's dominance as the global reserve currency is on the decline. The news disseminated in the public domain on de-dollarisation often borders on conspiracy theories, disinformation and fake news spread by some of the leading BRICS countries. However, a closer examination of the facts reveals that this notion is nothing more than a delusion. The US dollar's position as the primary reserve currency is deeply entrenched and supported by several key factors.
The new mantra of BRICS- We will dethrone the dollar
In 2023 BRICS countries (Brazil, Russia, India, China, and South Africa) lead the charge in de-dollarization. These nations have long sought to reduce their reliance on the U.S. dollar for international trade and finance, and recent geopolitical events and Western sanctions have accelerated their efforts.
Russia has been at the forefront of de-dollarization efforts, driven by its geopolitical rivalry with the United States and the need to protect its economic sovereignty. The imposition of Western sanctions on Russia following its invasion of Ukraine in 2022 significantly weakened the country's access to the dollar-dominated financial system. As a result, Russia has actively sought alternatives to the dollar, limiting its international settlements and conducting business in alternative currencies. President Vladimir Putin has repeatedly emphasized the importance of reducing Russia's dependence on the dollar and safeguarding its economic autonomy.
China has long criticized the dominance of the U.S. dollar and its ability to create roadblocks in Chinese trade and technology. The souring of U.S.-China relations has underscored the strength of the dollar and its impact on Chinese interests. China recognizes the need to depart from the U.S.-dominated global system and has utilized initiatives like the Belt and Road Initiative to promote de-dollarization regionally and internationally. As the world's largest trading partner and a major player in development financing, China is uniquely positioned to aid in the de-dollarization efforts of BRICS nations.
Brazil, as China's largest trade partner, has a vested interest in using local currencies for bilateral settlements. However, approximately 90% of Brazil's export invoicing is denominated in dollars, prompted Brazilian policymakers to support the formation of a BRICS reserve currency. While Brazil's stance on de-dollarization has weakened in recent years, the country still acknowledges the potential benefits of initiatives that simplify trade relations and reduce reliance on the U.S. dollar.
India, as a valuable ally and strategic partner of the United States, has a more nuanced stance on de-dollarization. Although not explicitly supporting a BRICS reserve currency, it has explored ways to minimize its dollar dependence. The Indian government has considered the use of the Indian Rupee in bilateral trade, particularly with oil-exporting countries, as a means to reduce reliance on the dollar. However, India faces challenges due to the significant invoicing of imports and exports in dollars, despite the limited trade with the United States.
The de-dollarization efforts of BRICS countries have the potential to significantly impact the global financial system. By reducing their reliance on the U.S. dollar, BRICS countries aim to create a more balanced and diversified international monetary system. While the formation of a BRICS reserve currency similar to the Euro may face challenges, the development of an efficient integrated payment system for cross-border transactions among BRICS countries is a crucial first step. This would simplify trade relations, minimize exchange rate risks, and enhance economic cooperation among BRICS nations. But this will not be the first widely proclaimed BRICS mega-campaign that could fail.
Great Expectations, Big Challenges, Great Disappointments
The International Monetary Fund (IMF) and the World Bank have been the pillars of global financial management for over 75 years. However, there has been increasing dissatisfaction with the dominance of these institutions, particularly in developing countries. The New Development Bank (NDB) was established by the BRICS nations in 2012 to provide a platform for developing nations to access financing for infrastructure projects and sustainable development. The NDB aimed to challenge the existing global financial architecture created by developed countries and provide an alternative financing option for the Global South. However, its early years faced high expectations and challenges, including limited membership and awareness, vague investment criteria, and controversial projects like the Trans-Amazonian Highway in Brazil. Critics have pointed out that the NDB's criteria for selecting investments have been vague, making it difficult to assess the bank's priorities and impact. Additionally, the NDB has faced challenges related to governance and political instability within its member countries, with some arguing that the selection of individuals to lead the bank and oversee its operations was not adequately prepared for the challenges ahead. Political tensions between member countries, such as China and India, have impacted the bank's functioning and decision-making.
The Disillusionment with BRICS Banking
However, five years after the establishment of the NDB and CRA, the initial optimism has been replaced with disillusionment. The BRICS' efforts to reform the traditional financial institutions have proven to be fruitless and even dangerous. Political and economic developments within the BRICS countries have hindered the realization of the original vision.
In South Africa, for example, the rise of corruption and state capture under the Zuma administration has undermined the credibility and effectiveness of BRICS banking. The NDB's loans to Eskom, the state-owned electricity company, and Transnet, the state-owned transport company, have been marred by allegations of corruption and mismanagement. These loans, which were meant to support sustainable infrastructure development, have instead been plagued by bribery and cronyism.
Furthermore, the macro-economic context in which the BRICS operate has deteriorated since the establishment of the NDB and CRA. The collapse of commodity prices, coupled with political instability and trade wars, has weakened the economies of Russia, Brazil, and South Africa. These countries have experienced currency devaluations and credit downgrades, further undermining their ability to fully leverage the potential of BRICS banking.
The Challenges of Currency Exposure and Corruption
One of the key challenges facing BRICS banking is currency exposure. Despite the rhetoric of promoting local currency lending, the majority of NDB loans have been denominated in US dollars. This exposes borrowers to currency fluctuations and increases the repayment burden, particularly in countries with weak currencies. The NDB's efforts to raise funds in local currencies, such as the proposed rand bond in South Africa, have been slow to materialize.
Corruption is another significant challenge that BRICS banking must address. Corruption is pervasive in all BRICS countries and undermines the credibility and effectiveness of financial institutions. The NDB's loans to corrupt entities, such as Eskom and Transnet in South Africa, have raised questions about the bank's due diligence and risk management practices. The presence of corruption also erodes public trust in the BRICS' ability to provide a genuine alternative to the traditional financial order.
China's involvement in global infrastructure development is a concern due to its association with corrupt regimes. Countries receiving investments under the Belt and Road Initiative suffer from high levels of corruption and weak governance systems, making it easier for China to pursue its projects without facing significant obstacles or scrutiny. This raises questions about China's commitment to good governance, accountability, and transparency. China's push to establish alternative institutions, such as the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB), has been met with both anticipation and skepticism. The AIIB has largely replicated existing practices and policies, while the NDB faces constraints due to differences among its members and limited credit ratings. Some argue that China's emphasis on speedy project implementation and disregard for proper procurement processes create an environment conducive to corruption, leading to the leaders of recipient countries viewing the projects as opportunities to sustain and legitimize their own corrupt practices.
Corruption in infrastructure projects can have severe consequences, such as undermined integrity, economic development, income inequality, and damage to public trust in government institutions. Misallocation of resources, often based on bribes and political connections, results in subpar infrastructure that fails to meet the needs of the population.
Malaysia's 1MDB scandal involving former Prime Minister Najib Razak highlighted the potential misuse of Chinese investments in infrastructure projects. The Wall Street Journal's report exposed evidence suggesting Malaysian officials suggested China finance infrastructure projects in Malaysia at inflated costs, potentially used to settle 1MDB's debts. Kazakhstan, an oil- and gas-rich country in Central Asia, has also faced allegations of corruption in infrastructure projects. The Kazakh government, characterized as a kleptocracy, has been accused of widespread corruption, weak governance, and a lack of transparency. China's investments in Kazakhstan have allowed autocratic regimes in the region to flourish, with Chinese aid, loans, and partnerships enhancing the Kazakh leadership's ability to stay in power. This scandal underscores the need for greater transparency and accountability in infrastructure projects and raises concerns about China's role in supporting corrupt regimes and the potential risks associated with Chinese investments in infrastructure.
The Bitter Reality BRICS Must Swallow
The US Dollar as the Global Reserve Currency
The US dollar has long enjoyed the status of the world's leading reserve currency, accounting for the majority of international trade and transactions. According to the US Federal Reserve, the dollar was used in approximately 79% of global trade between 1999 and 2019. This dominance is not a result of coercion or force but rather the widespread acceptance of the dollar due to its stability and the convenience it offers in international transactions.
The Myth of De-Dollarization
The idea of de-dollarization suggests that countries are actively seeking alternatives to the US dollar to reduce their dependence on it. While it is true that some countries, including India and Russia, have taken steps to decrease their reliance on the dollar in certain trade transactions, these measures should not be mistaken for a broader shift away from the dollar as the global reserve currency.
Bilateral Trade Agreements: Quick Fixes, Not Long-Term Solutions
One argument put forth in favor of de-dollarization is the increase in bilateral trade agreements between countries. These agreements are often presented as alternatives to using the dollar for international trade. However, it is important to recognize that these agreements serve as short-term solutions in specific circumstances where other, more affordable methods can be utilized to facilitate trade. They are not attempts to completely avoid the dollar or replace it as the primary reserve currency.
The Logical Fallacy of BRICS Exclusivity
Another point often cited in support of de-dollarization is the emergence of the BRICS nations (Brazil, Russia, India, China, and South Africa) and their efforts to conduct commerce outside of the US currency. However, the notion that these nations can completely bypass the dollar is absurd. These countries still owe US dollars at various points in their supply chains, and refraining from using the dollar for an extended period would impede their development. The idea of a BRICS currency as a viable alternative to the dollar is unrealistic, considering the divergent economies and lack of fiscal and political unity among these countries.
The Strengths of the US Dollar
The continued dominance of the US dollar as the global reserve currency can be attributed to several inherent strengths that other currencies have yet to match. These strengths include:
1. Size and Depth of the Dollar-Denominated Asset Market
The US dollar-denominated asset market is vast and diverse, making it an attractive destination for investments. It represents the largest markets for safe investments, ensuring liquidity and lowering transaction costs for nations holding and trading these assets. The market for dollar-denominated assets far surpasses that of any other currency, solidifying the dollar's position as the preferred currency for global trade and finance.
2. Trust and Stability
The US dollar's status as a trusted and stable currency is another significant factor in its dominance. Countries prefer to use the dollar because it is widely accepted, relatively stable, and eliminates the need for additional transaction costs. The dollar's stability provides a level of certainty and confidence that other currencies have yet to achieve.
3. Lack of Viable Alternatives
Despite the emergence of alternative currencies like the Chinese yuan and gold, these substitutes are far from displacing the dollar as the global reserve currency. The limited use of the yuan in global trade, largely due to China's capital controls and closed capital account, hinders its potential as a reserve currency. The euro, on the other hand, faces trust issues following the Cyprus banking crisis and the structural challenges posed by the diverse fiscal policies and monetary systems of the European Union member states. Other currencies like the Japanese yen, British pound sterling, and Australian dollar, while significant in their own right, are not strong enough to challenge the dollar's dominance.
The Challenges of De-Dollarization
While some countries may seek to reduce their dependence on the US dollar, the process of de-dollarization is far from simple. Several challenges and limitations prevent a swift transition away from the dollar as the global reserve currency. These challenges include:
1. Capital Controls and Convertibility
China's strict capital controls and limited convertibility of the yuan impede its adoption as a reserve currency by other nations. A currency cannot serve as a global reserve without an open capital account, and China's capital controls restrict the free flow of its currency. Until China relaxes these controls, the yuan's potential as an alternative to the dollar remains limited.
2. Lack of Trust and Confidence in Alternative Currencies
Trust and confidence play a crucial role in the acceptance of a currency as a global reserve. Alternative currencies like the yuan and cryptocurrencies face skepticism and lack the track record and stability required to gain widespread trust and acceptance in international trade and finance. The global market prefers the familiar and established stability of the US dollar, making it difficult for alternatives to gain significant traction.
3. Economic Realities and Trade Imbalances
Many countries, including India, face trade deficits with major trading partners, making it challenging to promote their own currencies as alternatives to the dollar. The use of local currencies in trade depends on bilateral trade relationships and the balance of trade. In cases where countries import more than they export, the demand for their currency is limited, hindering its potential as a global reserve.
5 Myths About Dedollarization
Many commentators warn that the dominant position of the US dollar as the world's reserve currency is under threat. However, it is important to examine these claims critically and to separate fact from fiction. Fabrications which, in many cases, are not dissimilar to the fake news spread by the Russian and Chinese troll factories aimed at achieving political goals through the turmoil and confusion they create. Here are five common myths related to dedollarization thrown into the public domain, which is generally not expected to have much financial literacy and can be easily manipulated.
Myth 1: Central banks are rapidly shedding the dollar as a reserve currency
One of the prevailing myths about dedollarization is that central banks are quickly reducing their holdings of US dollars as a reserve currency. However, data from the International Monetary Fund (IMF) tells a different story. While there have been slight declines in dollar reserves, the US dollar still remains the largest reserve currency among central banks worldwide. In the fourth quarter of 2022, the US accounted for 54% of foreign exchange reserves, down slightly from the previous year. The euro, which is often cited as a potential rival to the dollar, accounted for only 19% of reserves during the same period.
The stability of the dollar as a reserve currency can be attributed to its widespread acceptance and reputation as a safe haven asset. Countries choose to hold US dollars because they are seen as a relatively stable and reliable currency, especially in times of economic uncertainty. The dollar's incumbency is deeply entrenched, and it would take a significant economic shift for central banks to abandon the dollar as their primary reserve currency.
Myth 2: The dollar is losing its position as the most important currency in global trade
Contrary to popular belief, the US dollar's role in global trade has remained remarkably stable over the past few decades. In fact, of the millions of daily currency transactions that took place in April 2022, the US dollar was involved in 88% of them, according to data from the Bank for International Settlements (BIS). This level of dominance has remained consistent, despite efforts by some nations to reduce their reliance on the dollar.
While there has been increased rhetoric surrounding the desire to diversify away from the dollar, particularly from countries like China, the reality is that the dollar's position in global trade has not significantly changed. The sheer convenience and liquidity of the dollar continue to make it the currency of choice for international transactions. People's actions speak louder than words, and the data clearly shows that the dollar remains the most important currency in global trade.
Myth 3: China's yuan is the biggest threat to the dollar
China's rise as an economic powerhouse has led many to believe that the Chinese yuan could pose a significant threat to the US dollar's dominance. However, the reality is that the yuan plays a relatively minor role in the global economy compared to the dollar. According to the IMF, the yuan accounted for only 2% of all foreign exchange reserves in the fourth quarter of last year, with a significant portion of that held by Russia.
While China has taken steps to promote the use of the yuan in international trade, such as securing bilateral agreements and selling its currency to other countries, these efforts have had limited impact on the dollar's overall dominance. The yuan's limited convertibility and the lack of trust in its value outside of China hinder its potential as a global reserve currency. It is unlikely that the yuan will surpass the dollar in the near future, given the significant hurdles it faces in terms of liquidity and international acceptance.
Myth 4: Another currency could soon compete with the dollar
Despite ongoing efforts to diversify away from the dollar, it would be premature to assume that another currency will soon rival its dominance. The process of displacing a currency as deeply entrenched as the dollar takes time and requires a viable alternative. While there has been talk of potential contenders like the euro or cryptocurrencies, none of these options currently possess the necessary qualities to replace the dollar as the global reserve currency.
The sheer size and depth of the dollar-denominated asset market make it a highly attractive destination for investors. Dollar-denominated assets represent the largest markets for safe investments, providing liquidity and stability. The reserve currency status of the dollar also reduces transaction costs and facilitates international trade. Any potential rival currency would need to match or surpass these characteristics, which is a significant challenge.
Myth 5: The end of dollar dominance would be catastrophic for the US economy and stocks
Contrary to popular belief, a decline in the dollar's dominance would not necessarily spell disaster for the US economy or the stock market. While a drop in the dollar could discourage foreign institutions from investing in US Treasury bills and securities, it would simply mean that the US would need to find alternative sources of funding. The US economy is highly resilient and adaptable, and it has the ability to attract investment from other sources.
It is important to remember that the strength of the US economy and the performance of the stock market are influenced by a multitude of factors beyond the dominance of the dollar. Economic growth is driven by a variety of factors, including innovation, productivity, and domestic consumption. While the dollar's status as the global reserve currency is undoubtedly advantageous for the US, its potential decline would not be catastrophic.
Conclusion: The Inevitability of the US Dollar's Dominance
The China-led BRICS project has the potential to change the global economic landscape with its huge population, rich resources and growing economies. But their growing influence poses challenges to the rules-based international order and threatens the post-World War II international financial architecture. The BRICS countries, led by China's economic power, are challenging Western economies and advocating a fairer and more inclusive global economic system. However, concerns have arisen about governance, transparency and long-term sustainability due to China's involvement in infrastructure projects and its links with corrupt regimes, whereby they are de facto reviving colonialism in a new light vis-à-vis their economically weak partners.
In conclusion, the de-dollarization delusion is a misguided notion that fails to recognize the inherent strengths and advantages of the US dollar as the global reserve currency. While some countries may seek alternatives to the dollar for specific transactions, the idea that the dollar will be replaced as the primary reserve currency is unrealistic. The size and depth of the dollar-denominated asset market, the trust and stability it offers, and the lack of viable alternatives all contribute to the dollar's continued dominance. De-dollarization faces significant challenges, including capital controls, lack of trust in alternative currencies, and economic realities that limit the potential for widespread adoption. The US dollar's position as the global reserve currency is here to stay, and its strength and stability will continue to play a vital role in international trade and finance.
The idea of dedollarization and the potential replacement of the US dollar as the world's reserve currency is riddled with misconceptions. Central banks continue to hold significant reserves of US dollars, and the dollar's role in global trade remains dominant. While there may be ongoing efforts to diversify away from the dollar, the lack of viable alternatives, the size and depth of the dollar-denominated asset market, and the inherent benefits of the dollar as a safe haven currency make dedollarization unlikely in the near term. The US economy and the stock market are resilient and can adapt to changes in the global currency landscape. It is important to approach discussions of dedollarization with a critical eye and a nuanced understanding of the complexities involved.