Two of the world’s most powerful countries are already moving forward strongly to change the steer of the international financial system by replacing the dollar dominance
The three-day summit between Chinese President Xi Jinping and Russian President Vladimir Putin was keenly watched and the most interesting outcome of their discussion is grabbing more attention. Vladimir Putin, explaining their talks, stated that both countries are in favor of using the Chinese yuan for settlements between Russia as well as other countries like Latin America, Asia, and Africa.
So, two of the world’s most powerful countries are already moving forward strongly to change the steer of the international financial system by replacing the dollar dominance. The dollar has remained one of the strongest currencies in the world for decades and the current move by China and Russia, supported by Iran and Saudi Arabia have the potential to shift the US dollar’s dominance in the global market. But will they triumph? Let’s first take a look at how the dollar became the monarch of currencies.
The King of Currencies
The US currency had been one of the strongest currencies in the world. Since its first printing in 1914, the dollar slowly climbed to become the world’s reserve currency. From the US becoming the world’s largest economy (even surpassing the UK) to becoming the owner of the majority of the world’s gold (owing to the WWs), the US dollar was capped as the world’s reserve currency and was backed by the world’s largest gold reserves because of the Bretton Woods Agreement. Instead of gold reserves, other countries focused on collecting reserves of US dollars. This in turn increased the demand for the US Treasury Securities, which the countries considered safe for storing money.
The demand for Treasury Securities increased along with the deficit spending that was required to fund the Great Society domestic programs and the Vietnam War. This made the United States increase the usage of paper money. Growing concern about the stability of the dollar has spread among other countries and the nations began converting their reserves into gold. The demand became so much so that then-president Richard Nixon had to intervene and de-link gold from the dollar which led to the floating exchange rates that exist today.
There have been periods of high unemployment and high inflation, but the dollar has remained the world’s reserve currency to this date. Today, nearly 60 percent of the world’s central bank’s foreign exchange reserves are invested in dollar-denominated assets. Nearly all commodity contracts, including oil, are priced and settled in dollars.
The United States and Dollar Domination
Since USD is one of the strongest currencies in the world, it gives America extraordinary economic as well as political power. The United States can withdraw sanctions on countries independently and if the US decides to spend freely, it can ensure that its debt will be bought up by the rest of the world. Since the transactions involve the use of dollars, the US can punish the countries like Russia and Iran by striking sanctions and restraining their access to global finance. The monetary policies of the United States can also affect other countries in the world because they influence the value of the dollar.
The Russia-Ukraine war and America’s open condemnation of Russia along with disparities with China give a perfect reason for both countries to team up and move away from the dollar. The Central Bank of both Russia and China keep fewer reserves of USD and the trade transactions between both countries take place in yuan. According to the reports, they are also encouraging other countries to do the same.
Saudi Arabia is actively engaging in talks with China to price some of its oil sales in yuan. The talks with Beijing over oil contracts to be priced in yuan have been going on and off for the past few years, but now it is seeing progress since Saudi Arabia is growing increasingly unhappy with the US. The lack of US support in the Yemen Civil War and the US administration’s effort to strike a deal with Iran over its nuclear program have created tensions between both countries.
China buys more than 25 percent of Saudi Arabia’s oil exports and the sales would increase the value of the yuan. KSA is also considering yuan-dominated future contracts known as the petroyuan in the pricing model of Aramco. However, Saudi Arabia could back off as a sudden change from dollar to yuan could shake up the Saudi economy. KSA still plans to do most of the oil transactions in dollars according to WSJ reports. The current decisions could influence other countries to trade in yuan as well.
However, these are not the only reasons for some countries to move away from the dollar. For smaller countries, the dollar-denominated debt exposure, and their plans to improve regional trade also prove one of the main reasons to be dependent on other currencies. The appreciation of the value of currency makes the dollar-designated debt much more expensive. For the countries that buy large quantities of food and other supplies, the import bill becomes even more expensive.
Southeast Asia’s major economies including India are planning to trade in a currency other than the dollar and are forming a mechanism where mobile apps can be used to trade between the nations in their local currencies without depending on the dollar.
The Bottom Line
In general, as of the reports of the IMF, the US economic dominance is seen shrinking. The US economy in 2000, accounted for 30 percent of the global GDP and now it has reduced to 25 percent. The center of economic power, in terms of trade and global output, is slowly shifting towards emerging market economies led by China.
Moving away from one single currency for trade transactions will have its advantages as well as disadvantages for other economies. Moving from a centralized currency would pave the way for more multilateral trade relations between the countries rather than the US becoming the center of the trade universe. On the other hand, carrying trade in one single currency makes the transactions more efficient without the risk of having currency volatility.
The current decision to dethrone the dollar and place another currency at the center will ultimately provide the same results and we can’t be sure the country whose currency is being used instead of the dollar would not weaponize the currency like the accusations against the US. Dethroning the dollar by Russia and China requires more talks and support from other countries and unseating the dollar for international trade transactions might not happen immediately. However, the interesting developments on the matter in the coming days will be worth taking note of.