The De-Dollarization Movement: Real? Or Smoke and Mirrors?

Breakfast with Bwana

By Anil Madan

“Every night I ask myself why all countries have to base their trade on the dollar.” That was Brazil’s president Luiz Inácio Lula da Silva in a speech last month at the New Development Bank in Shanghai, known as the “BRICS Bank”.

Putting the hyperbole — or should be call it poetic license? — aside, Lula has been vocal, even impassioned, about ending the monopoly of the US dollar as the world’s reserve currency.

“Why can’t we do trade based on our own currencies?” he added, drawing loud applause from the audience of Brazilian and Chinese attendees. “Who was it that decided that the dollar was the currency after the disappearance of the gold standard?”

2023So, what is behind this move to replace, even abandon the use of the dollar as the medium of exchange and pricing in international financial transactions, as does it have any serious traction?

People who are accustomed to the dollar’s stranglehold on international transactions may be tempted to dismiss Lula’s ramblings, and indeed the expressions of the Chinese, Indians, Russians, Iranians, South Africans, and even the Saudis as crackpot ideas. Not so fast.

There has probably been a reserve currency in some form or other ever since nations traded with each other. In early times, gold or silver, even precious stones may have served the purpose. As European colonial powers dominated the world’s trade routes, it was no surprise that the currencies of Spain, France and England were used as the medium of exchange at various times.

For the British economy, the chickens finally came home to roost after the toll of World War I and World War II, as well as the costs of managing the Empire took their toll. It is well known that large stocks of gold were shifted to New York after World War I as it was deemed a safer place to keep one’s assets. The roaring bull market of the 1920s gave overseas investors a chance to ride the American wave. After World War II, America was the dominant world power and New York its financial capital. The Bretton Woods Agreement of 1944 cemented the role of the dollar as the world’s reserve currency as the reign of British Pound Sterling ended.

Ever since President Nixon ended the gold standard, the dollar has no longer been backed by a store house of gold, but by the full faith and credit of the United States. Not unsurprisingly, although the full faith and credit of the United States have long been considered unimpeachable, since the early 1970s, as US deficits and debts mounted, there has been a chorus of calls to replace the dollar with something more reliable and dependable.

But what could replace the dollar and we might ask why indeed is the dollar so dominant? A simple answer to the first question is that there really is nothing viable to replace the dollar. On the other hand, since the dollar is backed by nothing other than the ephemeral trust people put in the US government to honor its debts, why would it be so difficult to use another medium, say the Chinese Yuan? China’s economy is the second largest in the world and most of the world’s nations have China as their primary trading partner. Or why could we not use some form of cryptocurrency especially if all nations agreed to honor its value? But wait, isn’t the Euro really a form of cryptocurrency, something that was created out of thin air and suddenly people began trading in it because for them there was no alternative? 

Undoubtedly, the dollar’s reserve currency status owes much to the fact that oil and petroleum products are traded in dollars. Global oil demand runs to millions of barrels of oil per day and the resultant daily trade volume is in the billions of dollars. The demand for dollars to facilitate these transactions is immense. It is difficult to see what could replace the dollar.

Consider a practical problem. Suppose China and the other BRICS countries agreed to conduct their trade in a medium other than the US dollar. In 2022, China’s total trade with Russia was $190.3 billion, with exports to China of $76.1 billion and imports from China of $114.2 billion. China’s surplus was $38.1 billion. Brazil’s total trade was $171.5 billion with a trade deficit of $48.3 billion. India’s total trade was $135.9 billion, with exports of $118.5 billion and imports of $101.1 billion, or a trade surplus for India.

It is one thing to offset trade balances as long as trade generally balances out. But if China were to hold the $48.3 billion surplus that it has with Brazil, in what currency would it hold that sum? If China were to hold the Brazilian Real, what would it do with the money? There are two choices: buy Brazilian government bonds and collect interest in Real—or perhaps have a provision for payment of interest in some other currency, even the US dollar. Or purchase assets in Brazil. The same applies to trade with Russia. Would China want to hold Rubles? And on the other hand, would India want to hold Chinese Yuan?

Given that the dollar is a convenient medium of exchange, why the push for de-dollarization? One primary factor is that the US dominates the world’s financial system including the network of international interbank transfers. Another is that the US has unilaterally imposed sanctions on many countries including, most notably, Iran and Russia. Both nations have vast quantities of oil and energy products to sell. They have potential surpluses. They are content to hold Euros instead of dollars. But the US has enough clout to get the EU nations to cooperate, albeit reluctantly at times, with its sanctions regime.

The US Federal Reserve Bank estimated that for the decade 1999-2019, the US dollar was involved in 96% of trade transactions among nations in the Americas, 74% among nations in Asia, and almost 80% among nations in the rest of the world. The US dollar is estimated to be the determining medium of exchange in almost 90% of all foreign exchange transactions.

It is difficult to imagine either the Yuan or the Euro becoming the medium of international exchange. The EU countries’ economies are collectively a mess. The desire to hold Chinese Yuan will depend to a great extent on whether China is willing to play in the rules-based order and the confidence holders of Chinese credits will have that China will honour them. Certainly, China’s actions against the US, Canada, Australia, and Vietnam, provide some examples that the Xi regime can be quite as arbitrary as the US government at times seems to be.

Could a cryptocurrency replace the dollar as the medium of international exchange? Well, that would take a great leap of faith by all nations. The US could derail the process by refusing to accept such a cryptocurrency.

As the world’s economies seem to be faltering whereas the US economy is chugging along, it seems that for the short term, the dollar is likely to get stronger. And no other nation seems to have the clout to impose its currency as the trading medium.

This is not to say that the US dollar is forever entrenched. US budget deficits are soaring, and the national debt seems to be out of control. It is not unreasonable or inconceivable for the nations of the world to come together and find a mechanism for carrying credits and facilitating exchange of goods among themselves without using the dollar. Rising inflation that seems difficult to control and US bank failures add to concerns about the long-term value of the dollar.

On the other hand, as I have often said, it is not wise to bet against America. This nation has formidable financial clout and asset valuations to rival any in the world.

Cheerz…
Bwana

Mauritius Times ePaper Friday 11 August 2023