EspressoLogy

The term de-dollarisation has been making headlines recently. Several countries are pushing for de-dollarisation. Some are already charting out plans to shift away from the greenback.

So, what exactly is de-dollarisation and why is everyone suddenly talking about it?

De-dollarisation means reducing the dependence on the US dollar for international trade. Currently, the US dollar is the world’s most traded currency. Central banks across the world prefer to keep their foreign exchange reserves in US dollars. Before we understand why countries want to dump the dollar, it’s important to know why it became so popular.

How did the US dollar gain popularity?

The strength and attractiveness of a country’s currency depends on multiple factors, such as:

• Strength of its economy, which reflects in the stability of its currency.
• Quantum of exports. This creates demand for its currency globally.
• Comfort of its government and central bank to allow free trade in the currency.

The US economy had all these characteristics for several decades helping the dollar become the predominant currency for use in global trade.The dollar is seen as both safe in periods of volatility and one of the most convertible currencies.Another reason for its dominance is oil, a key commodity that most economies need, is priced in US dollars. 

Why does everyone want to dethrone the dollar now and attain reserve currency status?

Most countries have a lot of US dollar assets. So, they feel increasingly threatened by the power the US holds over them.The US sanctions on Russia after it invaded Ukraine were one of the triggers for the fear. The Russian economy suffered a blow with the US freezing billions worth of its assets and barring it from the SWIFT system widely used for banking transactions. The value of the Russian Rubble briefly hit historic lows.  

This worried other countries that the US could leverage its global position to impose sanctions making their dollars worthless.The worsening economic condition in the US added to the worries. The US economy grew 2.1 percent in 2022, down from 5.9 percent growth in 2021. Inflation in the country has also soared to historic levels in the past few years.

Other countries fear these factors could translate to a weaker dollar affecting their imports.Most countries including India also want to attain the reserve currency status becoming it has its own set of benefits. It increases demand for your currency, reduces borrowing costs, increases global influence, reduces exchange rate risks, and provides greater access to global markets.

Is de-dollarisation likely to happen soon?

The US dollar has a significant share in global forex reserves and in international trade. Currently, about 60 percent of global foreign exchange reserves are in dollars.There is also no alternate currency to immediately replace the US dollar.The biggest contenders - China’s yuan, the British Pound, and the Euro come with their own set of issues.

The euro is politically fragmented since it is used by 27 nations, which casts a shadow on its long-term stability. UK’s political uncertainty and a much smaller economy makes the pound vulnerable to economic shocks, while China lacks transparency.And then there is oil. Countries that need oil for local consumption need dollars as part of the petrodollar system, a deal between the US and Saudi Arabia.

Meanwhile, the UAE and India are already discussing using rupees to trade non-oil commodities. Moscow and China are also teaming up to reduce dollar reliance. Iran and Russia are working towards a gold-backed cryptocurrency.

What remains to be seen is if any of these currencies can step up in the future and challenge the dollar’s dominance.

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