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De-dollarization: myth or reality

Started by Admin, Feb 11, 2024, 08:10 PM

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"De-dollarization is an inevitable consequence of changes in the global economy, and we must adapt to the new reality." - Christine Lagarde, head of the International Monetary Fund (IMF).

"We are seeing the beginning of dedollarization. The world is looking for alternatives and this is a challenge for the United States." Joseph Stiglitz, Nobel Laureate in Economics.

From this article you will learn:
  • Why the dollar is the world's main reserve currency;
  • Why many countries want to get rid of the dollar in whole or in part;
  • Whether it is really possible to get rid of the dollar;
  • What are the successes of dedollarization?

In recent decades, the global economy has faced challenges that raise questions about the structure of the global monetary system. De-dollarization is nothing more than the refusal of countries and economic entities to settle in dollars. Since World War II, the dollar has gained status as the world's dominant reserve and trade currency. Talk of de-dollarization began in the late 1990s in the wake of the so-called dot-com crash and the global financial crisis of the late 21st century. A second wave of discussion and some action began with the explosive growth of the cryptocurrency market and the imposition of sanctions in the wake of Russia's invasion of Ukraine. These policies have both supporters and opponents and have their advantages and disadvantages respectively.

Why does the dollar play such a big role in the world?
At the end of World War II, the US economy accounted for 49% of world GDP and 70% of world industrial production. Such impressive numbers were achieved for two reasons: the partial or complete destruction of other industrial centers in the world, and the growth of the economy through military orders, etc. As a result, the US took advantage of its position and imposed its trade terms on extremely weakened countries, the central element of which was dollar settlement.

The situation remained almost unchanged after the recovery of the global economy. Also at that time, due to the instability of the US economy, the dollar became the main reserve currency.  Even now, the U.S. economy is a strong brand and many believe in its stability, so for many decades the dollar has accounted for more than half of the world's reserves. Reserves are held in various forms, and a large portion of them in the form of U.S. Treasury bonds. U.S. Treasury bonds are the most popular and liquid, so holding them is advantageous for other countries' central banks, as they can quickly sell these bonds and dispose of the money if needed. According to the IMF, at the end of 2023, the share of dollar assets in global foreign exchange reserves was 59.17%.

When and why did the idea of dedollarization emerge?
As mentioned above, the idea itself emerged after the collapse of the Internet bubble. In the second half of the 1990s, with the proliferation of personal computers and the Internet, a number of Internet companies emerged that seemed to be the new Klondike in the eyes of investors. On March 10, 2000, that bubble burst. As a result, investors around the world became concerned about the inflation of new bubbles and the impact of these crises on the global economy. In 2000, the size of the U.S. economy accounted for one-third of the world economy, and the share of transactions in dollars was nearly 70 percent.

The figures show the heavy dependence of the rest of the world on the US. After the collapse of the Internet bubble in 2000, there was a debate in the expert community about dedollarization, even though the collapse of the bubble had no serious consequences for the global economy. However, experts and planners feared for good reason, and after 8 years it became obvious that they were right, as the cause of the global financial crisis came solely from the US, and other countries were not to blame. Besides, many people remembered the US abandonment of the gold standard and the turmoil this decision caused. In 2010, with the development of the cryptocurrency market and the enthusiasm that accompanied this process, the conversation about depolarization was revived with renewed vigor.

There are also two other important reasons for the dedollarization:
  • The use of the dollar as a tool to impose sanctions and pressure other countries has become a source of anxiety for some countries, which has been a motivation for the diversification of foreign exchange reserves, especially by Russia and countries of the global South;
  • The economic growth of countries such as China and India has made them important players in the global economy. These countries want to reduce their dependence on the dollar, preferring to use their currencies in international transactions;
  • Central banks' digital currencies. The introduction of digital central bank currencies, such as the electronic Chinese yuan, represents a new stage in the evolution of the global monetary system.

Has dedollarization been successful?
Despite the crises caused by the dollar's dominance and the fact that talk of dedollarization has been going on for several decades, the success of the policy has been very modest and there has been no dedollarization in terms of world foreign exchange reserves.

Here is the structure of world foreign exchange reserves. As you can see, in 2004 the dollar accounted for about 55%, while by the end of 2022 the dollar will account for 59.17% of the world's foreign exchange reserves.

Reason for the failure of dedollarization
Perhaps the main reason for the failure of this process is the attractiveness of the dollar in international trade. All the most basic and even secondary commodities are sold and bought with dollars. Oil, gas, etc. are exchanged for dollars. Even entire countries with large economies peg their currencies to the dollar, such as Saudi Arabia, Bahrain, the United Arab Emirates and others to a lesser extent. What's more, even trade between two foreign countries can take place in dollars. For example, trade between Italy and Saudi Arabia can be mainly in dollars, and this applies not only to the Middle East, but also to other parts of the world.

Another reason for the dollar's continued dominance is US power in other areas, such as diplomacy, technology, political-military power and, in part, cultural power. Simply put, the US uses leverage to maintain the status quo. For example, by threatening sanctions that would destabilize the country, which in turn could trigger social discontent and threaten the authorities.

Another reason is the lack of serious steps by China. Given the size of the Chinese economy and the interdependence of China and the global economy, much depends on the country's policies in the process. However, according to expert Zoe Liu Zunyuan, the reason for this behavior is that China is unwilling and unable to topple the dollar as the world's reserve currency. The yuan's share of global reserves is very modest at just a few percent. Moreover, more than a third of China's foreign exchange reserves are held in U.S. government bonds. It is important to say that these are approximate figures, as the exact numbers are classified.

BRICS countries' position
In general, BRICS policy toward the dollar can be characterized as moderately critical. While India and South Africa have not taken any action against the dollar, Brazil and Russia are promoting the idea of dedollarization and have been doing so for the second decade. Russia in

Brazilian President Lula da Silva said last year: "Why can't we trade in our own currencies?"
The BRICS countries signed currency agreements and swaps that allowed them to trade and invest using their national currencies, bypassing the dollar. This helped reduce dependence on the dollar in their foreign economic relations. Incidentally, for many years the leaders of the BRICS countries met and discussed the principles of the BRICS common currency.

One of the advantages of such a currency was thought to be protection against devaluation in the event of a rise in the price of the dollar. Unfortunately for the BRICS, most economists say that such a currency is essentially impossible due to the lack of independent central banks in all countries, as well as the lack of a single coordinated monetary policy. As a result, the BRICS single currency project is essentially buried due to the inability of BRICS countries to agree among themselves and build strong and independent financial institutions.

Another important development is the creation of the BRICS Bank, officially known as the New Development Bank (NDB), which was established by these countries to finance infrastructure projects and ensure financial stability. The bank also supports the use of national currencies in credit transactions.

Why won't the euro be able to take away the dollar's dominance in the coming years?
It's much simpler than the Brics. The euro is the second most popular reserve currency after the dollar. The euro accounts for 20 percent of the world's foreign exchange reserves. However, this number almost never changes. In one or two years the number may rise and then fall, and such a cycle continues for many years. Eventually, the euro's share of global foreign exchange reserves remains at 20 percent. The euro is not so popular because, in the eyes of many, the lack of a common treasury and a common stock market introduces great uncertainty. Of course, this will not change in the coming.

Although several currencies can compete with the dollar, in reality only the euro competes with the dollar in global foreign exchange reserves. Due to various problems, the BRICS common currency is an unfeasible project for at least the next few years. Historically, after World War II, the international trade system was based on the dollar due to the dominance of the U.S. economy at the end of World War II. Not much has changed since then, and the dedollarization of global trade has been hampered by several major factors, including the high cost of abolishing the dollar and the ability of the US to slow down the process through its technological, diplomatic and military-political superiority.