Passing the "test" of de-dollarization, the dominant position of the USD is still difficult to overthrow

The dominance of the US dollar has been a feature of global trade for more than half a century. There are ample reasons to believe that the US dollar will remain the dominant currency in the international monetary system in the face of the de-dollarization trend.

Passing the 'test' of de-dollarization, the dominant position of the USD is still difficult to overthrow. (Source: BLS)

Recently, the issue of de-dollarization has become “hotter” as the US has continuously weaponized the USD for its political and economic goals. Along with the strong movement in geopolitical-economic competition, some countries have openly declared to turn their backs on the USD.

Meanwhile, more and more people, including many analysts, believe that China's yuan will challenge the USD's position as the top reserve currency - which has been solid for decades.

The 'global rift' divides the world into two orbits

However, in reality, even if the volume of world trade settled in renminbi is likely to increase in the coming years, this is unlikely to pose a serious threat to the US dollar's position as the center of the global financial system.

Warnings of the impending collapse of the US dollar are nothing new. Speculation has been rife since the 1990s that the US currency’s global reserve status would be threatened by the Japanese yen.

In the 2000s, when the common European currency - Euro was born, it was predicted that it would challenge the USD. Now it is only the turn of the Renminbi.

Because the arguments put forward to defend the superiority of the above currencies over the USD are partly related to economic weight.

There is currently a debate about when China will overtake the US as the world’s largest economy. It is not yet known when, but it is clear that the US and China will remain the two largest economies in the world for the foreseeable future. Accordingly, China will naturally be a partner in a large portion of cross-border transactions.

More importantly, the emergence of China as a strategic rival to the US is reshaping the global economic system, thereby causing many to question the hegemony of the US dollar.

The era of globalization that swept the world in the 1990s and 2000s is over. In its place has been a phenomenon that analysts at Capital Economics call “global fracturing.” This is the idea that the world is splitting into two blocs, two “orbits”: One largely pro-American, and the other largely pro-Chinese.

It is argued that as China pulls other economies into its orbit, it will push for more renminbi payments in trade within the bloc, thereby reducing the use of the US dollar.

This seems to have been demonstrated by recent high-level meetings involving Chinese President Xi Jinping and other heads of state.

In December 2022, at a summit between Chinese President Xi Jinping, Saudi Crown Prince Mohammed bin Salman, and leaders of the Gulf Cooperation Council (GCC), the parties announced a “new comprehensive energy cooperation model,” which includes promoting energy trade between China and the Gulf in renminbi.

And during a recent visit to Beijing, Brazilian President Lula da Silva called for an end to the dollar's dominance in world trade.

Prove by facts

However, while the global rift will fundamentally reshape the world's economic and financial landscape over the next decade, the consequences for the US dollar are likely to be much less dramatic than feared.

There are three reasons to support this statement.

First , while much of the debate focuses on the USD's status as the world's preeminent reserve currency, its financial and geopolitical influence stems largely from the greenback's dominance in cross-border transactions.

According to a triennial survey conducted by the Bank for International Settlements (BIS), 88% of foreign exchange market transactions in 2022 will be in US dollars – roughly the same as in the 1980s, when the BIS first conducted the survey. Meanwhile, only about 5% of transactions involve the Chinese yuan.

Moreover, while trade between countries linked to China is growing strongly, it still accounts for only 6% of global trade.

In contrast, more than 50% of global trade takes place within the “orbit” of the US, and more than 80% of global trade involves a country affiliated with the US. Of course, these trade relationships will continue to be transacted in USD.

Second, China's high domestic savings rate means it tends to run large current account surpluses, which would counteract the renminbi's status as a leading reserve currency rival to the US dollar.

China's capital controls also make it difficult to convince markets to see the yuan as having the same role as the dollar.

For the renminbi to become a major international currency, China would need to provide the rest of the world with a large pool of safe, liquid, and convertible renminbi assets that can be used as reserves for other central banks and as collateral in financial markets. In turn, that would require a major shift in Beijing’s policy approach, relinquishing much of its political control over the capital economy. That is something the renminbi currently lacks.

Finally , the US dollar has several advantages. For a currency to be widely used as an international medium of exchange, it must be available and easily convertible around the world. That depends on the international market being willing to hold it in large or small quantities. In other words, it must function as a store of value.

The US dollar is not the only currency that can perform this role. But any alternative would need to have these key attributes – it would need to be backed by strong and stable institutions and issued by a central bank that operates an open capital account.

And in fact, it is worth noting that despite a series of sanctions and asset freezes against Russia over the past year, about half of the country's exports are still paid for in dollars or euros.

In addition, any currency that shares similar characteristics to the US dollar would have to overcome the powerful “network effects” that underpin the greenback’s global dominance. In economics, a “network effect” refers to an entity that has acquired intangible value or special importance through its large number of users and thus becomes harder to eliminate.

All of these factors have the potential to defeat the emergence of the renminbi on a scale that threatens the USD's position.

Turn the clock forward 10 years and the global financial system is likely to be much more fragmented today – but one thing that has remained constant is that it is still US dollar-centric.

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