Are we asking the right questions about de-dollarisation?

Fiat currencies are not the only risk to the dollar’s dominance in the global economy

The dollar’s dominance in the global financial system is reflected in its use in currency denomination, international bank loans, debt securities, foreign exchange transactions and its role in official central bank reserves. A paper by Steven Kamin, senior fellow at the American Enterprise Institute, and Mark Sobel, OMFIF’s US chair, highlights that international dollar usage across various measures has hovered around 60% or higher and is relatively unchanged since the 1990s.

At an OMFIF discussion with geoeconomic experts, Kamin and Sobel pointed out that there is no fiat currency that poses a serious threat to the dollar’s dominance in the global economy for the foreseeable future. There may be factors that make the dollar less attractive as the key currency of the financial system, but it remains superior to both the euro and renminbi. They observed that the dollar retaining its top spot is by far the most likely scenario.

This view is consistent with the findings of OMFIF’s annual Global Public Investor study of central bank reserve managers. The 2023 report, based on a survey of 75 central banks, showed that respondents anticipate the dollar’s share of reserves will remain above 50% over the next decade.

The unparalleled size of the US economy, deep and open capital markets, sound economic policy-making, enforcement of the rule of law and full convertibility of the dollar are unmatched by other currencies. Correspondingly, the US’s status as issuer of the world’s most liquid, risk-free, safe asset (US treasuries) compounds the inertia of dollar dominance in the global balance sheet, as financial institutions look to match assets with existing liabilities. This provides a self-reinforcing ‘network effect’, said Elliot Hentov, head of macro policy research at State Street Global Advisors.

Is there no alternative?

While agreeing with most of the paper’s premises, others have taken a slightly different view. ‘Can the renminbi replace the dollar in the current financial system? No,’ explained Geoffrey Yu, senior market strategist at BNY Mellon. ‘But having said that, I think that is asking the wrong question.’ The dollar’s dominance in the current financial architecture ‘doesn’t mean China isn’t going to try to create a new form of a financial system’ over the next several years or decades. ‘There is no guarantee that assets we transact in today will be the same as tomorrow,’ noted Yu.

What would that system look like? It’s too early to say what kind of role China and the People’s Bank of China are looking to take in the global economy. But there are two ways that the US could potentially be left out of an alternative financial institutional arrangement.

In the more benign scenario, China will look to continue its regional and global economic influence, developing an alternative institutional arrangement parallel to the current financial and economic system, with the renminbi at the centre. If the institutional architecture were simply built without the US in mind, this could look like the post-war Bretton Woods system, created without consideration of the Soviet Union or Eastern bloc. In this case, the US would be more marginalised than outright excluded, and the dollar would most likely remain outside of the Chinese regional or geopolitical spere of influence.

In a more extreme case, an alternative system could be designed with an overt geoeconomic tilt that excludes the US. That scenario could seriously erode the dominance of the dollar, but it remains unlikely for now. The panellists agreed that the renminbi does not yet pose a real threat to dollar dominance, but the number of countries transacting and trade invoicing in the Chinese currency is growing.

Gerard DiPippo, senior geoeconomic analyst at Bloomberg, estimated that around 30% of China’s trade with the world is settled in renminbi, up from around 15% prior to western sanctions against Russia following the invasion of Ukraine. However, the few countries transacting primarily in renminbi at present are those that have no alternative, like Russia or Sri Lanka, explained Rachel Ziemba, senior fellow at the Center for a New American Security.

Geopolitics and digitalisation – a perfect storm?

The panellists noted that whether this group of countries transacting or trade invoicing in renminbi will grow largely depends on how the US imposes financial sanctions – unilaterally imposed sanctions pose more of a threat to the dollar than those imposed multilaterally.

This chimes with Sobel and Kamin’s assertion that the US poses the biggest threat to dollar dominance if US policy-makers run unsustainably poor macroeconomic policies, abuse financial sanctions and undermine the trust of political allies.

For DiPippo, the question of whether the dollar can be replaced as the world-leading currency is also misguided. Pointing out the potential for a ‘low threshold’ alternative to the dollar, he asked: ‘Is there an alternative that is good enough to have the robustness and rails to get around US sanctions?’

Advancements in fintech could potentially reduce the role of the dollar in global payments systems, and the digital renminbi is the most advanced central bank digital currency project, explained DiPippo. He said he will continue to track developments around the use of renminbi and is looking to see whether Project mBridge could offer a viable alternative to a dollar-based payments system once it goes live.

Project mBridge is the multi-CBDC platform developed by the Bank for International Settlements’ Innovation Hub Hong Kong, Hong Kong Monetary Authority, Bank of Thailand, People’s Bank of China and the Central Bank of the United Arab Emirates. It is the largest multi-CBDC project involving cross-border transactions.

Taken together, the two main threats to dollar dominance outside of the current financial framework appear to be the innovation of financial technology and geopolitical fragmentation.

As Kamin reflected, for now the global economy seems to need a dominant currency. But perhaps the real question is not whether the dollar will be usurped as king of the current global economic structure. Perhaps the question should be: what will the future structure of the global economy look like? If it looks quite different to today’s system, there is certainly scope for erosion of the dollar’s dominance.

Taylor Pearce is Senior Economist, Economic and Monetary Policy Institute at OMFIF.

Whether or not the introduction of CBDCs will impact central banks’ reserve management strategies will be explored in OMFIF’s forthcoming Global Public Investor 2024 report, along with other asset and currency allocation trends. 

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