The Dollar’s Hegemony in Jeopardy

The Dollar’s Hegemony in Jeopardy

Ira Singh
16 July’23

In recent years, the once unassailable position of the US dollar as the world’s dominant reserve currency has been showing signs of vulnerability. A combination of factors, including economic shifts, geopolitical developments, and the rise of alternative currencies, has raised concerns about the future of dollar hegemony and its implications for global markets.

Changing dynamics

One of the primary drivers behind the erosion of the dollar’s hegemony is the shifting economic landscape. Calls to move away from relying on the U.S. dollar for trade are growing.The rise of emerging economies, such as China and India, has led to a gradual rebalancing of global economic power. As these countries continue to grow and assert themselves on the international stage, their currencies, particularly the Chinese yuan, have gained prominence. This diversification away from the dollar has weakened its grip on the global financial system.

China isn’t the only country calling for a shift away from the U.S. dollar.

More and more countries — from Brazil to Southeast Asian nations — are calling for trade to be carried out in other currencies besides the U.S. dollar, according to sources.

Brazilian President Lula made a state visit to Beijing in April where he reportedly called for reduced reliance on the U.S. dollar for global trade.

Trade between Brazil and China reached $150 billion in 2022, a 10% jump from a year ago, according to S&P Global Market Intelligence.

During a recent visit to China, Malaysia’s Prime Minister Anwar Ibrahim was said to have suggested setting up an “Asian Monetary Fund” to reduce reliance on the U.S. dollar. In an (April 6) interview with CNBC, Malaysia’s trade minister also acknowledged Malaysia’s concerns about Asia’s dependency on the U.S. dollar.

At the ASEAN finance ministers and central banks meeting in Indonesia in March, policymakers also discussed the idea of cutting their reliance on the U.S. dollar, the Japanese yen and the euro and “move to settlements in local currencies” instead.

In early April, Indian media widely reported that the Ministry of External Affairs (MEA) had announced that India and Malaysia were starting to settle their trade in the Indian rupee.

India and UAE agree to settle trade in rupees and dirhams

During Indian Prime Minister Narendra Modi’s one-day visit to the United Arab Emirates (UAE), one of the largest oil producers in the Middle East, the two nations’ central banks signed a memorandum of understanding to establish a framework to promote the use of local currencies such as the rupee and the dirham for cross-border transactions. They will also link their instant payment systems, India’s Unified Payments Interface (UPI) and the UAE’s Instant Payments Platform (IPP), according to recent media reports.

In a major boost to the position of the Indian rupee, New Delhi and Abu Dhabi on Saturday agreed to create mechanisms for settling trade in national currencies, as opposed to the use of US dollars.

The U.S. dollar has been king in global trade for decades — not just because the U.S. is the world’s largest economy, but also because oil, a key commodity needed by all economies big and small, is priced in the greenback. Most commodities are also priced and traded in U.S. dollars.

But since the Federal Reserve embarked on a journey of aggressive rate hikes to fight domestic inflation, many central banks around the world have raised interest rates to stem capital outflows and a sharp depreciation of their own currencies.

“By diversifying their holdings reserves into a more multi-currency sort of portfolio, perhaps they can reduce that pressure on their external sectors,” said Cedric Chehab from Fitch Solutions.

To be clear, the U.S. dollar remains dominant in global forex reserves even though its share in central banks’ foreign exchange reserves has dropped from more than 70% in 1999, IMF data shows.

The U.S. dollar accounted for 58.36% of global foreign exchange reserves in the fourth quarter last year, according to data from the IMF’s Currency Composition of Foreign Exchange Reserves (COFER). Comparatively, the euro is a distant second, accounting for about 20.5% of global forex reserves while the Chinese yuan accounted for just 2.7% in the same period.

Geopolitical developments have also played a significant role in challenging the dollar’s dominance. In recent years, there has been an increasing push by various countries to reduce their reliance on the US dollar as a means of conducting international trade. This has been driven, in part, by the extraterritorial reach of US sanctions and the desire to protect national interests from potential economic vulnerabilities. Russia, for instance, has been actively reducing its holdings of US dollars in its reserves, opting for alternative currencies and commodities.

Furthermore, the growing popularity of digital currencies, most notably cryptocurrencies like Bitcoin, has introduced a new dimension to the challenge faced by the US dollar. While cryptocurrencies are yet to fully mature as a viable alternative to traditional fiat currencies, their decentralized nature and borderless transactions have attracted significant attention. Central banks and governments worldwide are exploring the potential of central bank digital currencies (CBDCs) as a means to enhance financial sovereignty and reduce reliance on the US dollar.

The implications of a weakened dollar hegemony are far-reaching. The United States has long enjoyed certain benefits due to its currency’s global dominance. The ability to borrow at low interest rates, run persistent trade deficits, and exert influence over global financial systems have all been predicated on the dollar’s position as the world’s reserve currency. If this position is further eroded, it could lead to higher borrowing costs, reduced leverage in international negotiations, and a diminished ability to control economic outcomes.

However, it is essential to note that the decline of dollar hegemony does not necessarily mean an immediate collapse or replacement of the currency. The dollar still retains significant advantages, such as the depth and liquidity of its financial markets and the stability of the US economy. Moreover, finding a viable alternative to the dollar is a complex task, as it requires a currency with widespread acceptance, stability, and a strong underlying economy.

While the US dollar’s hegemony is showing signs of weakening, it remains premature to predict its imminent demise. Nevertheless, the shifts in global dynamics, coupled with the rise of alternative currencies and digital assets, indicate a growing desire among countries to diversify away from the dollar. The future of the international monetary system may witness a more balanced and multipolar landscape, challenging the long-standing dominance of the US dollar.