Talk of de-dollarisation — and putting an end to the dollar’s hegemony — has been doing the rounds for decades, but recent economic and geopolitical developments have again highlighted the momentum building against the dollar’s dominance as the reserve and payment currency of the world. The dollar’s massive appreciation last year didn’t help its cause. The Dollar Index’s almost double-digit increase last year, amid already tough post-pandemic economic conditions, inflicted significant pain on emerging markets.

Dollar-denominated debt repayments soared and became unaffordable in some cases, while the rising costs of food and energy contributed to sharp rises in the cost of living and contributed to greater food insecurity.

Turkey, where the lira depreciated by a third against the dollar during the year, responded to the damaging impact of a strong dollar by introducing a new currency scheme to prop up the lira. The scheme incentivises companies to hold their offshore earnings in lira rather than the dollar, the preferred currency because of its safe-haven status.

More recently, the governments of Brazil and Argentina announced their intention to create a common currency, a prospect that was greeted with a great deal of scepticism internationally because their economies are in such vastly different states.

Also, experience has shown it takes decades to create a common currency and there are many challenges that stand in the way. The euro is the only common currency that has stood the test of time, but it has been an extremely challenging endeavour and the exercise hasn’t affected the dollar’s position as the primary reserve currency.

However, Brazil and Argentina’s statement of intent, against a backdrop of a global economy that is becoming increasingly divided, serves as a keen reminder of the momentum again building against the dollar’s hegemony — both as a reserve currency and the currency in which international trade and financial transactions are conducted. 

Yet, so far, Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley, told a Brookings Institution roundtable, there has only been “a very gradual, almost glacial decline” in the dollar’s role as a reserve currency and global means of exchange.

The greenback still comprises just short of 60% of total global central bank reserves and remains the primary means of cross-border payments. Two decades ago, its share was 70%, which translates into a reduction of 0.5% each year.

Reasons that the dollar could remain dominant for the foreseeable future are that the US is still the biggest fixed interest rate market, which means that flows into the dollar-based asset are unlikely to wane, and the US is a net debtor to the rest of the world. 

What about the yuan?

Meanwhile, its most likely successor, the yuan, has features that are not appealing to global investors — capital controls and an authoritarian government — and without global investor support, China alone is not likely to knock the dollar off its perch.

But there are several forces at play that increase the likelihood of the dollar losing its supremacy and, if history repeats itself, it could take as little as five years for an alternative reserve currency (the dollar in the mid-1920s) to overtake the previous incumbent (the British pound). The dollar’s ascendancy, admittedly, had been decades in the making, but when the tipping point was reached the seismic shift in the global financial system was swift.

Global geopolitical polarisation is likely to be the single biggest force behind de-dollarisation in the years and decades to come. US tensions with China are precipitating China’s efforts to internationalise the renminbi and create a digital yuan that it hopes to be the primary reserve currency in the future. It is conceivable that the growing divide between the developed countries, namely the US, the UK and Europe, and a China-Russia bloc that includes other friendly nations could see two reserve currencies materialise.

The great global currency divide may be already in the making in the form of the multiple BRICS (Brazil, Russia, India, China and South Africa grouping) de-dollarisation initiatives that have emerged in the wake of the 2008 financial crisis; intended to reduce currency risk and bypass US sanctions.

The US government’s decision to sanction Russia’s dollar reserves will have given de-dollarisation efforts even further impetus after highlighting how easily a country can lose control of its dollar reserves.

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A Cambridge University Press study, Can BRICS De-dollarize the Global Financial System?, pinpoints BRICS’ foremost achievements as building financial cooperation through measures such as establishing the New Development Bank (NDB) and the Contingent Reserve Arrangement.

It describes the NDB’s commitment to using local currency finance instead of the dollar as “merely the tip of the iceberg of BRICS’ de-dollarization initiatives” and describes the 2008 financial crisis as creating “an opportunity for rising powers to seek greater status and representation in global governance”.

It questions whether the accelerated de-dollarisation process in Russia and China over the past few years will only be a temporary change in response to current tensions, or whether it will result in a broader paradigm shift in global finance. The latter is more likely, given China’s aggressive global ambitions and Russia being unlikely to (ever) retain its pre-war position in the global financial order.

The Brookings Institute’s New Century Chair in International Economics, Eswar Prasad, says developing countries are beginning to have better-developed financial markets and are making technological advancements that could result in a world in which, for instance, all major commodity contracts will not need to be denominated and settled in dollars.

Also, Prasad notes that China is developing a cross-border interbank payment system that could, once other emerging market payment systems match up, enable China to trade with Russia or with India directly, without using the dollar. Thus, he believes the dollar’s role as a medium of exchange could “become much less pressing” and it’s feasible that the dollar’s role as a payment currency could decline over time.

While the glacial erosion of the greenback may suggest that it’s not going to happen any time soon, it could be sooner than you think. As Malcolm Gladwell said in his book The Tipping Point: “Look at the world around you. It may seem like an immovable, implacable place. It is not. With the slightest push — in just the right place — it can be tipped.” DM